MiFID II Creates HFT Brouhaha

Terry Flanagan

Latest version includes language that would require algorithmic traders to post firm quotes at all times.

European regulators are considering placing market-making obligations on firms that employ algorithmic trading, joining the debate that has been brewing at least since the May 6, 2010 flash crash and its repercussions.

The latest version of Markets in Financial Instruments Directive, which is scheduled to be presented by the European Commission later this month, contains a clause that says:

“An algorithmic trading strategy shall be in continuous operation during the trading hours of the trading venue to which it sends orders or through the systems of which it executes transactions. The trading parameters or limits of an algorithmic trading strategy shall ensure that the strategy posts firm quotes at competitive prices with the result of providing liquidity on a regular and ongoing basis to these trading venues at all times, regardless of prevailing market conditions.”

The language is anathema to firms that employ high-frequency trading strategies.

“Many market participants who use algorithms in their trading strategies (the vast majority of whom are not currently operating as registered market makers) are concerned, even outraged, by this proposed legislation, which seems ambiguous at best and absurd at worst,” Mike O’Hara, publisher of The High Frequency Trading Review, wrote in a blog on Friday.

Those opposed to imposing market making requirements for HFTs say they would increase spreads and make trading more expensive.

“You can have 25 cent spreads and less messaging, less volume, and less fleeting liquidity, or you can have penny spreads in a hyper-efficient market, but this is only possible through lightning-quick transfer of risk,” Bernard Dan, CEO, Sun Holdings, said at Markets Media’s Chicago Trading and Investing Summit in Chicago this month.

Dan took issue with the view that firms that employ HFT are less accountable for their behavior than other firms.

“Many prop firms like Sun that employ HFT as a means of executing certain trading ideas or pre-calculated strategies re SEC-registered broker-dealers, well capitalized, subject to rules of exchanges and in many cases market makers with obligations,” he said.

For the HFT firms concerned, pulling out of the market on May 6, 2010, was the sensible thing to do, O’Hara said.

“ If you’re running a trading program based upon a set of parameters and those parameters suddenly go right out of whack as volatility goes through the roof and prices collapse in a heap, how do you know that it’s not due to some external catastrophic event, which you might not yet be aware of?” he said. “From a risk management perspective if for no other reason, it makes complete sense to halt your program while you figure out what is going on.”

Regulators in the U.S. and Europe have been wrestling with how to treat HFT and automated trading in general. In the United States, the SEC and CFTC are considering whether to impose requirements on HFTs to function as market makers.

The Joint SEC-CFTC Advisory Committee on Emerging Regulatory Issues earlier this year recommended the SEC evaluate whether incentives or regulations can be developed to encourage those who engage in market-making straggles, a large portion of whom employ high-frequency trading, to provide buy and sell quotations that are reasonably related to the market.

The European Commission, in its 2010 consultation paper on the review of MiFID (MiFID II), proposed that market operators be required to ensure that HFTs continue to provide liquidity on an ongoing basis subject to similar conditions that apply to market makers, and that orders would rest on an order book for a minimum period before being cancelled.

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