On balance, high-frequency trading (HFT) is likely neither good nor bad for European equity markets, but HFT strategies could be used to carry out market abuse, according to Andrew Bowley, head of electronic trading product management at Nomura.
With flows in Europe typically divided between multiple brokers, exchanges and in many instances different dark pools, Bowley warns that HFT firms could take advantage of such a fragmented European market structure, using a combination of different platforms and brokers to commit market abuse.
“No-one has a full picture of the market,” he said. “At Nomura, we monitor the use of our infrastructure to prevent market abuse. But a high-frequency, multi-broker, multi-exchange strategy could trade buy orders with us, for example, and the sell orders elsewhere. If we don’t see the sell order, it is very difficult for us to identify that instance of market abuse.”
Bowley’s view echoes that of Swedish regulator Finansinspektionen, which recently concluded that while the negative effects related to high frequency and algorithmic trading were limited, nonetheless HFT raises concerns the market could be subject to greater abuse.
Although Sweden’s regulators are yet to act, HFT is currently the subject of several other European regulatory initiatives, including the Financial Transaction Tax in France and proposals contained in MiFID II. At the request of national regulator Consob, Italy’s Borsa Italiana also recently introduced a charge for firms which cancel a high proportion of their orders.
According to Bowley, more market research and a clearer picture of HFT activity in Europe is needed before effective regulation can be drafted. The French tax may be misjudged, he suggests, because since it applies to French-listed shares but exempts market makers, it would likely hurt institutional investors while having little effect on HFT firms - the intended targets.
“We need to focus on studying and understanding HFT properly, not on rushing through legislation,” he said. “The UK government-sponsored Foresight Project, which is investigating the effects of computerised trading, is a positive example of this approach.”
In the US, the large trader rule, approved by US regulator the Securities and Exchange Commission (SEC) in July, aims to give regulators better oversight of the market participants with the largest trading volumes. Under the rule, entities that meet the threshold will be assigned a unique ID number to give to their broker-dealers, which will be required to maintain transaction records for each large trader and report that information to the SEC upon request. Firms that do not use a third-party broker to access markets will be required to keep their own records.
Bowley contrasts this initiative favourably to measures such as mandated minimum order resting times or minimum order sizes, which have been proposed by the European Parliament’s Economic and Monetary Affairs (ECON) Committee as part of a series of revisions to MiFID II. The ECON proposals, he says, could restrict investor choice and prompt a withdrawal of market makers from the region’s trading venues, leading to reduced liquidity and depressed trading volumes.
“Forcing market makers to stay in the market or rest their orders increases their risk significantly – making them far less likely to provide liquidity,” he says. “In an extreme market event, it’s like asking them to stand on a train track when there’s a train coming. It just doesn’t make sense. We need sensible debate on how to create the right market making regimes, mixed with commercial structures.”