US equity markets could copy moves announced in recent weeks by European exchanges to limit high-frequency trading (HFT) through message traffic charges, but market participants warn such fees will restrict liquidity if applied too broadly.
Fees to control the number of messages HFT firms send to trading venues are gaining traction in both the US and Europe. Last week, futures market operator the IntercontinentalExchange unveiled the results of its message-based tariff, a year after its introduction. Similar charges are also gaining in popularity in Europe, specifically in Italy,Sweden, France and Germany. Meanwhile, US regulator the Commodity Futures Trading Commission (CFTC) will soon issue a concept release concerning the activities of high-frequency traders.
“The imposition of messaging fees could have far-reaching implications beyond what they are trying to achieve,” Len Amoruso, general counsel at US brokerage Knight Capital, told theTRADEnews.com. “Given the sophistication of today’s market, fees and restrictions on how trading occurs has to be done very carefully to avoid impacting price formation and legitimate market making practices.”
While other bourses, such as Borsa Italiana, have opted for a flat fee to control message traffic, ICE said its policy, which covers its most heavily-traded futures and OTC contracts, was designed to discourage inefficient and excessive messaging without compromising market liquidity.
“ICE believes that it is incumbent upon exchanges to adopt rules and design controls that effectively address the existence of HFT within the context of market structure,” said Chuck Vice, the exchange’s president and COO.
At the start of 2011, ICE adopted a weighted volume ratio (WVR), a calculation that overweighs orders far away from the prevailing market price relative to those orders near the best bid or offer at the time of entry. Traders that exceed the WVR benchmark incur a charge, which increases as higher thresholds are exceeded.
"Before 2011, ICE's messaging policy, like many other exchanges, was a simple order-to-trade ratio with published benchmarks above which high-frequency traders were assessed a fee," said Mark Wassersug, vice president of operations, ICE. "However, this simplistic approach didn't differentiate between orders that added to liquidity and those that were far out of the market.”
According to ICE, the introduction of the policy has reduced the WVR by 63% in ICE Futures US markets, 19% in ICE Futures Europe markets and 53% in ICE's OTC markets. The exchange also said violations of its highest threshold dropped by 93% as HFT firms adjusted their algorithms accordingly.
According to John Comerford, global head of trading research at agency broker Instinet, other exchanges will consider the introduction of message charges in the context of their competitive position.
“In highly competitive markets, I can't see exchanges unilaterally adding charges as they'd clearly see their market share erode,” said Comerford. “In the more monopolistic markets, I could very well see exchanges adding message-based charges.”
Amoruso added that regulators should also play a role in determining messaging policies, using the monitoring tools being introduced by the Securities and Exchange Commission in response to the flash crash of 2010 to better understand the nature of high-frequency liquidity.
More tools to monitor trading activity could come as a result of the CFTC’s concept release, which the regulator said would focus on testing and supervision of automated market participants.
“These concepts will be designed to address potential market disruptions that high-frequency traders and others who have automated market access can cause,” said CFTC chairman Gary Gensler as part of a testimony delivered to the US House Agriculture Committee last week.
Although he doubted the efficacy of messaging tariffs, Comerford said he expected more input from regulators in the future.
“Given that regulatory changes and political pressures are many times intertwined, I'd expect to see continued reports on potential message-based tariffs, mostly from the regulatory side,” he said.