Catch me if you can

Most industry observers recognise the need for MiFID II to include new rules that govern the risks associated with electronic trading, but proposals that are too severe may damage liquidity.

Is it really the best idea to curb algorithmic and high-frequency trading (HFT) at a time of such low liquidity across European equities markets?

While it’s true that high-frequency trading accounts for up to 40% of overall European equities volume, the region’s policymakers continue to assess the impact of electronic trading on market stability.

Many concerns stem from incidents in the US, such as the 6 May 2010 flash crash, where a rogue algorithm led to a precipitous drop in the Dow Jones Industrial Average, and more recently the botched BATS Global Markets and Facebook IPOs, as well as the trading error that nearly wiped out broker Knight Capital.

These incidents were catalysts for regulators across the globe to consider electronic trading curbs to prevent similar incidents, with Hong KongAustralia and Germany all pursuing separate legislation on electronic trading.

What Europe-wide legislation could be on the cards under MiFID II?

While the European Securities and Markets Authority released guidelines for brokers and trading venues on the systems and controls they use for automated trading, MiFID II will go a step further.

Proposals in the European Commission’s October 2011 draft included the need for brokers’ trading systems and DMA pipes to have risk controls that prevent erroneous trades, detail the nature of algorithms to domestic regulators and the need for algorithms to be in continuous operation throughout the trading day.

This was seemingly not tough enough for MEPs, with their final MiFID II draft including a 500 millisecond resting period for all orders, a ban on sponsored access, fees to discourage excessive orders and the prohibition of maker-taker trading venue fees.

The Council of the European Union is believed not to have tackled such issues in detail during its ongoing MiFID II discussions, but its latest draft does not include a minimum resting time or a ban on sponsored access.

Much of the initial furore around the more onerous proposals appears to have died down for the time being. This could signal a retraction of some proposals, after intensive lobbying efforts from banks and trading venues, or simply due to the fact that other issues – like the regulation of dark pools – have become more significant.

Is the buy-side likely to support the direction of travel in MiFID II?

Most buy-side traders would likely recognise the need for legislation to be updated to include provisions that cover electronic trading but many feel some of the new rules in MiFID II are too heavy handed.

A minimum resting period for all algos – even those used by institutions to target certain benchmarks – is likely to discourage some forms of trading that pose little threat to market stability.

But views on HFT remain mixed, with buy-side firms weighing the extra liquidity that such strategies provide to the market, against the ethereal nature of some HFT liquidity and the ability for their trading intentions to be exploited by tech-savvy trading firms.

The buy-side is also worried that market structure is being tipped to favour the needs of HFT firms, such as through exchanges that offer specialised order types and connectivity specially designed for high-speed market access and trading.