11.19.2012
By Terry Flanagan

HFT: You Can’t Live With Them, You Can’t Live Without Them

The industry continues to be split down the middle on the benefits of high-frequency trading.

On the one hand, algorithmic trading brings about increased liquidity—the holy grail for investors—and reduced spreads, while the negative view just portrays the HFT community as turning the market place into a sort of casino where millions of trades are done faster than the blink of an eye every second by algorithms who seemingly have no strategy and little inclination on how a company’s fundamentals affect a share price.

The one constant in all of this, though, is the rise of technology, which has helped to create today’s fast-paced trading landscape and enabled HFT to thrive. The Foresight Project, a much-anticipated two-year study commissioned by the U.K. government into HFT that was published last month, says that this advancement in technology is only going to increase.

“Continuing advances in the sophistication of ‘robot’ automated trading technology, and reductions in cost are set to continue for the foreseeable future,” said the October 22 report, which gathered evidence from 150 academics and experts from 20 countries.

“Future trading robots will be able to adapt and learn with little human involvement in their design. Far fewer human traders will be needed in the major financial markets of the future.”
This lack of control by humans may well be at the heart of the arguments of some politicians who seem hell-bent on slowing down HFT, especially in Europe, with proposals such as minimum resting times, order cancellations fees and continuous obligations to quote. It is the future banning of technology, then, that may bring about the end of HFT as we know it.

“Technology allows HFT and the structure of the markets opens the doors for this type of trading, but the investing community cannot see any evidence of tangible benefit,” said Gary Wright, chief executive of London-based research firm BISS Research, in a recent blog.

But restricting technology in the form of regulations coming from the European Union may actually force high-speed traders to flee the market place—it is estimated that HFT accounts for 40% of daily equity volumes in Europe and as much as 60% in the U.S.—and bring about the immediate reduction of liquidity and force up execution costs for the buy side, many of whom are ironically opposed to most forms of HFT.

Dr Christian Voigt, business solutions architect, Fidessa

Dr Christian Voigt, business solutions architect, Fidessa

“Technology drives innovation, and sometimes innovation creates new problems, but the answer should never be to ban technology,” said Dr Christian Voigt, business solutions architect at trading and technology company Fidessa.

“In this case, ill-directed regulation threatens to undermine the benefits HFT brings to the market. Let’s hope the effect is not to drive the HFT community to pursue its business objectives beyond the reaches of EU regulation, weakening the European markets.”

Some European countries even seem to be trying to outpace the Brussels reforms, with Germany recently passing its own anti-HFT laws, which promise a two-speed Europe until the European-wide regulation, in the form of MiFID II, enters into force, which is expected some time in 2014 or 2015.

“Regulations per se is not a bad thing but we need to make sure regulations don’t hurt the benefits that HFT bring to the market place,” Michael Krogmann, executive vice-president of Deutsche Börse, operator of the Frankfurt Stock Exchange, told Markets Media.

“In addition, it is very important to have a level playing field among the venues in Europe.”

Concerns for the stability of markets has increased following the so-called ‘flash crash’ of May 2010, the botched initial public offerings of Facebook and Bats Global Markets earlier this year and Knight Capital’s $440 million trading loss in August.

The U.S., too, which is lagging somewhat behind Europe on the matter in terms of regulatory intervention, is looking at ways to tame HFT, with the U.S. Securities and Exchange Commission possibly planning to introduce so-called ‘kill switches’ to allow market participants to shut down trading, and a best-practices guide to electronic trading.

“Society has to decide what sort of financial market it wants,” said Wright at BISS Research. “There is nothing wrong with HFT, but it’s not really helpful for the increase in real investments or for new companies to list. Who wants to bring a company to market when its share price is at the beck and call of machines?”

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