Germany’s HFT ‘Solution’ Should Be Adopted by MiFID II, Says Prop Trading Group

Terry Flanagan

High-frequency traders are hoping that pre-emptive legislation by Germany on HFT, which is seen as less harsh than that currently advocated under the MiFID II proposals, may sway European policymakers into scaling back their plans to clamp down on HFT.

Germany has decided to go it alone in Europe by introducing new rules to curb HFT, with the laws expected to be enacted some time next year—which is likely be two years ahead of any MiFID II legislation.

The HFT community are banking on the German rules being a success in creating more orderly markets, which have seen events such as the U.S. ‘Flash Crash’ in 2010 and last month’s Knight Capital trading debacle shake investor confidence, so that the more onerous MiFID II plans will never see the light of day.

“Clearly, the German ministry of finance has set an example on how you work these rules out and implement them very quickly,” Mark Spanbroek, secretary-general of Brussels-based FIA European Principal Traders Association (FIA EPTA), a proprietary trading group which represents firms that trade their own capital on European exchange-traded markets such as Knight Capital, Optiver, Getco, Citadel Securities and Quantlab Financial, told Markets Media.

The German solution to HFT does not include some of the more controversial measures that have been mooted under MiFID II, which is just days away from a crucial vote at the European parliament that will likely firm up many of the disputed proposals.

Although similar in scope to the current MiFID II proposals, Germany is introducing the new HFT rules as it currently has no laws in place to monitor the growing practice of HFT. Some estimates say that 50% of all trades on the Deutsche Börse, Germany’s main exchange based in Frankfurt, are now done by HFT. However, the German rules do not include some of the more controversial measures in the latest MiFID II draft, including minimum resting times for orders to remain valid on an exchange for at least 500 milliseconds and market-making obligations for all firms engaged in algorithmic trading are kept under the rules and responsibility of the exchange.

“Obviously Europe needs pick up on the German example and learn from that,” said Spanbroek. “The Germans did a good thing; the proprietary trading firms which trade with their own capital and under their own risk will be regulated going forward. FIA EPTA has always promoted this. We are under strict regulation which is good and it should be like that. If Brussels wants to impose things such as the minimum order resting time then the German rules will be the resistance.”

Under the law, which will be applicable to all German venues, the German finance ministry wants the definition of proprietary trading to be extended to include HFT, meaning that high-frequency traders will fall under the remit of Germany’s Federal Financial Supervisory Authority, its financial regulator. HFT firms will also need a permit to trade on German venues, while there will be order-to-trade ratios imposed as defined by the exchange. Market participants will also be required to ensure that there are no disturbances to the markets, thereby preventing severe market swings, while certain HFT strategies will fall under market abuse rules as this was in the past, such as fake orders that create a false or misleading impression of supply and demand.

“The German laws are going to be put in place before MiFID II and will be a year or two in advance but will have to align to MiFID II whatever the outcome,” Benoît Lallemand, senior analyst at Finance Watch, a Brussels-based group that aims to serve as a counterweight to the financial industry, told Markets Media. “If they go further than MiFID II they will have to go back.”

Others believe that the new German rules will just add more complexity and costs for market participants.

“It is as much surprising as questionable that Germany has decided not to wait for a common European solution given that the MiFID II proposals are already at a fairly advanced stage,” said a recent report from law firm Shearman & Sterling.

“Instead, Germany appears to opt—not for the first time—for a national solution that precedes and pre-empts legislation at a European Union level. Germany recently applied the same strategy with respect to the prohibition of naked short selling and disclosure requirements for short selling. This resulted in the need for several subsequent revisions of the applicable national rules within a short timeframe and created (and is still creating) much confusion and considerable costs for market participants without any clear benefit for market integrity and efficiency.”

MiFID II—or the revised Markets in Financial Instruments Directive to give its full title— promises to significantly alter the way financial markets operate in Europe and looks set to impose at least some far-reaching measures to curb the rise of high-frequency trading, which now accounts for some 40% of all trades in European equity markets.

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