10.03.2012
By Terry Flanagan

HFT May Actually Be The Winner From MiFID II’s 500 Millisecond Ruling

The controversy in Europe surrounding the potential introduction of a minimum resting time for orders to remain valid on an exchange for at least 500 milliseconds— in a bid to quell the rise of high-frequency trading—continues to grow, although some traders believe the rule will actually benefit the HFT community in the long run.

“There are a number of people out there who are smarter and more nimble and spend much more on technology spend than everyone else in the market and the regulators and politicians don’t get that,” said a senior London-based buy-side trader.

“It doesn’t matter about the minimum resting times. All the guys who do high frequency will make a different type of money in the new scenario as they will get there faster than everyone else and they will be very aggressive and snipe order books more than anyone else in the market place. And no-one will be able to react to that for a year or two.”

The European parliament’s Economic and Monetary Affairs Committee (Econ) last week voted overwhelmingly in favor updating the Markets in Financial Instruments Directive, otherwise known as MiFID II, and one of the more obvious political statements made by Econ was to introduce this 500 millisecond built-in latency in a bid to make a stand against the rise of high-frequency trading, which is now thought to account for around 40% of all trades on European equity markets. The original MiFID document in 2007 had no provisions in place to monitor high-frequency trading.

“It’s clear that the European parliament has made a very public statement,” Mark Spanbroek, secretary-general of Brussels-based FIA European Principal Traders Association (FIA Epta), a proprietary trading group 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, told Markets Media

Other proposals that target HFT which made it into the parliament’s version of MiFID II include an obligation for firms to provide liquidity to the market if a firm has a written market making agreement with an exchange, which may encompass all HFT firms. This is the ruling that is riling the HFT community the most as they say it will force HFT firms out of markets and cause liquidity to vanish almost overnight if it were to be implemented.

While plans to bring in order-to-trade ratios—another measure in MiFID II to curb the excesses of high-frequency trading—despite many European venues already having it in place to some extent, appears to have the support from many in the industry, including the HFT community.

However, there is some way to go in the political process in Brussels before MiFID II becomes binding. The Econ draft of MiFID II will be voted on by all MEPs, although this is thought to be a mere formality. Then the Council of Ministers—with nations such as the U.K. and the Scandinavian countries thought to be vehemently against MiFID II in its current format—will table its own version, likely around the end of November, with input from the European Commission before the three institutions of Europe sit round a table and thrash out the final law, in a process called trialogue. Formal implementation is not expected until 2015.

“To be clear, 500 milliseconds has been voted by parliament but there are two components before we get to trialogue,” said a London-based exchange executive.

“To put it in perspective, of these three components of formalizing regulation and directives, the parliament is the most political and least knowledgable about how financial markets work. There is a way to go before anything is finalized.”

Markus Ferber, the German center-right MEP, who is tasked with guiding MiFID II through the European parliament and also into trialogue, now appears likely to have some ammunition—in the form of the minimum resting time—to bring with him into trialogue process, which is expected to take place around December. Ferber has adopted a tough approach to HFT and what he views as its predatory practices.

“The minimum order resting time for [Ferber] is a bargaining chip—he recognizes that very well,” said Spanbroek at FIA Epta, who is against the 500 millisecond rule being introduced although he thinks HFT firms will just pinpoint 499 and 501 milliseconds in the future to generate their profits.

“The fact that order-to-trade ratios are there already, they can’t use that as a selling tool by parliament. Every exchange has an order-to-trade ratio. It is just a matter of how well they are functioning and how well they are sharpened up. So it’s not rocket science to bring that forward.

“What we really do not like is the fact that they are stubborn on 17(3) [the market maker obligation in MiFID II]. They basically claim that all participants in the market who are so-called market-makers will have to quote continuously—and the definition they use for market makers is anyone who holds out in the financial markets through an electronic system, which these days is most traders.

“They do not really understand the structure and the structure impact of the markets. Particularly the micro-structure. You will lose liquidity providers and you gain the takeout order business. It will mean that everyone just sends orders to the market and there is no passive order flow. [MEPs] claim that is good for the market; we certainly do not claim that and nor do academics either. The big stumbling block is 17(3) still.”

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