The Markets Committee has released its analysis of the 7 October 2016 ‘flash event’ during which sterling depreciated by around 9% versus the dollar in early Asian trading, before quickly retracing much of the move. The report concludes that a range of factors – rather than a single driver – catalysed the event.
Drawing on detailed analysis conducted by the Bank of England as well as intelligence gathered by the Markets Committee, the report concludes that the time of day played a significant role in making the sterling foreign exchange market more vulnerable to imbalances in order flow. Significant demand to sell sterling to hedge options positions and the execution of stop-loss orders as the currency depreciated also had an impact. The presence of staff with less expertise in the suitability of particular algorithms for the market conditions appears to have amplified the movement.
“There are direct lessons from the 7 October flash event which have been taken on board by the Foreign Exchange Working Group developing the new code of conduct for currency markets, the FX Global Code. These include market participants’ obligation to consider the disruptive consequences of their trading activity, governance around algorithmic execution of trades, and how market participants might best determine the low (or high) point of pricing in a flash event,” said Guy Debelle, Chairman of the Markets Committee.
The sterling event represents an additional data point in what appears to be a series of flash events. These have occurred in a broader range of fast, electronic markets than was previously the case, including some markets whose size and liquidity historically have provided some protection against such events, the report says.
“Since such events have the potential to undermine confidence in financial markets and impact the real economy, it is important for policymakers to continue to develop a deeper understanding of modern market structure and its associated vulnerabilities,” Mr Debelle said.
Mark Carney, Governor of the Bank of England, said: “The report finds that there were no material losses incurred by systemic financial institutions, large volumes were transacted around the event window despite the illiquid time of day, and spillovers to other markets were very limited.”
“It is vital, however, that we learn the lessons of this flash event and similar episodes in other financial markets, as orderly market functioning underpins market confidence. It is also important that firms have adequate governance, systems and controls and give due consideration to the potential impact of their activity on market functioning,” Mr Carney said.