U.K. Regulators Eye HFT
BIG PICTURE: Watchdogs recommend market-making commitments, Europe-wide circuit breakers, and resting periods.
U.K. regulators are attempting to define and measure the impact of high-frequency trading, an effort begun after last year’s flash crash.
The effort is parallel to that undertaken in the United States by the Securities Exchange Commission and Commodity Futures Trading Commission
Regulators in the U.S. and Europe have been wrestling with how to treat HFT and automated trading in general. MiFID devotes an entire section to automated trading, while in the United States, the SEC and CFTC are considering whether to impose requirements on HFTs to function as market makers.
In principle, a commitment by market-makers to provide liquidity, whatever the state of the market, would go to the heart of potential price discontinuity problems, according to Andrew Haldane, executive direct5or, of financial stability at the Bank of England.
“Market-making commitments would not forestall the arms race,” Haldane said in a speech last week. “But they would lessen the chances of liquidity droughts and associated fait tails and persistence in prices. Perhaps for that reason, there have been proposals in both the U.S. and Europe for a set of market-making commitments.”
Market participants are trying to make sense of these and other public statements in order to gauge what’s in store.
“Policymakers now face myriad challenges, including responding to public perceptions,” Dan Hubscher, industry marketing manager -capital markets at Progress Software, told Markets Media. “Understanding HFT’s current roles in the markets does require soliciting detailed views from market participants themselves.”
The U.K.’s FSA and HM Treasury, in a published comment on automated trading provisions under MiFID, said that more research needs to be performed in order to determine HFT’s overall impact on the markets. Toward that end, the U.K. Treasury is sponsoring a research project, led by the Government Office for Science, to explore how computer-generated trading may evolve in the future.
In addition to market-making commitments, Haldane recommended that circuit breakers and resting rules be implemented.
Market-wide circuit breakers that mimic those adopted in the U.S. are needed in Europe, he said.
“Although the pattern of trading fragmentation in Europe is similar to the U.S., current MiFID proposals do not envisage an automatic cross-market trading halt,” Haldane said. “But in a world of location-free, tightly arbitraged trading, cross-market circuit-breakers might become increasingly important. Indeed, these rules make potentially need to cross continents.”
As for resting rules, a tradeoff exists between the value of split-second trading and liquidity provision and the greater market uncertainty it engenders. “At time, the efficiency of financial markets and their systemic resilience need to be traded off,” Haldane said. “This may be one such moment.”
The prospect of regulations directed at HFT could have unintended consequences unless carefully implemented. “Any regulation should provide a thoughtful intervention,” said Hubscher. “Otherwise, we run the risk of employing a blunt tool where a finely calibrated one is needed.”
Tools such as risk firewalls, trading monitors, and real-time market surveillance tools are available today and could effectively address many of the concerns about HFT raised by regulators.
“Using surveillance and monitoring technology alongside HFT will not entirely prevent flash crashes or fat fingers, but it will go a long way toward helping firms to protect themselves when these things happen,” Hubscher said.
However, the larger problem is that appropriate controls are not yet used uniformly across the markets. “U.S. regulators only became aware of the flash crash after it was over,” Hubscher said. “We still see instances of trading algorithms gone wild, and of the ‘drunken trader’ getting onto his trading system and moving the price of oil with a single trade in the middle of the night.”