Clampdown on banks after sterling flash crash bungles

Bank of England Governor Mark Carney today called on currency trading firms to raise their game in the wake of last year’s flash crash, which sent the pound tumbling almost 10% in a matter of seconds.

The Basel-based Bank for International Settlements — known as the central bankers’ bank — and the BoE launched an investigation after the events of October 7. Just after midnight, sterling tumbled from $1.26 to a 31-year low of $1.1491 in a matter of seconds before recovering most of the losses a minute later.

The BIS report found a cocktail of factors behind the crash, which happened at the quietest period in the $5 trillion-a-day global market before markets opened in Asia. But the BIS said the incident reinforced the need to “better understand modern market structure and its associated vulnerabilities”. It added: “In particular, there is still a relatively limited understanding of the implications of widespread automated trading.”

Carney (pictured) said: “It is vital that we learn the lessons of this flash event and similar episodes in other markets, as orderly market functioning underpins market confidence. It is also important firms have adequate governance, systems and controls and give due consideration to the potential impact of their activity on market functioning.”

Although the BIS failed to identify a fundamental trigger, it said the quiet period made the sterling foreign exchange market more vulnerable to imbalances in buy and sell orders — a scenario that resulted amid a glut of orders to sell sterling from traders looking to hedge themselves.

Once the pound started falling, stop-loss orders, which clients use to protect themselves from heavy losses, were automatically closed out, increasing the selling pressure. Liquidity dried up and market players said the crash was exaggerated by inexperienced staff during the quieter period. Reports have centred on the Japanese trading desk of Citigroup, which is said to have fired off repeated sell orders when the pound started to fall.

Guy Debelle, head of the BIS markets committee, said there were “direct lessons” from the crash which would be fed into a new forex Global Code of conduct, new voluntary guidelines due to be published in May, including the obligation of participants to “consider the disruptive consequences of their trading activity”.

Once currency trader said: “This comes down to a lack of liquidity. It’s pretty simple really: if you crack down on the investment banks, they cut down their trading activities and, lo and behold, the market disappears.”

The October event follows previous high-profile incidents such as the 1000-point fall in the Dow Jones Industrial Average in May 2010.