High-frequency trading (HFT) is never far away from the spotlight and has largely mystified market participants that have, up until now, struggled to determine its impact on liquidity and trading costs. And at times of high volatility, calls for HFT curbs inevitably follow.
Would a curbing of HFT flow be yet another blow to equity markets that have been starved of liquidity in recent times? Or is the HFT focus on blue chips too divorced from the capital market’s primary raison d’etre of stimulating SME growth and long-term investment?
Despite all the analysis opposing camps remain irreconcilable.
Has HFT lead to a reduction in spreads – and subsequently trading costs – that ultimately benefits the end investor, or have the millions of orders that high-frequency traders fire to markets in fractions of a second created a nightmare for traditional buy-side firms when trying to make sense of market data?
Some – namely France and the European Commission – think they already know the answer to these dilemmas. The French government has been particularly vociferous with its aim to reduce HFT through now-abandoned proposed levies on order cancels and a strong desire to move ahead with a financial transaction tax, even if unilaterally. EC in MiFID II seem to confuse the way algorithms are used by electronic market makers and long-only investors.
But the UK has taken a more considered and less incendiary approach by pooling industry expertise and committing to a longer-term government-led approach known as the Foresight initiative. While the publicity effort around the Foresight project has been lacking, those involved span brokers, exchange CEOs past and present, asset managers, prop trading firms, technology vendors, politicians, hedge funds, regulators, academics and industry bodies. It will produce a body of research that promises to go further than anything before it.
Indeed, the US Securities and Exchange Commission as well as the European Securities and Markets Authority – the regional securities watchdog that will devise many of the technical standards accompanying MiFID II – are awaiting the results of the Foresight research with baited breath.
The UK government’s strong involvement will help to retain the project’s independence, which will differentiate it from many other HFT studies from organisations with a clear vested interest.
For instance, while prior research has tended to reach overarching conclusions that dismiss the link between high-frequency trading and inflated volatility, the Foresight review seems to appreciate that the reality is more nuanced. One of the Foresight working papers notes that while there is no direct evidence that HFT increases volatility, there are certain circumstances where even “well intentioned management and control processes can amplify risks and lead to undesired outcomes”.
The first step of the Foresight project was the publication of 17 driver reviews that attempt to establish the facts and define HFT in a more tangible way, something many previous pieces of research have failed to do effectively.
The lack of data on HFT is a constant thorn for the industry, and there are some high-frequency firms that aren’t even captured by the proposed MiFID II legislation.
France’s attack on HFT and the banking sector in general is clearly influenced by the country’s upcoming election in April but seems to miss the point that, devising HFT policy without a true representation of its activity could be damaging to market liquidty.
Foresight on the other hand has the potential to do exactly what its name suggests and equip the industry with a better set of tools on which to base HFT regulation and plan for the future evolution of financial markets.