For better or worse?

Will current MiFID II proposals to curb high-frequency trading activity make Europe's equity markets safer or just sink liquidity to new lows?

How exactly are regulators proposing to control high-speed trading and what impact could they have on liquidity? 

There are a number of national and Europe-wide proposals to ensure better oversight and control of high-frequency trading (HFT). But it is the latter, through proposals in MiFID II that have some market participants worried about the liquidity impact.

Potentially damaging measures that have been approved in the European Parliament Economic and Monetary Affairs Committee’s (ECON) version of MiFID II include a ban on maker-taker pricing and imposing a minimum resting time of 500 milliseconds for all orders.

Such requirements would make Europe instantly less attractive to HFT firms.

Many rely on rebates offered by venues for posting liquidity to turn a profit and use high-speed technology to refresh quotes that might become stale if they do not reflect stock price changes. Expect European trading activity to nosedive if these rules make it through the regulatory process.

Worth noting though, is that other changes proposed by ECON and individual member states are less contentious.

MEPs want HFT firms that consider themselves market makers to enter into written agreements with the exchanges they operate in, to ensure they stand up to their claims of liquidity provision.

They have also proposed HFT firms store raw data of quoting and trading activity that would be available to national regulators on request. Meanwhile, domestic markets Germany and Italy have implemented message traffic fees to prevent undue load on their trading system and prevent the use of poorly designed HFT strategies.

Separately, the German ministry of finance has recently approved new rules that would recognise HFT firms for the first time and require them to hold a minimum level of capital.

Would the market operate just as efficiently if HFT didn't exist? 

Views on this topic are mixed and perhaps will be for years to come.

On the face of it, predictions that put HFT activity at around 40% of overall liquidity in Europe means it clearly has a bearing on the ability of the buy-side to complete trades.

Also bear in mind that while much HFT activity is classed as either pure prop trading or electronic market making activity, the latter makes up the majority of activity and is relied upon by some of the region’s largest markets to build a base of liquidity.

With equity trading sharply down – value of trading in Europe was €660 billion last month; 28% lower compared to a year earlier – threatening the viability of a further 40% through HFT curbs would plunge volumes to new lows.

Sounds logical, but I’ve heard HFT doesn't always provide the liquidity that benefits the buy-side? 

The words “ephemeral, fleeting and hot potato liquidity” have all been used by various market observers – including the Securities and Exchange Commission – to describe HFT.

Common observations from the buy-side are that the liquidity HFT firms provide can disappear within a flash and cause adverse price movements because of strategies that front-run their positions.

So what are the chances of the potentially damaging MiFID II rules becoming reality? 

Given the highly-charged, political climate that, at times, threatens to derail MiFID’s objective of creating a competitive, safe, single market structure for Europe, it’s anyone’s guess.

Part of the problem – which is perhaps due to both tight-lipped HFT firms as well as over-zealous regulation – is that HFT strategies are not very well understood, making it difficult to separate strategies that could be considered beneficial from those that are abusive.

While MiFID includes a number of HFT curbs, there is also the Market Abuse Directive, which, among other measures, proposes creating an advisory committee comprising national experts to determine the types of HFT which could constitute market abuse.

Nonetheless, much of the debate among MEPs appears to have focused on punishing banks for their role in the financial crisis, rather than creating an optimal environment in which different types of market participants can interact effectively.

ECON’s stance is highly likely to receive full backing from the Parliament before the end of this year. It is now up to the Council of the European Union – which has meetings on MiFID II scheduled for every week this month – to decide how it wants to deal with HFT.

The market now faces an anxious wait in the hope that representatives of member states’ governments will deliver sensible, well-run markets that serve all types of market participants, rather than pandering to the desire to see the financial sector castrated for the recent crisis.

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