Japan’s $617 Billion of Bad Orders Raises Broker Concern

The unleashing of 67.78 trillion yen ($617 billion) of mistaken stock orders in Japan is reviving concern about the accountability of brokers overseeing trades in the world’s second-biggest equity market.

While the orders were canceled before being executed, averting losses for whoever placed them, they highlight the potential for catastrophe anytime someone gets details wrong with instructions to buy or sell securities. One of the biggest American market makers, Knight Capital Group Inc., almost went bankrupt in 2012 after its computers bombarded U.S. exchanges with erroneous orders that couldn’t be undone.

The Knight incident spurred a yearlong review by U.S. regulators into procedures used by brokerages to prevent computer and software errors from roiling markets. Though the sheer size of today’s orders in Japan may have kept them from being carried out, executives at trading firms said they were concerned about how they reached the market.

“It’s not rocket science that there was a fat finger here, but it reopens the question about accountability,” said Gavin Parry, managing director at Hong Kong-based brokerage Parry International Trading Ltd. Parry speculated the mistake reflected faulty data entry. “There is a probability a broker mistook the number of shares for the value of shares,” he said.

Sweden’s Economy

More than 40 requests to transact equities with a value greater than Sweden’s economy were voided at 9:25 a.m. in Tokyo before they could be matched, according to data compiled by Bloomberg from the Japan Securities Dealers Association. JSDA received an error report from a member and is still confirming what happened, according to an official who asked not to be named as he isn’t authorized to discuss individual cases.

The biggest order was for 1.96 billion shares of Toyota Motor Corp., or 57 percent of outstanding shares in the world’s biggest carmaker by value, for 12.68 trillion yen through an off-exchange transaction. Toyota declined to comment. Other stocks with cancellations included Honda Motor Co., Canon Inc., Sony Corp. and Nomura Holdings Inc.

Off-exchange or over-the-counter trades are made directly, without supervision from the bourse. Should there be an error, brokers are required to file a report within five minutes, an official at the association said. About 4.15 trillion yen was traded off-exchange in August, according to JSDA. That compares with about 41 trillion yen on the first section of the Tokyo Stock Exchange.

Trading Regulations

JSDA is a self-regulatory organization for brokerages and financial institutions. The group’s functions include creating rules for members and conducting inspections. The association compiles data from its members on transactions that take place off the exchange, according to its website. The Financial Services Agency, the market regulator, has oversight on all securities transactions including off-exchange trades.

Brokers governed by the JSDA “must confirm the contents of an order from a customer and the order itself are appropriate” based on the client’s assets and other factors, according to an English translation of rules posted on the organization’s website. They’re expected to set restrictions on things like order size and conduct regular inspections to ensure the proper function of order-management programs.

“OTC transactions happen directly between two parties, which makes it difficult to find out who was involved,” said Sumiyo Yamamoto, vice president at Jefferies Japan Ltd. At the same time, she said, the order was so large it was unlikely to have gone through unnoticed.

High Frequency

“With OTC trades, you can cancel anytime during market hours,” she said. “Also, the amount was huge, so someone would’ve noticed before the market closed.”

Orders to buy or sell stock are submitted and withdrawn all the time in electronic markets, where software strategies are used by arbitragers to profit from price discrepancies and by market makers to anticipate demand. The sheer size of today’s cancellations took traders by surprise.

“I’ve never heard of orders this big being canceled,” said Ayako Sera, a Tokyo-based market strategist at Sumitomo Mitsui Trust Bank Ltd., which oversees about $474 billion. “There must have been an error.”

While Japanese stocks fell today after the error, the decline wasn’t big in relation to other countries. The Nikkei 225 Stock Average slumped 0.6 percent, roughly the fifth-biggest drop among developed nations tracked by Bloomberg.

Knight’s Error

In the U.S., Knight Capital lost more than $450 million in August 2012 when its computers spewed bad orders on to U.S. markets. In that case, many orders were matched. The company was later bailed out and sold.

A year later, the U.S. Securities and Exchange Commission proposed a sweeping overhaul of rules governing how brokers handle trades, requiring firms to have written policies and procedures to ensure that systems supporting trading, clearing, order-routing and surveillance have sufficient capacity and remain available, even in times of stress.

Mistakes occur periodically on the world’s electronic trading venues. In 2009, UBS AG accidentally ordered 3 trillion yen of convertible bonds issued by Capcom Co. In 2005, Mizuho Financial Group Inc.’s securities unit was unable to cancel a mistyped order for J-Com Co., costing the bank 27 billion yen at the time.

While no losses were recorded today because the orders weren’t filled, there should be an explanation to alleviate concerns, Sera said.

(Corrects spelling of Parry’s name in fourth paragraph.)
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