Since the emergence of “Modern Portfolio Theory” and the “Capital Asset Pricing Model” in the late 1960s, institutional investors have taken a quantitatively driven approach to portfolio construction, looking to create portfolio diversification and obtain better risk-adjusted returns by balancing their asset-class exposures. This journey has seen several important advancements in thinking about how to optimally achieve desired results.
Funds that want to take the total portfolio approach first need to get the total portfolio view. To do that they not only need data – and lots of it – but a rock-solid understanding of exactly how they’re going to use it.
Regulator finds insto trading lessons from ASX outage
The Australian financial regulator has urged institutional investors trading on the ASX to better prepare for future market blackouts in the wake of a meltdown on the exchange last November.
In a new report charting a series of ASX operational incidents during the week starting November 16 last year, ASIC (chaired by Joe Longo, pictured) found some large institutional investors had poor oversight of trading dependency risks and inadequate back-up plans to cover outages.
The ASIC review says the ASX halt saw several large investors scrambling to rout trades to the alternative Chi-X platform “but almost all their brokers were unable to facilitate this”.
Some institutional investors also did not fully understand their broking partners’ reliance on the ASX, the report says, nor the bourse’s shutdown procedures.
“Not all firms we met with were aware of ASX’s incident management arrangement for handling market outages, including communication channels, notification periods prior to the market re-opening and how closing prices would be determined if the closing auction was disrupted,” the ASIC review says. “This contributed to their uncertainty and reluctance to continue trading.”
Furthermore, the ASX glitch – sheeted to a software upgrade – caught out some institutional index investors.
“A few firms that use indices from major index providers were not aware of their index calculation frameworks and methodologies for closing prices during an outage of the main trading venue,” the ASIC report says. “These procedures generally set the closing price as the last traded price on the main trading venue where available, even if there were more recent trades on other trading venues.”
Undoubtedly, the ASX shutdown on November 16 (and series of other operational failures during the week) imposed significant costs on brokers and investors.
Only A$567 million of Australian equities changed hands on the outage day – including just A$14 million after the ASX closed soon after the official open – compared to the average daily volume of A$10 billion in the previous week, the ASIC report says.
But it could’ve been worse.
“Several institutional investors noted that not being able to trade the underlying instruments held by their funds would have caused significant issues if the outage had occurred on a day that required significant trading activities, such as an index rebalancing day or a day with large inflows or outflows from investors,” the review says.
ASIC says the ASX incident should prompt large institutional investors to review:
- trading arrangements with executing brokers for market outages, including the types of trading that remain available, any dependencies on particular markets and alternative arrangements where trading is critical;
- market operators’ incident management protocols for market outages; and,
- index providers’ procedures for market outages.
The Australian market regulator imposed new conditions on three ASX licences last week covering the group’s main trading platform as well as its settlement and clearing systems.
In particular, the licensing changes are aimed at “mitigating risks for future upgrades” – notably the scheduled transition from the CHESS trading system to a new blockchain-based version in 2023.
Joe Longo, ASIC chair, said in a release: “The ASX outage was a very serious event, exacerbated by subsequent operational issues. The imposition of these licence conditions will confirm that remedial actions are implemented appropriately and efficiently to address these operational issues – including for the critical rollout of the CHESS Replacement Program.”
Last August the NZX suffered multiple outages after hackers disrupted its system with ‘distributed denial of service’ attacks.
A Financial Markets Authority report on the incident published this January concludes that the NZX “failed to meet its licensed market operator obligations due to insufficient technology resources”.
