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(This article provides information about Nasdaq’s Pre-Trade Risk Checks, available to U.S. equities trading clients.)
For institutional trading and investing firms, risk management should be approached in both a top-down and bottom-up approach. At the macro level, firms must actively assess the broader environment and leverage technological innovation to modernize their approach to risk.
But ultimately, risk must also be identified and mitigated on a bottom-up, granular level, with specific measures and controls aimed at minimizing specific risks in specific activities. In other words, it’s critical to flag errant trades before they happen.
Nasdaq’s new risk checks offering allows users to apply “last-stop” checks when an order is sent to an exchange. When incorporated into a holistic risk management framework or even used on its own, risk checks can provide a valuable line of defense at the transaction level.
Our new capability gives users the ability to have risk checks at the pre- and at-trade levels. Specifically, as an order enters the exchange, this check could offer “fat finger” protection and screen for violations of firm policies pertaining to restricted stocks, hard-to-borrow securities, market impact thresholds and more.
Nasdaq rolled out risk checks for its PSX and BX equity exchanges on March 13 and launched on the Nasdaq Stock Market on March 27. The free service for exchange customers offers flexible controls and protection parameters at a single order and aggregate exposure levels via a RESTful API. In addition, customers can configure automatic actioning when exposure limits are breached and retrieve historical information in real time.
In collaboration with Nasdaq and four other U.S. exchange operators, Citadel Securities published a 2021 whitepaper assessing exchange best practices for reducing operational risk at broker-dealers. The electronic market maker noted the interconnectedness of the market ecosystem and the importance of approaching risk mitigation from that perspective.
“Greater attention has been paid in recent years to implementing controls that prevent trading system malfunction risk at the individual trading firms who own this risk,” the whitepaper stated. “But capital markets globally have focused less on safeguarding the interface between individual firms and exchanges in the event an error at an individual firm does still arise, which plays an important role in stopping damaging and disruptive events before they occur or limiting the effects of those events. Exchanges here have a vital role to play in helping their participants manage these risks.”
Reducing operational risk at broker-dealers benefits firms by averting potential trading losses, as well as the monetary and reputational costs of regulatory actions. At the market level, reducing operational risk helps maintain market integrity and stability.
Nasdaq’s risk checks appeal to trading firms to backstop trades, which is especially important amid highly volatile markets. They’re also conducive to sponsored access, where a non-member firm can trade through an exchange member. Risk checks would help limit the risk put on the exchange member for the underlying client’s trade activity.
Nasdaq developed risk checks as part of its broader push to modernize market infrastructure services and facilitate more system interoperability. “We are excited to bring this capability to market,” said Erin Sheehan, U.S. Equities Product Manager at Nasdaq. “It’s API-based, and customers get risk notifications and the ability to post and pull data more efficiently. There’s also interoperability with third-party solutions and with a firm’s own systems.”
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