A senior member of pan-European securities watchdog the European Securities and Markets Authority (ESMA) has said the potential market risks posed by high-frequency trading (HFT) are “more than just concerns” for European regulators.
Speaking at the European Exchanges Summit in London, Carlos Tavares, vice chairman at ESMA and chairman of Portuguese regulator CMVM, said that while there are divergent views on HFT, more work was required to determine whether its impact is in line with the best interests of the market.
“HFT and algorithmic trading can have implications on systemic risk, in terms of amplifying adverse market conditions in some circumstances,” said Tavares. “For example, the order-to-trade ratio has increased a lot in recent years, and we need to look at how this influences volatility and whether this is what we want from regulated markets.”
Tavares noted that ESMA had already seen some cases of abusive algo and HFT strategies. He added that it would also be crucial to ensure that market fairness is maintained, given the ability of some HFT firms to access information that is not available to other investors.
ESMA is just one entity that is contributing to a growing body of academic and market-led research into HFT. In February this year, ESMA sent out questionnaires on HFT to a range of market participants, the responses to which were handed over to a newly established ESMA taskforce looking at market microstructure issues.
The UK government initiated its own HFT investigation in November 2010 via an initiative called Foresight, led by Sir John Beddington, the government’s chief scientific adviser. Academic research on HFT is also growing, including a series of studies from the Capital Markets Cooperative Research Centre, the Sydney-based research consortium, that dismisses the link between HFT and high volatility.
According to the latest draft of MiFID II dated 7 October, the algorithms used by HFT firms could be subject to strict liquidity requirements, such as the need to operate continually during market hours and post quotes at competitive prices regardless of prevailing market conditions. Investment firms that use algorithms will also be required to detail the nature of strategies and risk controls to national regulators on an annual basis.
Under MiFID II, ESMA will have responsibility for devising the technical standards required to implement the new rules, which may include detailing conditions for the use of algorithmic trading strategies used by HFTs.
Achieving harmony
Speaking after Tavares, Raul Malmstein, member of the management board at ESMA and chairman of Estonian regulator Finantsinspektsioon, emphasised the securities regulator’s goal of creating a single rulebook for Europe.
“In an ideal world, we would have one federal authority with a single rule book in order to achieve maximum harmonisation,” said Malmstein. “What we have today is three European supervisory authorities in ESMA, the European Insurance and Occupational Pensions Authority and the European Banking Authority. 2012 will be the first year for ESMA to really prove itself.”
ESMA replaced the Committee of European Securities Regulators at the beginning of 2011. Unlike its predecessor, ESMA has powers to enforce compliance with regulatory standards, responsibility for the development and application of technical standards and the ability to intervene in disputes between national regulators.
Malmstein added that ESMA’s budget for 2012 would increase to €20 million, from €16 million currently, while headcount would also grow by 25% to 101 staff next year.