From paper shares in safes, through digital records in central databases, to distributed blockchain ledgers – financial market technology is constantly evolving. Automation promises increasing efficiency and scalability, but at the same time it raises the question whether IT code can fully replace the institutions responsible for trust in the market.
The stock exchange floor, where brokers shouted over each other, was replaced by quiet server rooms handling thousands of orders per second. Automation of trading and post-trade processes has brought unprecedented efficiency. Infrastructure systems such as kdpwstream have the capacity to process hundreds of thousands of operations per day, with a precision unattainable by manual processes.
However, the admiration for technology should not obscure the fundamental truth about the financial market, as valid today as it was decades ago: technology is only a carrier of trust, not its source. In an environment where transactions are concluded in fractions of a second, the risk of error – technological or human – does not disappear. It only changes its scale and pace of materialization, taking the form of systemic risk.
The modern stock market is sometimes compared to a robot fighting arena. Algorithms compete with each other for information and time advantage. HFT (High Frequency Trading) strategies execute thousands of trades per second, reacting to signals invisible to the human eye. However, it is worth asking what would happen if there was an error in this precise mechanism that escaped standard control procedures.
The day the stock market crashed
Let's imagine a quiet afternoon on the Warsaw Stock Exchange. The session takes place with minor fluctuations in the main indices and average investor activity. The situation changes when one of the brokerage houses implements an update of the algorithm responsible for automatic liquidity provision. An error is made during implementation – the parameter responsible for the volume or price limit is set at a level many times higher than expected.
As a result, instead of executing small orders as part of a market making strategy, the algorithm begins to generate aggressive buy orders at prices significantly higher than current quotations, while formally staying within the granted operational limits. In a very short time, before the supervisory systems can react, the exposure of the brokerage house begins to exceed its equity. The exchange executes orders in accordance with the applicable offer matching rules.
The prices of several companies rise rapidly, triggering a chain reaction. Algorithms of other market participants identify the price impulse, interpret it as a demand signal and join the purchases. A phenomenon called flash rally is emerging on the market – instant, artificial price euphoria. In a short time, the value of turnover in trading systems reaches billions of zlotys. On the screens it looks like the boom of the century, but in reality the increases are the result of an operational error.
If there were no central clearing and risk management mechanisms, the effects of such an event could be difficult to control and spread to other market participants. The brokerage house causing the confusion would become insolvent, and its contractors could also feel the potential consequences. It is in moments like these that the importance of capital market infrastructure, designed with extreme situations in mind, becomes apparent.
Black swan fuse
In real conditions, in the described scenario, the infrastructure of the KDPW Group, in particular the KDPW_CCP clearing house, would play a key role. Risk management systems monitor the level of exposure and use of security deposits in real time, signaling when established thresholds are exceeded. Standard deviations are handled automatically, but in extreme situations operational decisions are made by risk management teams.
Exceeding certain thresholds by our hypothetical brokerage house would result in immediate intraday margin calls and intensified operational supervision. Failure to cover the exposure would result in blocking the brokerage house from concluding further transactions until the threat is eliminated. If a market participant was unable to meet its obligations, the clearing house would launch formal “default management” procedures intended in the event of default, without transferring the risk to other market participants.
Due to the fact that KDPW_CCP acts as a central counterparty, becoming a party to each cleared transaction, the counterparty risk is not transferred to the entire market and is secured in one system node. Settlement of transactions concluded by participants takes place using a multi-level security system, including guarantee funds.
The fictional scenario about a brokerage house that destabilized the market due to an algorithm error shows a certain truth about automation. Technological progress accelerates processes, but also the materialization of the effects of mistakes made and multiplies their “field of destruction”. Without institutional “fuses”, even a local event could undermine confidence in the entire capital market.
Trust remains a human domain
Although a significant part of market processes today is automatic, defining risk and making decisions in non-standard situations remains the responsibility of people. It is the experts who determine security parameters, deposit levels and procedures in the event of events that the algorithms – based on historical data – cannot predict.
Automation works great in a repetitive environment, but it loses effectiveness when “black swans” appear on the market. In this sense, KDPW plays the role of an institutional arbitrator, ensuring the consistency of ownership provisions through the so-called “golden record” – the only legally binding picture of the state of ownership on the Polish capital market. Machines can process records, but only an institution of public trust supported by regulations gives them binding force.
IT code can speed up the transaction, optimize costs and reduce operational errors. However, he is unable to take responsibility. And it is responsibility, not lines of code, that remains the ultimate guarantor of trust in the capital market. For this reason, blockchain and artificial intelligence do not eliminate the need for institutions such as the KDPW Group.
Material written in cooperation with KDPW
