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Innovations in Trading and Technology

20 November 2012

Hitting HFT Right Where It Hurts (Everybody)

Attempts by European politicians to restrict high-frequency trading are likely to punish technological innovation, reduce liquidity and raise execution costs for the buy side -- without meeting aims to shore up market stability, says Fidessa's Christian Voigt.

The European Commission (EC) has strayed from the basic regulation of financial markets (who is allowed to buy what) and is starting to step into the how and why of buying. To be fair, it has been given the tough target of resolving the financial crisis and creating a single rulebook for the continent’s capital markets in a single raft of new regulations. Broken up into several overlapping pieces, including the revision of MiFID and MAD, the regulations alternately prioritize risk reduction and cost reduction, creating a natural tension between these two positions.

Given the complexity of this enormous task, it is perhaps not surprising that very different aspects of trading are becoming intertwined in the minds of the politicians that edit the EC’s text.

High-frequency trading (HFT) has been a key focus. Trading high volumes of assets based on small price movements to make intraday profits, HFT firms have been widely vilified. However, the reasons most typically given are in fact based on popular misconceptions.

[For a detailed look at the perceived unfair advantages afforded high-frequency traders, see Haim Bodek's series on Why HFTs Have an Advantage. Part 4 of the series examines the DAY ISO order type.]

While the debate on the impact of HFT on financial markets is far from concluded, regulators and politicians decided that it was about time they intervened and put the brakes on those IT-savvy traders.

Hence, in the recent vote of the European Parliament’s economic and monetary affairs committee on MiFID II and MiFIR, measures such as a minimum resting time are part of the their final proposal. The measure proposed by MEP Markus Ferber, ECON’s rapporteur on the issue, to make trading venues keep orders on their books for 500 milliseconds was intended to make ultra-fast transactions “less interesting” and to curb “excessive speculation.” Beyond that, further measures, such as order cancellation fees and continuous quoting obligations for market makers, are potentially also included in MiFID II and MiFIR.

These measures, encouraged by the flawed assumptions outlined above, would certainly hurt HFT as intended. This will have two key detrimental consequences. First, liquidity in the market would reduce, forcing up execution costs for the buy side. Second, a precedent would be set for politicians to interfere in the technology enabling existing business models. After all, intraday trading is not new. Market making is not new. These are the models that technology has effectively accelerated with HFT.

This sounds very much like an attempt to ban technology from financial markets. Technology drives innovation, and sometimes innovation creates new problems; but the answer should never be to ban technology. In this case, ill-directed regulation threatens to undermine the benefits HFT brings to the market. Let’s hope the effect is not to drive the HFT community to pursue its business objectives beyond the reaches of EU regulation, weakening the European markets.

Spotlight-white-trans For more stories in the Innovations in Trading and Technology Spotlight Series click here.

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3 Comments to "Hitting HFT Right Where It Hurts (Everybody)":
  • Comment_230146_210851315613283_100000652474653_678322_2285980_n
    crammond1964

    21 November 2012

    HFT assumptions of increased liquidity have been flawed and result appears to show that the markets can and will cope without them . We do not ban technology but use it to improve our mkts sadly HFT has done the complete reverse and after 7 yrs the jury has found them guilty on most counts ...

  • Missing
    fodbarnes

    22 November 2012

    Unfortunately the misunderstanding applies more generally in Europe. Because Europe does not have the equivalent of Reg NMS many of the order types, and/or interactions between order types, that appear to behind many of the problems that are associated with HFT in the US (see the articles by Haim Bodek) simply don't exist in Europe. Nor has the research needed to properly evaluate the impact of, say, the 500ms resting rule been done. (Eg what proportion of orders resting on a European exchange have rested for less than 500ms before they execute? If its small, then the impact of the rule is likely to be minimal, if its large then the opposite.) Evidence based policy making should deliver benefits, but the current approach in Europe is likely to deliver seriously unexpected results.  

  • Comment_230146_210851315613283_100000652474653_678322_2285980_n
    crammond1964

    22 November 2012

    fodbarnes ... safe to say that there was zero research  when HFT  entered the market floor !

    I may be a dinosaur but was very aware how our liquidity and volume would suffer with their input ; not saying told you so BUT find it very interesting how it panned out . Perhaps our markets are better without them and they are better off elsewhere  ; i have a few suggestions ! The queries we have of HFT have been on going since 2003  so we have a point .

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