10.17.2012
By Terry Flanagan

Minimum Resting Time in Europe Is ‘Going To Be Awful’, Warn Market Users

Blink and you may have missed it. Or, maybe not.

The European parliament’s controversial proposal to introduce 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 leave market participants bewildered, to say the least, and also fearful of the potential consequences.

This was apparent during many of the panel sessions at Markets Media’s inaugural European conference at the May Fair hotel in central London late last week.

One of the main worries over the new rule, which is one of the more controversial proposals of the updated Markets in Financial Instruments Directive, or MiFID II, to make it into the final European parliament draft last month, is that liquidity will vanish if the ruling makes it on to European statute books.

“This 500 millisecond approach is going to be awful,” Jose Marques, managing director and global head of equity electronic trading at Deutsche Bank, Germany’s largest bank, told Markets Media’s European Trading Investing Summit on October 11.

“The problem is if we enshrine a new rule in the wrong place in market structure and we make it part of the MiFID II regime it then becomes very difficult to correct an error. There will be a downside for everyone—if it negatively affects capital markets you can also start knocking off 5%-10% of GDP.”

Spreads, which have come down in recent years—due in no small part to high-frequency trading—will also likely widen substantially if the minimum resting time ruling is introduced.

“A good example to show that spreads would widen, which is not even relatively high-frequency driven, is an ETF [exchange-traded fund] market maker, who I imagine would be classed as high-frequency, because in its nature he is market making,” said Owain Self, global co-head of direct execution and global head of algorithmic trading at UBS, a Swiss investment bank.

“But if you’re trading an ETF in Euro Stoxx 600 or a fixed income ETF where the underlying price of the constituents could change thousands of times a second and you are only allowed to update your quotes twice a second, you are going to have to have a wider spread to allow for that volatility on the underlying price. So spreads are bound to widen.”

Panelists also believed that the potential 500 millisecond ruling would hinder technological advancements in the market place and that it may not even achieve its aim of lessening the influence of high-frequency traders in European markets. HFT is now thought to account for around 40% of all trades on European equity markets.

“You shouldn’t be legislating against technology by making orders rest for 500 milliseconds,” said Michael Horan, director and head of trading services at Pershing, part of custody bank BNY Mellon’s empire. “If you do that, spreads will widen and HFT will not be interested.”

And HFT firms in the future may just redirect their gaze to pinpoint 499 and 501 milliseconds to generate their profits by picking off traders whose orders have remained in clear sight for half a second or more.

“Once the rules are put in place, especially the 500 millisecond rule, it will just create the same thing but slower,” said Horan. “It will not solve anything, we need to be very careful.”

While others in specific European markets were fearful that they could be unwilling early adopters of the controversial 500 millisecond ruling. Germany, for example, has pushed ahead with its own laws, to front-run MiFID II, on high-frequency trading and their laws are likely to be implemented some time next year. MiFID II, on the other hand, is not expected until 2015.

The current German regulation on HFT, which will eventually have to fall into line with MiFID II under European Union law, has no mention of introducing a minimum resting time, but it could add it into its law earlier than the rest of Europe if MiFID II does include the 500 millisecond proposal. German exchanges, for example, are fearful that they will become unwitting guinea pigs.

“Of course we need to be careful, especially Germany, otherwise we would have to implement all these rules prior to other markets in Europe—especially the 500 millisecond rule,” said Michael Krogmann, executive vice-president of Deutsche Börse, operator of the Frankfurt Stock Exchange.

The buy side, though, believe something should be done to quell high-frequency trading although not necessarily via this 500 millisecond ruling.

“They need to cap trading speeds,” said Jason Rolf, a fund manager at Amati Global Investors, an investment manager. “A thousandth of a second. I don’t see what benefit is added by trading quicker than that.”

However, there is some way to go in the political process in Brussels before MiFID II becomes binding. The European parliament’s Economic and Monetary Affairs Committee draft of MiFID II will soon 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.

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