Two senior national regulators have cast doubt on the viability of proposals by the European Parliament to control high-frequency trading (HFT) and have highlighted the practical challenges of implementing some of the rules.
In a debate on creating effective and intelligent rules around HFT that kicked off the TradeTech Europe’s focus day, representatives from the UK’s Financial Services Authority (FSA) and the Netherlands’ Association for Financial Markets (AFM) said they recognised the multiple concerns related to HFT but admitted that current regulatory proposals falter because of a lack of hard evidence.
“There are concerns around the risks of algos going rogue, market abuse and exactly what constitutes HFT,” said Tim Rowe, manager of trading platforms and settlement policy at the FSA. “But many of the proposed amends to MiFID II appear to be based on anecdotal evidence and fear, which may or may not be legitimate.”
Although he welcomed the growing body of academic research on HFT, including the Foresight project, a UK government-funded investigation into computer-based trading, Rowe added, “This is policy-making based on an information vacuum and there is not any clear hard evidence of what the actual problems associated with HFT might be”.
The comments follow the release of proposed amendments to MiFID II made by the European Parliament’s Economic and Monetary Affairs Committee. The proposals, due to be debated by MEPs on Wednesday 24 April, include a ban on direct electronic access – i.e. the practice of sponsored access and direct market access – and a provision for all orders to have a minimum lifespan of 500 milliseconds. There is also a requirement for trading venues to charge higher fees for market participants that have a high ratio of cancelled orders compared to executed orders.
Piebe Teeboom, senior policy advisor, strategy and policy at the AFM, labelled a number of the proposals as “incoherent”. The Netherlands is home to a number of well-known HFT firms including Optiver, IMC and Flow Traders.
“On the one hand, there is a proposal that wants to commit participants to the market for a longer time, but on the other, the ban on direct electronic access limits the way people can enter the market,” said Teeboom. “There is a real paradox presented by some of these proposals and we think the real focus should be on the core trading systems and controls.”
Rowe questioned the urgency of the problem that the proposed introduction of minimum holding periods and order-to-trade ratios was attempting to address.
“There are legitimate reasons for cancelling orders and I am yet to hear anyone articulate what limitations on this will resolve. The proposals don’t account for the differences in the time it takes to send an order to a market or the fact that HFT firms could just use multiple markets to counteract their impact,” he said, adding a minimum resting period could require a substantial re-engineering of trading venues.
Peter Nabicht, executive vice president at Allston Trading, a US-based market maker that has recently set up operations in Europe, expressed particular concern at the proposal for a minimum quote life.
“This rule could increase systemic risk in the market,” he said. “Market-moving news is disseminated in microseconds, so a 500-millisecond quoting minimum would prevent the market from reacting accordingly. This will ultimately reduce liquidity and lose people money. You can not divorce how the markets work from the rest of the world.”
The need for compromise
Panellists also doubted the efficacy of another MiFID II proposal, the now-infamous article 17(3), which would require users of algorithmic trading strategies to commit to providing liquidity on a continuous basis.
Rowe said that compromises would have to be made and said that the FSA would prefer to see a solution whereby firms that want to engage in market making register with regulators and adhere to strict rules.
“These proposals have come from a very small group of people and have been laid out on the table of every European jurisdiction – regulators, politicians and government – for a debate that is still on-going,” he said. “There is an awful lot of disagreement between the different regulatory bodies but we will reach a compromise.”
There was however, a broad consensus on other regulatory initiatives to control HFT and other aspects of electronic trading, with Sam Tyfield, partner at law firm Katten Muchin Rosenman, noting the commonality between guidelines issued by the pan-European securities watchdog the European Securities and Markets Authority, prop trading industry body the Futures and Options Association’s European Principal Traders Association and the Securities and Exchange Board of India.
Panellists agreed that such guidelines – and the requirements they place on firms to keep records of algorithmic strategies and systems – would help regulators to gain a better understanding of HFT.
While the debate about how best to regulate HFT in Europe, through MiFID II and other new rules such as the Market Abuse Directive, will rumble on for at least another 12-18 months, Mike Williams, CEO of Genesis Asset Management, the only buy-side representative on the panel, said that markets are in danger of ignoring the needs of long-term investors.
“The markets are lacking confidence and end-investor trust is fundamental to the operation of the market,” he said. “When you look at some of the ‘good ideas’ the financial industry has had in the past, like portfolio insurance, collateralised debt obligations and derivatives, history is clearly not on our side.”