A market surveillance system designed to spot market abuse under new
pan-European standards was activated by the actions of a high-frequency trader
(HFT) the very first day the new guidelines came into effect.
The alert was triggered at 9:05am 1 May by the potential ‘quote
stuffing’ of an HFT firm trading through an investment bank based in London and
executing on the London Stock Exchange through a low-latency connection.
The alert – understood to be the first identified under the new regime –
came through market surveillance systems deployed by an investment bank and
developed by specialist provider Redkite Financial Markets.
Defined by the European Securities and Markets Authority (ESMA) as a
form of market abuse, quote stuffing is the entering of large volumes of orders
to hide your trading strategy or create uncertainty for other market
Along with other deemed methods of market abuse/manipulation such as
ping orders, momentum ignition and layering/spoofing, as of 1 May, quote
stuffing is now prohibited by ESMA’s new automated trader guidelines.
“When looking at the ESMA alerts it is very important to take into
account the context of the trading activity to reduce the number of false
positives,” said Matthew Coupe, director of sales, EMEA, at Redkite. “When
looking at quote stuffing and layering in particular, we analyse the trading
behaviour over a period of time, taking into account cancellation ratios,
number of orders submitted and the pricing point they have been submitted at.”
The ESMA guidelines were intended to create a regime for electronic
trading systems operated by both trading venues and brokers. They apply to
automated trading of all financial instruments defined under MiFID.
“Redkite’s suite of ESMA alerts are live and installed successfully among
our global client base,” said Robert Kay, CEO, Redkite. “ESMA’s compliance
deadline, which came into force this week, means that all market participants
using automated strategies now need the tools in place to monitor and identify
potentially abusive trading practices in real time.”
Exchanges and alternative venues must have clear rules and procedures
for preventing, identifying and reporting instances of possible market abuse
and market manipulation.
At present, the ESMA alerts are only guidelines for the market, and regulatory
authorities across Europe have differing approaches to implementation and
“However, no regulator is likely to want to be seen to be allowing
potentially abusive trading on their market, especially if this is seen to be
at the expense of retail investors or traditional asset managers,” said Coupe. “Not
following through on implementing the guidelines could seriously undermine the
credibility of any market operating without appropriate controls on member
activities. Users of Redkite Surveillance see these alerts just like any other
and firms will handle them as part of their regular workflow. If deemed appropriate,
we would expect a ‘Suspicious Transaction Report’ would be raised to the regulatory
authority in the usual way.”
According to ESMA, trading venues must have a number of measures – such
as adequate pre-trade controls and automatic mechanisms to constrain or halt
trading in market turmoil – in place to ensure “fair and orderly markets”.
Brokers using algorithms must have appropriate governance for developing
or buying algorithms, roll out algorithms in a “cautious fashion” and ensure
staff can monitor the behaviour of algorithms.
While ESMA's guidelines are not uniformly enforced across Europe, the European Parliament has requested order-to-trade ratios for all trading venues and has asked for a deeper investigation into high-frequency trading (HFT) as part of its suggestions for the Market Abuse Directive (MAD).
The debate about how best to regulate HFT in Europe, through MiFID II and other new rules such as MAD, is expected to take at least another 12-18 months.