Serving the real economy
High-frequency trading (HFT) offers little value to the real European economy
and practitioners should carry the burden of regulation, according to Benoit
Lallemand, senior research analyst at Finance Watch, a Brussels-based public
interest group focused on making finance benefit society.
In April, Finance Watch published a paper, ‘Investing
not betting’, which examined Europe’s financial markets in light of the proposed
MiFID II rule changes. While supportive of MiFID rapporteur Markus Ferber MEP’s
proposals to the European Parliament, Lallemand is concerned that HFT is harmful
to long-term investors – and that many of the arguments adduced in its favour
do not stand up to scrutiny.
"HFT firms claim that they reduce
costs for everyone by narrowing spreads,” he says. “But spreads are only one aspect and the
evidence shows that trading costs by value have risen.
They make their money by getting in front of other, slower traders. Pension
funds don’t benefit from a tiny reduction in the size of their spreads – they
benefit from movements in the real economy."
in the air?
Exchanges and trading platforms around the
world have sought to attract high-frequency flows in recent years as a way to
drive up trading volumes. But Lallemand believes that HFT firms do not
contribute genuine liquidity. Instead of adding value, high-frequency market
makers may have actually damaged existing liquidity, he says, because the
limited depth and millisecond duration of their quotes denies proper investors
the chance to trade large blocks of stock when needed.
To Lallemand, HFT represents a
disconnection between the financial markets and the real economy. He contrasts
the activity of “speculators” that trade purely based on short-term prices,
against long-term investors who follow trends that are connected with real
production that has tangible benefits for society.
French broker CA Cheuvreux is one of a
number of market participants that have already highlighted the high proportion
of cancelled orders typically generated by HFT firms as a problem for market
transparency, since these create ‘noise’ that makes it difficult for market
participants to discern real liquidity. But HFT may also be increasing the
potential for market abuse, warns Lallemand, as it is extremely hard to monitor
HFT firms executing trades across multiple trading venues. That creates the
potential for one firm to manipulate prices by buying large quantities on one
venue and selling against that activity on another.
"We are not against HFT,” he says. “But
do you want to pay for the surveillance to ensure these HFTs are not using
abusive strategies? Is the heavy cost that would impose worthwhile to
society? We should remember the core function of the financial
markets, which is to facilitate investment in the real economy."
European regulators and some exchanges have
already introduced measures aimed at clamping down on HFT. France’s proposed financial
transaction tax contains provisions to charge firms that cancel above a certain
proportion of their orders, while Italy’s Borsa Italiana has already introduced
higher charges for firms that exceed a defined ratio of cancels to actual
transacted orders. Yet more needs to be done, according to Lallemand.
"There is an
imbalance in the HFT debate,” he says. “The HFT firms claim they are under
pressure, but the regulatory moves on HFT are either a long way from
being finalised – MiFID II is due in 2014 at best – or they make little
real difference; for example the Italian exchange charging for
message traffic doesn’t stop HFT, it just puts a cap on the extreme end of
The Finance Watch paper suggests several
solutions to European regulators, including a call for the widespread adoption
of traditional market-maker style agreements as a means to ensure quality
liquidity by encouraging greater responsibility and reliable participation in financial
markets. Market making agreements generally contain provisions such as the
agreement to remain in the market and provide consistent liquidity over longer
periods of time. MiFID proposes such obligations and electronic market makers
such as Getco have indicated they are willing to accept them.
Ensuring that quotes rest for an “adequate”
period of time in Europe’s order books should also be a priority, suggests
Lallemand. Resting time in the book is needed to provide a chance for long-term
traders to trade without being crowded out by HFT, he says, while regulators
should also seek to ensure that depth of book is protected, which can only be
achieved by shielding the natural liquidity provided by long-term investors.
“We need to restore trust in financial
markets and promote as much natural liquidity as possible,” he says. “Failure
to reform the region’s markets to the benefit of the long-term investor would
be to risk driving many asset managers out of these markets altogether.”