FIA issues best-practice error trade recommendations

The Futures Industry Association (FIA) has released recommendations regarding the adoption of error trade procedures on derivatives exchanges, following a year-long special review committee investigation into the matter with principal international futures exchanges.

The committee reviewed existing error trade procedures and met with market participants – including the Chicago Board of Trade, New York Mercantile Exchange, the Euronext/Liffe and Eurex – to develop the best practices, designed to produce consistency in cancelling erroneous trades.

To reduce the number of erroneous trades being processed through an electronic trading system, the FIA recommended that exchanges implement price limits that would reject an order outside the limit prior to execution, or require a market participant to reconfirm it. The FIA also suggested that a ‘no-bust’ range be defined. Within this price range, trades may not be subject to cancellation, even if executed in error, ensuring that only erroneous trades that may significantly and adversely impact other market participants are subject to cancellation.

Other recommendations include defining a resolution timeframe for cancelling erroneous trades promptly, and a mechanism that ensures market participants are aware that an erroneous trade may be cancelled. To avoid uncertainty among market participants, exchanges should also adopt policies that identify the types of other transactions that will be cancelled if an erroneous trade is cancelled, such as contingency orders and stop orders executed as a result of the erroneous trade.

The FIA said the recommendations were made to enhance market integrity for participants that use electronic trading systems, since erroneous trades may adversely affect other market participants. In particular, large orders executed at prices substantially away from the prevailing market price could cause other participants, both in the market for the specific futures contract and in related derivatives and underlying cash markets, to take actions that are not economically justified and, ultimately, will result in substantial losses.

Last November, European derivatives exchange Eurex experienced a futures contract trading entry error. About 5,000 contracts, worth up to $600 million, were traded erroneously. As a result of incorrect market participant order entries, Eurex cancelled certain trades in futures and options on the DAX and Euro Stoxx 50 indexes.