Beware the ‘Splash Crash’

Introducing ‘the splash crash’.

Like the flash crash but worse because it involves the “flash” spreading cross-asset class to everything from forex to commodities.

The idea springs from John Bates, the chief technology officer of Progress Software, as cited by Jim Mctague in Barron’s this week, and the worry is that investors currently do not appreciate the level of cross-asset algo-influence in the market.

As Mctague writes:

I’ve recently heard from a computer-trading expert warning of the very real possibility of a more widespread and catastrophic “splash crash,” a dislocation by high-speed trading computers that could simultaneously splash across many more asset classes and markets. Imagine our metaphorical jet buried in the earth up to its tail.

The possibility of a splash-crash nightmare springs from John Bates, the affable chief technology officer of Progress Software a $1.89 billion company whose worldwide headquarters is in Bedford, Mass. Bates has an impressive résumé, including a doctorate in computer science from Cambridge University. He’s also a member of a panel of technology experts that advises the Commodities Futures Trading Commission.

“I think there is an extreme risk of seeing this because we’re not serious about putting measures in place to police against it,” says Bates, who freely acknowledges that his company has computer programs that it would like to sell to securities and commodities regulators to address this very issue.

With cross-asset spillage also comes cross-asset influence — the idea that equity markets in the United States could be influenced by something as remote as commodities trading abroad.

There is thus a risk, he says, that the whole market could be open — because of its structure — to abuse by a malicious party, if they have enough cash to burn. The exploitation of the system thus becoming a tool for terrorism in the worst case scenario:

“You almost need something like a Norad [the joint U.S.-Canadian North American Aerospace Defense Command]… for the markets,” Bates says. Because some 15% of the U.S. economy is based on financial services and the markets, they should be protected on the basis of national security, he asserts.

While it’s not mentioned in the article, it’s worth bearing in mind that if there’s one thing in particular linking asset classes together in a fast-paced trading manner, it’s the equitisation of all asset classes (from bonds to commodities) by means of exchange-traded wrappers.

Though ETF provider and index funds argue they have no influence on the underlying.

Related links:
Next Danger: “Splash Crash”
– Barron’s
High Frequency Trading and ETFs
– FTfm
How ETFs fueled high frequency trading
– FT Alphaville
HFT in commodity ETFs - FT Alphaville

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