11.09.2012
By Terry Flanagan

HFT is Dead, Long Live HFT

The raft of measures proposed by policymakers in Europe to severely curtail high-frequency trading may, in fact, do quite the opposite.

Late last month, the European parliament almost unanimously backed the MiFID II plans, which promise sweeping reforms to Europe’s financial markets, as the document continues on its slow-winding path way through the corridors of power in Brussels.

The package was adopted by MEPs and is now heading to ‘trialogue’ where a final law will be thrashed out in the coming months between the Council of Ministers, parliament and the European Commission. It includes a host of anti-HFT proposals, including its most controversial—the introduction of a minimum resting time for orders to remain valid on an exchange for at least 500 milliseconds—and others such as a minimum tick size regime, the testing of algorithms, fee structures at venues, circuit breakers and market making obligations.

Some market users claim that if these proposals were to become law then liquidity would vanish almost overnight as many HFT firms would exit markets and volatility would be ramped up to levels not seen since the onset of the financial crisis in late 2008. It is thought that HFT now accounts for around 40% of all trades on European equity markets.

“If these rules come in, while there may not be a bright future for HFT market making, there should be plenty of opportunity for volatility and for very fast computerized speculators and arbitrageurs,” said Colm Furlong, product marketing manager at trading technology firm Fidessa, in his latest blog.

“Precisely the ones that the European Union politicians don’t seem to like much. It looks like a promising future for the fast robots.”

Furlong believes that this increasingly volatile landscape, in a post-MiFID II world, would prove a blessing for some in the HFT community.

“The irony is that the fast traders and speculators welcome the villainous volatility,” said Furlong. “There is no point having all this liquidity if the markets are flat or barely moving. The speculators want the markets whipping.”

Market making may, though, be the glue that keeps the markets from whipsawing from one extreme to another.

“Market making is a HFT activity that mitigates volatility,” said a recent study into the effects of high-frequency trading, entitled ‘The diversity of high frequency traders’, by Björn Hagströmer and Lars Nordén at the Stockholm University School of Business.

It went on to add that as market making constitutes the “majority of total HFT activity” then “both regulators and exchanges should encourage HFT market making”.

The Foresight Report, a major recent study commissioned by the U.K. government into HFT, also concluded that HFT was not responsible for market volatility as some, such as many buy-side institutional investors, claim.

“Research thus far provides no direct evidence that HFT has increased volatility, not least because it is not clear whether HFT increases volatility or whether volatility invites more HFT—or both or neither,” said the October 22 report, which gathered evidence from 150 academics and experts from 20 countries.

“For example, HFT may cause some volatility, but some volatility may cause HFT to increase since this offers many profitable trading opportunities.”

It is thought that despite the overwhelming majority of MEPs in favor of imposing severe restrictions on HFT in Europe and the strong hand the MEPs now have to play in the trialogue process, the Council of Ministers, which represents the executives of the 27 member states, could still water down the parliament’s proposals as countries such as the U.K., with its sprawling financial services sector, are likely to veto the plans as they stand.

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