Buy Side Faces Up To Esma’s Automated Trading Rules


Market participants are in broad agreement that the automated trading rules recently introduced by the pan-European regulator are a step in the right direction to bringing more order to markets—although buy-side firms on both sides of the Atlantic need to be fully aware of the minutiae to avoid falling foul of the guidelines.

The European Securities and Markets Authority (Esma) expects that any algorithm a firm uses in financial markets will be tested and monitored, with trading systems watched in real time and action to be taken if any issues are discovered. Risk management procedures are being improved, while brokers will need to better monitor suspicious activity that they facilitate and exchanges, too, will need more up-to-date kit to provide a continuity of service at all times.

Algorithmic trading is not now the preserve solely of the high-frequency trading community and proprietary traders. More and more buy-side investors, such as institutional funds and pension funds, are beginning to explore automated trading strategies to get the best price in the market and avoid seeing their orders being anticipated by others due to growing fears about the impact of HFT on the market.

However, some buy-side participants believe that the algorithms they use for executing long-term trading decisions should not in any way be compared to the super-fast trading strategies adopted by HFT firms who rapidly trade in and out of positions to try to claim very small profits by making millions of trades in the mere blink of an eye.

“Algorithmic trading is not high-frequency trading,” said Christian Dargnat, chief executive of BNP Paribas Asset Management and vice-president of the European Fund and Asset Management Association, a major buy-side industry body.

“[It] provides best execution leading to trading cost reduction for the final investors and they are not decision making tools. They do not impact volatility or increase risks for the investors. It should not be forbidden to execute in the best conditions.”

The Esma reforms have been in place since May with other jurisdictions, notably the U.S., only now beginning to wake up to the issue following recent high-profile trading glitches earlier this year such as the Knight Capital software error that nearly bankrupted the U.S. market maker and caused erratic trading activity which left the firm with billions of dollars of unwanted securities and serious problems surrounding the initial public offerings of exchange operator Bats Global Markets and social networking site Facebook.

Philippe Carré, global head of client connectivity, SunGard

Philippe Carré, global head of client connectivity, SunGard

“The key is it applies to all 27 countries in the European Union,” Philippe Carré, global head of client connectivity at SunGard’s capital markets business in London, a trading technology firm, told Markets Media. Previously, before Esma was created in January 2011, supervision had remained mostly at a national level in the EU.

“So everyone has suddenly to scramble to make sure they are equipped and now you have a central EU authority to make sure each jurisdiction is implementing these rules,” said Carré. “You can no longer be ready when the time suits—you have to be ready and do it now.”

Esma brought in the rules to front-run the more meaty reforms that will eventually hit Europe’s financial markets, in the form of the updated Markets in Financial Instruments Directive, or MiFID II. With MiFID II still being negotiated by politicians in Brussels, any legislation—which will force firms into definite action—is not likely to be enacted until 2015. The original version of MiFID in 2007 had no provisions in it for algorithmic and high-frequency trading, which was in its infancy back then.

“Very clearly, [MiFID II] is politically a very sensitive issue—a lot of people are worried about HFT, beyond the MEPs,” Judith Hardt, secretary-general of the Federation of European Securities Exchanges, which lobbies on behalf of 46 of the region’s exchanges, told Markets Media.

A key focus of the Esma guidelines revolve around market abuse with trading platforms needing to be able to monitor the activities of their participants for suspicious or illegal activity. The guidelines specifically refer to trading platforms having the ability to detect ‘ping orders’, ‘quote stuffing’, ‘momentum ignition’ and ‘spoofing’.

“The Esma automated trading guidelines are a great first step in terms of trying to look at what is going on with trading activity,” Matthew Coupe, sales director of RedKite Financial Markets, a U.K. provider of real-time market surveillance systems, told Markets Media.

“It talks about a great number of buzzwords such as layering and momentum ignitioning. The problem is, the industry and regulators need to work together to make sure we have sensible definitions of what these are and how these work. It is not necessarily about the market surveillance element. Esma is there for covering risk controls and making sure orders going into the market are orderly and don’t breach risk limits.”

However, some buy-side traders believe that Esma’s automated trading guidelines will not impact on them quite as much as others in the market, such as the HFT brigade. The Esma rules are aimed primarily at the adverse effects of high-frequency trading.

“The quicker you are the better, but there is a trade-off between how much you are going to spend to be quicker and what you actually monetize,” said a senior London-based buy-side trader. “The vast majority of buy-side firms don’t understand the difference between a millisecond or two—they just don’t have strategies that would have very much difference between the two.”

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