HFT Coming Under Fire From All Angles in Europe

Terry Flanagan

It appears that the high-frequency trading debate in Europe has temporarily moved from Brussels to certain countries in Europe, as nation-specific rules are beginning to pop up that could seriously disrupt the practice.

A harmonized approach to regulation across capital markets in the European Union is one of the main tenets of the much-anticipated MiFID II proposals, but it appears that some countries are beginning to go it alone with regard to market structure as the MiFID II discussions continue to drag on in Brussels.

Mark Spanbroek, secretary-general, FIA Epta

Mark Spanbroek, secretary-general, FIA Epta

“I really hope that other nations do not adopt different stances before MiFID II comes out,” said Mark Spanbroek, secretary-general of FIA European Principal Traders Association (FIA Epta), a Brussels-based proprietary trading group.

“We are doing our utmost to make sure it doesn’t happen as then we are back 15 years. We can’t afford this as an industry and it’s not acceptable to us. We came from a world of regulatory arbitrage and side deals with exchanges and we simply cannot go back there. All these rules that throw up hurdles that can allow you to walk back or walk out into the OTC world just open up this can of history again.”

Germany is planning to push through a law demanding that all high-frequency traders have authorization on a par with big investment banks before they can operate in the local markets, as well as forcing all algorithmic traders to set up a branch or subsidiary in Germany before they can register to trade.

“We’ve come from no regulation to our industry to over-regulation,” said Spanbroek of FIA Epta, which represents firms that trade on their own capital on European exchange-traded markets, such as Knight Capital, Optiver, Getco, Citadel Securities and Quantlab Financial.

“It is basically saying we are going to be treated as Commerzbank and Deutsche Bank. We are not against regulation, we want the industry to be regulated but it is so over-regulated that you have to comply with a whole raft of reports and compliance issues as if you were dealing with customer money. That is wrong.”

Italy, too, is looking to hit-frequency traders hard with a law that will tax order amendments and cancellations that will take place in a time frame shorter than half a second.

“In a high-tech world you should be able to cancel close to 100% of your quotes,” said Spanbroek. “This tells you about how efficient the markets are if you are able to do that. We know that the cancellations of orders are also replaced by, for instance, a new order one decimal place away. So don’t be fooled that this is ghost liquidity. It is replaced by other liquidity. Recent research has proven this.

“If you cancel just 20% of the orders you are in a market that is highly inefficient as the bid-ask spread has widened so much that you can drive a bus through it.”

The net result of this over-zealous regulation may be to force liquidity away and widen spreads with HFT firms effectively being shoehorned out of these markets.

Some fear that it will be a precedent that other nations will follow as HFT, which is barely regulated at present, was in its infancy when the first incarnation of MiFID—the last major shake-up of capital markets—was unleashed on Europe in 2007.

Since then, HFT has been blamed for a variety of market events, such as the May 2010 ‘flash crash’ in the U.S. when the Dow Jones Industrial Average index plunged 1,000 points, almost 9%, only to recover within minutes. Skeptics, including some institutional investors, want HFT curtailed as they believe it damages market integrity and increases costs.

Although a recent study by the Financial Services Authority, the U.K. regulator, found no evidence that an increase in HFT activity impacted on execution costs for institutional investors on the London Stock Exchange. The study found that institutional execution costs had broadly decreased in the past decade, roughly the period of the rapid rise of HFT, except for a period at the height of the financial crisis.

“As we do see an increase in HFT activity but no concomitant change in execution costs, we fail to observe a relationship between HFT and institutional execution costs,” said the report.

Other rules that are set to stymie high-frequency trading across parts of Europe—and also, in the process, bring about a less level playing field—before MiFID II enters force include the proposed financial transaction tax in Europe, which will encompass just 11 of the 27 nations.

France has already had its version up and running since August 2012 and Italy is set to follow suit in a matter of weeks with its own rules ahead of the combined 11-nation version—which is set to be rolled out in countries such as Germany, France, Italy and Spain some time in 2014.

However, all of these rules and regulations are moving the integration ideal of MiFID further away from reality.

“MiFID is about competition and transparency for the end customer,” said Spanbroek at FIA Epta. “[All of this] is against MiFID which created just that transparency and competition in 2007.”

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