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Login glitch behind Tokyo Stock Exchange snafu

High-frequency trader connecting via Merrill Lynch apparently unleashed data flood

Tokyo Stock Exchange operator Japan Exchange Group scrambled to deal with a technical malfunction Tuesday morning. (Photo by Toshiki Sasazu)

TOKYO -- The technical failure that interfered with trading on the Tokyo Stock Exchange on Tuesday stemmed from an error in a high-frequency trader's systems and exposed the relative fragility of Japan's stock market infrastructure.

The problem was first spotted by the exchange's systems department around 7:30 Tuesday morning. A large volume of messages -- data swapped between systems when logging in or placing orders, for example -- flooded onto one of the four connections linking brokerages' ordering systems with the bourse's trading servers, sparking fears of cyberterrorism.

Messages are routinely sent each morning between brokerages and customers, and between brokerages and the exchange, as the trading day begins. But this particular morning saw messages pour in at more than 1,000 times the usual rate.

Ryusuke Yokoyama, spokesman for the Japan Exchange Group, cited "a certain brokerage" as the cause, which sources said was Merrill Lynch Japan Securities. Though the company has refused to comment, remarks from sources familiar with the situation suggest the problem originated with an overseas customer of Merrill Lynch Japan who conducts high-frequency trading.

High-frequency traders use computers to perform statistical analysis of past stock movements and place orders in fractions of a second. This particular trader apparently tried to log in on Tuesday morning but failed to access the Tokyo bourse's systems, possibly due to a programming bug, prompting it to send a stream of login requests.

This reached the TSE because the trader used direct market access, interacting with the bourse's systems without using the brokerage as a middleman.

Securities companies and the TSE itself have strong safeguards against problematic order data due to past glitches involving trades. But these were not built to handle issues with other kinds of data, letting the login messages slip through the cracks.

The influx of data took one of the four connections between brokerages and the TSE's servers out of commission. The exchange requires brokerages to have links with at least two communication lines. It started sending requests before 8 a.m. to securities companies to switch to other lines.

Some were able to do so with relative ease. But after trading began at 9 a.m., complaints from retail investors unable to log in or send orders began spreading online.

Internet-based and foreign brokerages were generally able to transfer to other connections. But big Japanese securities houses such as Nomura Securities, SMBC Nikko, Mizuho Securities and Mitsubishi UFJ Morgan Stanley Securities ran into more problems.

Scale may be a factor. Major players use a mix of connections to the TSE servers depending on such factors as whether an order is placed online or at a physical office. Customer orders were already arriving when the exchange sent its request to switch channels around 8 a.m.

"We can't switch from channels on which orders are coming in," said a system engineer at a major securities company.

Some suggest that the problem lies not with brokerages' systems, but with how they were operated. "Big players have vendors handle all their system design," so they probably do not normally handle connection switching themselves, said the president of an online brokerage.

Trading resumed normally on Wednesday, but the glitch may have caused some traders to suffer losses because they could not place orders when they wanted to. Brokerages will need to provide compensation if they admit that they were at fault.

SMBC Nikko, which quickly got a full picture of the damage, says it will need to correct or otherwise deal with 25,000 affected trades. But many major brokerages assert that they are not at fault. This situation could develop into a legal battle with securities houses on one side and Merrill Lynch Japan or the TSE itself on the other.

The Nikkei Stock Average fell 314 points on Tuesday amid a slump in China's stock market. The top seller of futures of the benchmark Topix index that day was Merrill Lynch Japan, which sold 4,681 more units than it purchased. When after-hours trading is added in as well, this equates to net selling to the tune of more than 100 billion yen ($887 million).

The Financial Services Agency has ordered the TSE to submit a report on the system failure, including the root of the problem as well as the issues with switching to the backup lines, it was learned.

As artificial intelligence and algorithms evolve, the TSE is likely to run into more unforeseen actions by investors, presenting new challenges for the operator of Japan's market infrastructure.

A previous version of this article mistakenly stated that a high-frequency trader's attempt to access Merrill Lynch Japan's system was the cause of the technical problem. The trader tried to access the Tokyo Stock Exchange's system. 

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