Thanks to technological hiccup after technological hiccup, High Frequency Trading (HFT) remains a permanent fixture in the financial press. With each blip, regulators and politicians promise to regulate HFT, but how they are going to put effective controls in place is still an open question.
Despite the noise, the issues with HFT remain the same. The industry can’t come to consensus on what HFT is, when it is safe to use and how it can best be kept under control. In offering a not-so-friendly reminder of the market dangers of HFT, the NASDAQ faced a glitch that forced exchanges to cancel trades after skyrocketing share prices were detected. This came only a few weeks after a fiasco – or “technology issue” – on a system run by Knight Capital caused an algo order to drive wild fluctuations in stock prices, resulting in an estimated $440 million loss and a rapidly sinking share price.
In the US, the CFTC Technology Advisory Committee on HFT was created in February 2012 “to ensure that markets evolve” and shed some light on the “how” and “what” of HFT. Their definition, whilst general, offers at least a start point, finding that HFT is a type of automated trading using algorithms, low-latency technology, high speed connections and high message rates.
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The definition omits other activities that might fall under the HFT banner, though it aims to be consistent with other Technology Advisory Committee work. With the definition still in a discussion phase, the industry will continue to be unsure for some time.
Europe has come closer to legislative control of HFT through MiFID II, and through the response of some more eager member states. MiFID II has attempted to define HFT through characteristics unseen in other regulations, including using colocation, circuit breakers, minimum daily portfolio turnovers, order-to-trade ratios and rebates for liquidity provision. Furthermore, MiFID II, rather controversially, is contemplating banning direct market access, in addition to controls to ensure that trading venues keep trades entered on their systems for at least 500 milliseconds.
Sure to add fuel to policy discussions is the new paper released by the UK Foresight Commission on crashes and their relation to HFT. Counter to the argument offered by many that an increase in liquidity equals a safer market, the paper suggests that more liquidity may be associated with more “volatility and crashes”, meaning regulators may have to rethink their approaches to HFT regulation.
Meanwhile, the Germans have shown a lack of patience with the pace of HFT regulation in the EU and offered their own regulatory opinions and ideas, expected to be submitted to parliament for passage by the second half of 2012. BaFin, with the blessing of the German ruling coalition, has reserved the right to monitor finance experts and HFT and has outlawed constantly testing market levels to influence prices. Fines will also be levied for even tiny price changes and disproportionate use of trading systems. All of this HFT attention across the continent means that Europe may see an accelerated legislative timeline, especially if more technological errors occur.
Other countries outside the US and Europe, motivated to avoid repeated examples of HFT malfunctions in their jurisdictions, have made moves to HFT regulatory control. Most notably, Australia’s Securities & Investment Commission released a proposed law to regulate algo trading, requiring annually tested system controls that would include pre-trade filters, limits and prohibitions, to avoid experiencing unnamed “recent events overseas”.
Furthermore, large fines, in the hefty ballpark of $1.1 million, have also been stipulated for a lack of order signal tracking. In a similar move, Hong Kong’s Securities Futures Commission has suggested that algos be tested yearly along with having proper controls to prevent wild trade fluctuations. India has also jumped on board, with its Securities and Exchange Board to monitor algo trading with a stronger focus on HFT, and has even received national pleas to shut down HFT altogether.
The bottom line is that the political imperative to do something about HFT will force changes in the way that automated trading works. However, as other efforts to control HFT have seen in the past, the market adapts very quickly to whatever rules are put in place. Are we now going to get this right? It would appear it is a bit early to answer. Whatever is done, it needs to be joined up globally.
- Differences within Europe on HFT regulation mean that the EU will soon be forced to take a position
- Do regulators have the technical expertise and the resources to regulate automated trading efficiently and effectively?
- To what extent will the current patchwork of HFT rules be aligned globally, despite being in early stages?