ETFs clearly bring many businessas-usual benefits which market participants value – for example, the convenience of being able to transfer risk at high-frequency via standardised, exchange-traded securities in fast markets. There is a question, however, of how these interlinkages work in stress. During the turbulence of August 2015, for example, equity investors flocked to trade in exchange-traded funds, causing ETFs to appear to be priced at large discounts to the value of their – sometimes less liquid – underlying security (Chart 11). On this occasion, once again, the dislocation was short-lived. But if a future stress in fast markets – such as those for ETFs – were to persist for a longer period, it might spill over to cause stress in other linked markets, including for less liquid underlying instruments, including government or corporate bonds as well as equities, leading to wider implications for financial stability. 17 18  This also caused the firm to default at the CCP, creating a loss that was mutualised among the rest of the CCP’s members. See Greenwich Associates (2016), ‘Long-term investors embrace FX algos’. 7  All speeches are available online at www.bankofengland.co.uk/speeches  7  There is therefore a need to ensure that market participants’ risk management frameworks keep pace with the speed at which these markets are capable of moving, taking into account the speed of possible shocks and the potential for propagation, including to slower markets.
The changing distribution of risks for individual firms  Moving on to my second example, even in the absence of systemic spill-overs from flash episodes, fast markets alter the pattern of risks that individual market participants are exposed to. And there good grounds for concluding that more needs to be done to ensure market participants take account of this consistently. 14  See BIS (2017), ‘The sterling ‘flash event’ of 7 October 2016’, January. See Joint Staff Report (2015), ‘The US Treasury Market on October 15, 2014’. 16 In this spirit, the FPC concluded following the sterling flash event that “such disruptions underscore the concern that liquidity in some markets may have become more fragile in recent years”. See Record of the Financial Policy Committee Meetings held on 23 and 29 November 2016. 15  6  All speeches are available online at www.bankofengland.co.uk/speeches  6  Use of algorithms does not change the fundamental risks associated with trading in financial markets (e.g. market, counterparty and operational risks). But use of high-frequency trading algorithms does change their relative intensity and can materially increase the potential to build up significant intraday positions. This latter point is most obviously true for those bank and non-bank intermediaries that specialise in highfrequency trading. And though these firms should be expert in managing such risks, history shows this is not a given.