German HFT Rule Clarity Sought

Terry Flanagan

A German regulatory initiative to potentially rein high-frequency traders is being watched by market participants and operators elsewhere in Europe and in the U.S., where rule makers are studying the methodology.

Licensing, regulation, and supervision of HFT firms and their strategies are the crux of developing German laws that could hold direct implications for traders on Deutsche Borse’s Frankfurt Stock Exchange, which is the world’s 10th-largest exchange by market capitalization

The Act for the Prevention of Risks and the Abuse of High Frequency Trading, or HFT Act, includes more definition around algorithmic trading activities than the German Banking Act it could replace. The HFT Act has been adopted by the German Parliament and will next be signed into law by the federal president; enforcement would commence within a three-month transition period.

The HFT Act calls for certain proprietary trading firms trading German markets or on multi-lateral trading facilities to be licensed as financial services institutions.  Regulation and supervision of HFT firms could be expanded to require submission and approval of algorithmic trading activities including information about the systems used, strategy detail, and an ‘earmark’ for each HFT order with identification of the algorithm that was used to create it.

Germany has been a frontrunner in efforts to regulate HFT, but any financial regulation proposal is subject to legislation at the European Union level and could theoretically be preempted by future EU reforms like the MiFID II, expected in 2015.

Some investment managers who participate on German trading venues say that interpretive clarity is a big problem in the rules package giving Federal Financial Supervisory Authority (BaFin) governance over HFT firms.

In a joint letter published last week, the MFA and AIMA requested that BaFin issue guidance that an investment manager trading on behalf of managed funds would not be interpreted as dealing for its own account, and should not be subject it to the same licensing regime as proprietary trading entities. The associations also suggested FAQs with specific language to help clarify other potentially ambiguous aspects of the rules.

New HFT regs may challenge some market participants and service providers regarding issues between jurisdictions and between different asset classes critical to cross-border compliance.

“People understand that high speed electronic trading is still very important – the technology bunny is here to stay, it’s not going back into the hat,” said Dr. Jock Percy, chief executive of Perseus Telecom, which furnishes ultra low latency, high-capacity global networks for financial markets.

A lack of clarity around regulations, taxation and compliance as well as the application and timing of what’s been decided can hold back market growth. “When elections are held in November, will the (HFT Act) bill be enacted into law quickly, or will it remain on standby for a while?” Percy noted.

Frankfurt is among the 30 connectivity points on Perseus’ global network, and the New York-based company has the German regulatory proposals in its scope.  “We need to decide where best to spend capital and what drives our customers’ requirements,” Percy said.

As with the Reg NMS implications in the U.S., much is now regarded as unnecessary oversight years after enactment with Reg Consolidated Audit Trail moving similarly, according to Percy. “As a connectivity company we look to work out the effects of what has been decided and have recently responded with risk mitigation and compliance services to help our customers,” he said.

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