28 Apr

The rise of the machines: the risks of robots in financial markets

rise of the machines

Introduction

The title of this article is borrowed, in part, from the third instalment of the Terminator movie franchise, released in 2003. The movie tells the story of a robot that returns to the year 2018 from a post-apocalyptic world with intent to destroy humanity’s ability to stand in the way of a future ruled by hostile machines by taking control of world’s computer systems. Far fetched? Perhaps, but there are some interesting similarities to that storyline with what researchers and market watchers are starting to observe looking at the gyrations taking place across the world’s financial markets over the past few years.

‘Flash’ Crashes

In May 2010, all the key US market indices experienced a massive collapse and then a swing to recovery, close to previous levels, in little more than half an hour. All this happened in the early hours of the morning before the trading floor was even open. The Dow Jones in particular experienced a loss of 1000 points in just a few minutes, equating to trillions of dollars in value. In 2013, a similar crash was experienced on the Singapore exchange that lost nearly US$7 billion in market capitalisation over 3 days. More recently in August 2015, another flash crash took place in the US with another 1000+ point drop precipitated by sell-offs in China and index drops in Europe prior to the opening on trade in the US. Major stock markets are not the only ones affected. At the start of 2016, Bloomberg reported on the flash crash of a 10% drop in the value of the South African Rand in the matter of minutes of one morning.

There is a lot of speculation as to the causes behind these changes from highly publicised examples of individual rogue traders all the way through to the panic-induced retail investor. As debates have evolved and research has discovered, there is an increasingly common denominator starting to emerge. A CNBC report from January 2016 recognises the US trading regulator CFTC’s (Commodity Futures Trading Commission) findings that “One of the key connections is the rapid placement and withdrawal of trading orders that lies at the core of high frequency trading (HTF)…this activity was at least significantly responsible for order imbalances in the derivatives market, which in turn affected the stock market.”

The Rise of the Machines

So where are the evil robots? The same CNBC report goes onto point out: “These crashes are caused by institutional trading from exchange traded funds (ETFs) and HFT. They are not caused by mums and dads trading because mums and dads simply do not act in such a coordinated fashion in such a short timeframe. Mums and dads also do not have the leverage to shift markets in this way within 30 minutes or an hour. That power lies in the hands of large-scale derivative traders.”

Large scale derivative trading is an increasingly automated process. Traders, ultimately human decision-makers, develop and instruct automated systems to make decisions on their behalf in times, places and frequencies that would not be humanly possible. Powerful institutions equipped with the capital, skills, information and infrastructure seek and extract return across global capital markets. As has been identified, the losers in this war are the retail investor and those institutions that are unable to compete with the sophistication and speed that these powerful robots have at their disposal.

It is not the robots that are evil, it’s the set of rules and algorithms that determine their behaviour to buy or sell that are the real problem. These rules do not apply discretion beyond what they are coded to do. Scarily, they are able learn by these rules and market movements to serve their masters for effectively and efficiently in future. Unsurprisingly, it’s the masters of the machines that stand accountable.

A relational view on robotic trading

The world’s financial markets are a clear example how relationships between nations, regions, industries and asset classes can impact each other through complex interconnections. Robotic trading is a mechanical attempt to identify these connections and derive an information advantage in a market to deliver financial return by trading assets based on rule-based assumptions. Essentially, this mechanical process looks to transform the observed dynamics of a relationship into a tradable transaction for gain for those who command it.

The unsettling reality is that investigators and researchers still do not know to what extent robotrading affects the world’s markets because of the pervasiveness of systems and the herding effect that they induce when it comes to other institutional investors trying to follow the lead of their more sophisticated peers. What is clear though, is that there are casualties in the process. Mums and dads do not have the speed and information to make decisions like robots do, but there still remain many millions of families across the world that invest their savings into markets to pay for school fees, retirement and rainy days. Attempting to make sense of market information so skewed by machines can be a fearful and potentially fruitless pursuit.

Colin Habberton is CEO of PayProp Capital in Stellenbosch in South Africa. Before that he was CEO of the GivenGain Foundation South Africa (GGFSA).

05 May

Do relationships matter in the election?

Polling_station_6_may_2010

CAMBRIDGE – In two days time, the people of the United Kingdom head to the polls to vote in the general election. The election has, understandably, dominated the media over the last few months. The newspapers and airwaves have been full of politicians and parties making promises about what they will do should they be elected on May 7th. Whether it is pay rises, taxes or economic stability, the promises that have been made, in the hope of securing votes, have been around issues of finance. Judging by the way it has dominated political discourse, it is the issue that politicians see as the most important issues for the British electorate.

These issues are all incredibly important, but missing has been any real discussion about the things that matter most: relationships. Indeed, material wealth is a poor indicator of true well-being. Surveys and studies repeatedly show that it is our relationships with those closest to us that we believe makes life worth living. Pledges focused entirely on financial matters reduce people to merely financial beings, when of course we are more than that.

In the interview below, Michael Schluter, the founder of the Relational Thinking Network, talks about the importance of relationships in life in general and specifically their importance in business. The interview took place in 2010 for ABC radio’s ‘Life Matters’ program. The book referred to is The Relational Manager, and can be purchased from us here.

Image: “Polling station 6 may 2010″ by secretlondon123 – originally posted to Flickr as Polling station

13 Feb

What to do about Greece’s Debt?

debt

The election of Greece’s left-wing government on a promise to reduce the country’s mountain of debt, has brought the issue of what to do with Greece’s debt firmly on the agenda.

The journalist Gillian Tett recently wrote about this in the Financial Times. She recollects a meeting where Economist Benjamin Friedman discussed whether Greece should have its debts forgiven. Some argue that as Germany received forgiveness for its debts, so Greece should be forgiven. Others argue that it’s immoral to forgive Greece its debts – “how can you forgive debt when a country has a retirement age of 50?”

Gillian Tett writes:

Either way, what became clear that night was that the question of how to handle Greece is a deeply emotional issue, not just a matter of economics — even (or especially) among central bankers. In one sense, that is no surprise.

As David Graeber noted in his seminal book Debt: The First 5,000 Years, credit is a social and political construct. And whenever societies have operated in the past with few constraints on how much credit they can create, this has invariably caused debt to spiral until it either triggered social implosions or the society has used rituals to forgive that debt. In the past, there have been many such safety valves, be it the debt jubilees used in biblical Israel or the practice of “wiping the slate clean” (that recorded debts) in ancient Mesopotamia.

The issue of Greek debt and whether it should be forgiven, is a strong reminder of the relational issues surrounding debt.

Earlier this week in The Daily Telegraph, there was a discussion about whether the current low interest rates should be an opportunity for people to pay off their mortgages, or to borrow more for a greater financial return. As well as ignoring the financial problems that taking on more debt causes, the article doesn’t take into account the relational implications of debt.

Firstly, the relationship between lenders and borrowers, at any level, is inherently unequal. There is a lack of parity between the parties. When unexpected events leave the borrower unable to service the loan, calamity often ensues.

Secondly, debt finance does little to reduce relational distance between corporate borrowers and corporate lenders. It is seldom associated with close involvement by the lender in the affairs of the borrowing company because the security provided for the loan acts as a convenient substitute for close monitoring.

Thirdly, increases in national debt in effect constitute a promise that future generations will meet the cost of the interest payments and eventually repay the debt.  What would be considered a grossly unfair transaction between contemporaries is waved through because future generations have no voice.

Finally, financial difficulty, and particularly debt, is a major cause of stress.  A Barclays survey showed that money was the most frequently cited reason for arguments between partners.  The psychological pressure resulting from personal debt is linked directly with child abuse and physical violence between adults in households.

Whatever decision is eventually taken on Greece’s debt, the impact of debt on relationships is clear.  As Graeber notes, when there have been few constraints on debt,  there has either been a social implosions or the society has used rituals to forgive debt. Debt is not a relationally neutral financial action. One hopes that with all the discussions surrounding Greece’s debt, society will wake up to the relational impact of debt and will be far more reluctant to borrow.