High-frequency traders are being warned that the perception of how they operate must change as one leading policymaker told a London conference this week that HFT is firmly in the crosshairs of the world’s regulators.
“The positive news is that the HFT industry really adds value and contributes to the growth and performance of the economy,” Dominic Swords, a visiting professor at Henley Business School in the U.K., told the joint World Exchange Congress and High Frequency Trading World Europe 2013 conferences held at the Guoman Tower Hotel in London earlier this week.
“However, there are areas of risk and vulnerability and the perception of those risks and vulnerabilities are what we need to pay attention to.”
Swords, who has previously worked at the Bank of England, believes that there are three main areas in which the HFT community must begin to show that it is getting its house in order otherwise the regulators will be forced to act.
“The first is periodic liquidity,” said Swords. “Because you are trading on low inventories and don’t have a requirement to ensure liquidity, when the market is under stress that is the very time that HFT might contribute to that illiquidity by disappearing from the market as that is how individual traders operate.
“The second is the self-fulfilling prophecy. In a HFT context, if you get a small change in the market it can become amplified into a major discontinuity by the way in which algorithms leap on top of each other and magnify this.
“Finally, there is abuse. Clearly in a system where profits go to those players with greater insight, greater access to better information and speed of response that will give people an ability to manipulate the market inappropriately. That is a concern.”
Although, Swords believes that regulators are not quite sure themselves as to what HFT really is and also what needs to be done to better regulate the practice.
“The state of the regulatory mindset currently is that they know that motivations and behaviors are important but aren’t really quite sure how to get a handle on it,” said Swords.
“I refer to regulators as the hopeful in pursuit of the unknowable.”
One such regulator to speak at the event was David Wright, the general-secretary of Iosco, the umbrella group of global securities regulators, who issued a warning that regulators were about to possibly seriously curtail the high-speed trading practice.
“Is HFT benefiting the whole market?” said Wright. “Some of the regulators on my board of Iosco—and we have all of the world’s top securities regulator—think HFT causes systemic worries. We are going to discuss this in our next Iosco board meeting in March in Sydney, Australia. All of this has got to be seen to be in the public good.”