Hitting HFT Right Where it Hurts (Everybody) – Analysis by Dr. Christian Voigt of Fidessa11.13.2012
Attempts by politicians to restrict high-frequency trading are likely to punish technological innovation without meeting their aims to shore up market stability, says Dr Christian Voigt, Business Solutions Architect, Fidessa
The European Commission (EC) has strayed from the basic regulation of financial markets (who is allowed to buy what) and is starting to step into the how and why of buying. To be fair, it has been set the tough target of resolving the financial crisis and creating a single rulebook for the continent’s capital markets in a single raft of new regulations. Broken up into several overlapping pieces, including the revision of MiFID and MAD, the regulations alternately prioritise risk reduction and cost reduction, creating a natural tension between these two positions.
Given the complexity of this enormous task, it is perhaps not surprising that very different aspects of trading are becoming intertwined in the minds of the politicians that edit the EC’s text.
High-frequency trading (HFT) has been a key focus. Trading high volumes of assets, based on small price movements to make intraday profits, HFT firms have been widely vilified. However, the reasons most typically given are in fact based on popular misconceptions.
While the debate on the impact of HFT on financial markets is far from concluded, regulators and politicians decided that it was about time they intervened and put the brakes on those IT-savvy traders.
Hence, in the recent vote of the European Parliament’s economic and monetary affairs committee on MiFID II and MiFIR, measures such as a minimum resting time are part of the their final proposal. The measure proposed by MEP Markus Ferber, ECON’s rapporteur on the issue, to make trading venues keep orders on their books for 500 milliseconds was intended to make ultra-fast transactions “less interesting” and to curb “excessive speculation”. Beyond that, further measures such as order cancellation fees and continuous quoting obligations for market makers are potentially also included in MiFID II and MiFIR.
These measures, encouraged by the flawed assumptions outlined above, would certainly hurt HFT as intended. This will have two key detrimental consequences. Firstly, liquidity in the market would reduce, forcing up execution costs for the buy-side. Secondly, a precedent would be set for politicians to interfere in the technology enabling existing business models. After all, intraday trading is not new. Market making is not new. These are the models that technology has effectively speeded up with HFT.
This sounds very much like an attempt to ban technology from financial markets. Technology drives innovation, and sometimes innovation creates new problems, but the answer should never be to ban technology. 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.