European Exchanges Adopt New HFT Strategies

Terry Flanagan

High-frequency trading, much the same as arbitrage and program trading strategies in the 1980s, is feared by some market participants but it now accounts for roughly 70%-75% of all equity trading in North America and Europe.

Advances in computing capacity and financial software platform capabilities have fuelled this rise in high-frequency and algorithmic trading in recent years. High-frequency trading firms often make many millions of trades every day and often enter and exit trades in a thousandth of a second.

The high-frequency trading firms compete with each other for very small, but consistent, profits. However, the future of the industry looks constrained, and is largely dependent on upcoming regulations and saturation of the market.

However, some exchanges, who are worried that the sheer volumes of orders are slowing down their systems, are looking to jump the gun and establish industry solutions before the regulators act.

Deutsche Börse is introducing a new levy that charges traders with high ‘order-to-trade’ ratios. The London Stock Exchange and Euronext already have similar policies in place.

And IntercontinentalExchange, a global operator of regulated exchanges and over-the-counter trading platforms, has gone one step further by recently revealing the first full-year impact of its high-frequency trading messaging policy – and says it now has systems in place to sort the good high-frequency traders from the bad.

ICE’s sophisticated system attempts to judge the quality of liquidity coming into its exchanges. Exchanges generally like high-frequency traders because they provide liquidity to the system, but not, according to ICE, “inefficient and excessive messaging” that can “compromise market liquidity”.

Mark Wassersug, vice-president of operations at ICE, said: “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.

“However, this simplistic approach didn’t differentiate between orders that ‘added to liquidity’ and those that were far out of the market. Our HFT Messaging Policy directly addressed this problem by overweighting orders far away from the market relative to those orders near the best bid or offer at the time of entry.

“The ratio of orders using the weighting scale to lots traded is called the Weighted Volume Ratio (WVR). Traders exceeding our WVR benchmark incur a fee and fees increase as higher WVR thresholds are exceeded. This framework has been extremely successful in managing the high-frequency traders in our markets.”

However, regulatory moves are already well advanced in Europe and the US to curb the excesses of financial markets and these laws may seriously curtail nanosecond trading. And proposals such as the mooted Financial Transaction Tax in Europe, which will levy a 0.1% charge on all equity transactions, could instantly wipe out any margins for high-frequency traders.

Reemt Seibel, communications officer for the Paris-based European Securities and Markets Authority, a pan-European watchdog that is tasked with monitoring electronic trading systems in European Union regulated markets, multilateral trading facilities and investment firms, said: “High-frequency trading can be a valid trading strategy. But there may, however, be risks in terms of orderly market functioning. Maintaining this is one of the aims in defining rules for algorithmic trading.”

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