UK regulator the Financial Services Authority has set out its plans for managing high-frequency trading (HFT) flow as it endeavours to keep pace with the evolving market structure in Europe.
At the TradeTech Liquidity conference held in London today, the FSA's director of markets Alexander Justham, said, “We are not here to turn the clock back. The concept of high-frequency trading is nothing new and we will continue to encourage competition and fragmentation and support the commercial strategies based on this environment.”
But he added, “There are new challenges arising from this environment that need to be managed by regulators.”
Justham identified four areas of HFT that the FSA is monitoring in detail: market efficiency, in terms of price formation and the quality of liquidity; resilience, particularly in light of the US ”flash crash' on 6 May; whether market abuse can be effectively monitored in a high-speed environment; and the ability to retain a level playing field across market participants.
While Justham was positive that high-frequency trading had reduced spreads and helped the price formation process across multiple trading venues, he noted that the impact on the depth of liquidity in an environment of shrinking order sizes was less clear and warrants further investigation.
“The jury is still out on the effect of HFT on liquidity depth and we think more evidence and analysis is required in this area,” he said.
The impact of the speed of trading on the resilience of markets is the second area of focus for the regulator. Justham emphasised that even though most European trading venues already have circuit breakers in place and ”naked' sponsored access is prohibited in the UK, human intervention is not as effective in maintaining fair and orderly markets as it used to be.
“The ”flash crash' in the US is a prime example of this,” he said. “The events of 6 May were the result of a panic by machines, not humans. There is no problem with having fast-moving markets, but the controls around this cannot lag behind.”
Considering market abuse, Justham noted that the changes in market microstructure could result in new forms of market abuse, such as rapid order entry and layering, that will need to be part of its ongoing investigation into HFT. The focus on ensuring a level playing field across the diverse business lines created by high-speed trading – such as sponsored access and co-location – was also emphasised.
Looking to the types of measures and controls the FSA may look to implement, Justham hinted that the regulator might impose stress testing of algorithms before they hit the market and greater harmonisation among venues – such as synchronisation of trading clocks – so that it would be easier to recreate a Europe-wide order book to help monitor abusive behaviour.
“When there are multiple algos working orders in stressful market conditions, this can be detrimental to the market,” he said.
The FSA's ongoing work into HFT will be fed into an investigation into automated trading by the UK government that was announced yesterday.
The project will be led by the government's Office for Science, under the direction of the chief scientific adviser, Professor Sir John Beddington.
The aim of the investigation will be to examine the impact of computer-driven trading on financial stability, liquidity, competition, market efficiency in allocating capital and transaction costs.
The initiative will involve representatives from across the industry including Andy Haldane, executive director, financial stability at the Bank of England, Professors Charles Goodhart and Oliver Linton from the London School of Economics, Professors Philip Bond and Dave Cliff from the University of Bristol and Kevin Houston, chairman of Rapid Addition and co-chair of the FIX Protocol global technical committee.