12.18.2014
By Terry Flanagan

Esma Struggles to Define HFT

The European Securities and Markets Authority said high-frequency trading accounts for between 24%  and 43% of value traded on European Union exchanges, but the regulator said that defining HFT remains a challenge.

The regulator studied 100 stocks from nine EU countries in its economic report, “High-frequency trading activity in EU equity markets”.

Data was collected by Esma for May 2013 from nine national authorities. The data covers all messages and trades executed on their trading venues as well as additional information such as the use of co-location, market making and provision of direct market access. The dataset included around 10.5 million trades and 456 million messages.

Esma said that one of the challenges for empirical studies is the operational definition of HFT.

“There is a variety of approaches in the literature to estimate HFT activity,” Esma added. “None of these approaches is able to exactly capture HFT activities and they lead to widely differing levels of HFT activity.”

The study chooses two approaches to provide a lower and an upper range for HFT activity. The lower amount comes from a direct approach based on the identification of HFT firms according to their primary business or the types of algorithms.

The upper range comes from an indirect approach based on statistics such as lifetime of orders or order-to-trade ratio. The regulator said that if the 10% quickest order modifications and cancellations of a given firm in any particular stock are faster than 100ms, then the trading activity of the firm in that particular stock is considered HFT.

The report said: “The difference in the results is mainly explained by HFT activity of investment banks which is captured under a lifetime of orders approach, but not under a HFT flag approach.”

Remco Lenterman, chairman of the FIA European Principal Traders Association and Managing Director of IMC, said in a tweet: “The Esma study shows how fruitless and foolish regulatory efforts are to define HFT.”

The study also found that on average, HFT groups have 9.1 different unique IDs, indicating that their trading is spread across multiple venues. Investment banks have 5.6 different IDs and other firms 2.2.

“Those features are in line with the assumption that HFTs are more likely to perform arbitrage across venues than other types of market participants,” added Esma.

FIA EPTA said in a tweet:  “HFT transfer information and liquidity across markets; this makes fragmented markets behave as if integrated.”

The trade organisation cited an academic paper last month by Jonathan Brogaard, Foster School of Business, University of Washington; Terrence Hendershott, University of California – Berkeley, Haas School of Business and Ryan Riordan, Queen’s School of Business, Queen’s University .

The academics surveyed 150 firms that trade in Canada on seven exchanges and said 61 exhibit behaviors that are consistent with HFT. They are responsible for much of the message traffic on exchanges and trade frequently but hold little inventory.

The report said: “Early results show HFT are integral in tying markets together.We find that HFT are responsible for the bulk of price discovery but that they are less important for liquidity.”

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