Saturday, April 14, 2012

The High Frequency Trading will not escape regulation

The High Frequency Trading (HFT) has grown considerably in recent years and today represent the AMF according to 90% of orders sent to the market and about 30% of actual transactions in Europe and Further more. The proportions taken by this practice are as worried. While the regulator, after leading an important discussion on these topic proposals currently before the European Parliament that could lead to a new framework for HFT in 2013, French MPs have meanwhile passed a law to tax this type of exchange on February 16.

 If approved by the Senate, this legislation could come into force on 1 August 2012.

During recent years, technological advances and computer willingness of governments to open the European stock market to competition as part of MiFID led to an increase in the number of trading platforms. This changing landscape stock has paved the way for arbitrage opportunities between the ever-increasing rate differences observed on these various platforms and therefore the development of the HFT.

To recap, the HFT combines the use of complex mathematical algorithms to that of ultra-performance computing technologies. This combination is used to analyze high-speed, continuously, all the information available on the market and execute consecutively high volumes of orders in a very limited period of time (several tens of orders by millisecond). A small shift course may, under these conditions represent opportunities for gains extremely important for banks or investment funds making use of the HFT. These actors are now located in New York, Chicago and London, cities which are the main trading platforms. They rent space physically close server platforms to set up their computers, (a phenomenon now commonly called "co-location"), which allows them to gain speed to market.

Because relatively new, the High FréquencyTrading has been extensive impact studies only recently. Mostly conducted at the request of the regulator as part of its preliminary work, all of these studies demonstrated that the impact of HFT depended on market conditions considered.

In market conditions "normal" it was observed that the practice of HFT had a positive effect on liquidity levels but also on market efficiency. The arbitration, basic strategies used in the HFT indeed contributes to a faster elimination of Aberrant and a reduction in bid-ask spreads and therefore to harmonize the prices observed in the various trading systems. In market conditions "abnormal" However, it was shown that the HFT could deteriorate the level of liquidity and increase price volatility, the high frequency traders have a tendency, in such circumstances, triggering a chain of command, thereby amplifying the abnormal nature of these situations in proportions which can become considerable. This is what the rest could be observed during the flash crash (flash crash) of 6 May 2010.

In addition to this snowball effect, the HFT also raises a number of concerns about information asymmetry it induces. The "traders" high frequency to the extent they are able to handle masses of information much faster than traditional traders, have indeed a competitive advantage that could encourage them to turn to other markets more opaque like dark pools or OTC markets to circumvent these difficulties.

Finally, among the strategies used in the HFT, some are purely of market abuse.

This observation leads the regulator to introduce today a number of proposals for regulatory control of HFT. The exercise is difficult because above the technical challenge of monitoring this practice, it will have to fight against its abuses without impeding its benefits on market efficiency and quality of liquidity.

In terms of market abuse first, Directive MAD (Market Abusive Directive) should in its final establish an exhaustive list of types of HFT under the market abuse and therefore strictly prohibited by law.

The new regime MAD should also extend the capabilities of investigation and sanction of national regulators at present very small. For example, the AMF has currently access to a single order book for NYSE Euronext, while the French values
​​are treated for several years on various platforms.

To guard against the effects of amplification of HFT in market conditions deteriorated and the fight against distortions of competition then, several options were proposed as part of MIF II:

    Companies using the HFT will thus be obliged to implement risk control procedures to prevent advanced potential malfunction of the algorithms. The description of these algorithms will also be made available to the regulator.
    The high frequency traders running a significant number of orders on a particular instrument will then be able to provide a continuous minimum level of liquidity of this instrument (as are forced to do the marketmakers currently)
    The high frequency traders will also observe a minimum latency before canceling the orders issued
    A minimum ratio of execution of orders placed under the HFT could be required which would involve the introduction of financial penalties for canceled orders.

The reduction of tick sizes briefly considered in turn has been rejected because it could lead to an increase in spreads unfavorable to investors, reducing the number of decimal places reduces arbitrage opportunities and thus the quality of price formation.

A number of observers are now doubtful about the implementation of these proposals because of the technical complexity of monitoring the HFT. The AMF was wondering when the fourth conference of the Enforcement Committee last October about the possibility of an outright ban of the HFT, however if the controller was not able to exercise effective control. However, the approach taken by MiFID and MAD II seems relevant. In striving to better frame the HFT and focus its ban on abusive practices only, the regulator wants to secure the market in effect without hampering his competitive nature because that is conducive to a continuous optimization process which has contributed greatly in recent years increased liquidity and price harmonization on the market. This course will assume however, that the controller provides the technical means of its ambitions. The tax on financial transactions proposed by the French government for its part should touch the HFT to a lesser extent as it will apply to orders numbers up to 0.1% and canceled orders amounting to only 0.01% and Beyond a certain threshold that has not yet been defined but "can not be less than two-thirds of orders addressed and may be modulated by size of balance sheet of the operators concerned."