The algorithms of automatic trading have rules embedded in their code such that quotes are immediately pulled if there is a severe market liquidity event. Moreover, the algorithms often have automatic rules that activate circuit breakers or socalled “kill switches” should the aggregate notional risk on a firm’s book exceed programmed limits. On 15 January, the algorithms acted quickly to pull the so-called “streaming prices” when liquidity in the reference market for these prices dried up. Where this did not happen simultaneously, it resulted in large open positions being accumulated by the banks, quite literally within seconds, as an overwhelming balance of client sell orders were automatically executed. Once pre-determined risk accumulation limits had been breached the algorithms instantaneously shut down. Whilst each algorithm, operating independently, may well have been quite prudently calibrated to protect the bank from building an exposure that exceeded its risk appetite, collectively, the impact on market liquidity was akin, albeit temporarily, to a cascading failure across a power grid. As a consequence, the foreign exchange market reverted to human voice orders as the substitute for automated trading. There were therefore outcomes that appear not to have been expected. So, at the risk of quoting Shakespeare inappropriately, all was well that ended (reasonably) well, but the risk that this would not be the outcome is too great to ignore. In summary, there is good evidence that financial market conditions have evolved in ways that reduce the likelihood of continuous market liquidity in all states.

Heng Swee Keat: Dealing with the implications of the crisis and implementing policy reforms Keynote address by Mr Heng Swee Keat, Managing Director of the Monetary Authority of Singapore, at the Opening of EDHEC-Risk Institute, Asia, Singapore, 21 January 2011. *  *  *  His Excellency Olivier Caron Ambassador of France to Singapore Mr Richard Simonin Chairman, EDHEC International Advisory Board Mr Olivier Oger Dean, EDHEC Business School Professor Noel Amenc Director, EDHEC-Risk Institute Associate Professor Frederic Ducoulombier Director, EDHEC-Risk Institute, Asia Ladies and gentlemen Introduction 1. Good morning. I am very pleased to join you today at the grand opening of EDHECRisk Institute’s Asian centre in Singapore. Key observations from the crisis 2. The financial crisis has fundamentally changed the way we perceive and manage risks and uncertainty. Assumptions and models that had been taken for granted are being challenged, and new developments are changing the risk landscape. Let me share three observations about risks. 3. First, the growing complexity and interconnectedness within the financial system, and between the financial and economic systems have multiplied risks significantly. There are now many more potential sources of failures and the transmission of shocks from one market to another have become faster and more unpredictable. 4. Prior to the crisis, financial and capital intermediation had increasingly shifted to relatively unregulated non-bank financial institutions. Complex securitisation structures and off-balance vehicles that were thought to disperse risks led instead to concentration of risks and excessive leverage.