10.16.2012
By Terry Flanagan

Retail Investors Fearful of Evaporation of Liquidity From MiFID II

Market participants in the retail space are genuinely concerned that the European Union’s seeming mission to slow down high-frequency trading may actually have the unintended consequence of obliterating liquidity in equity markets.

There are fears that if certain rules proposed in the European parliament’s latest draft of MiFID II, which promises sweeping reforms to Europe’s financial markets, make it on to the statute books then many high-frequency traders may just pack up their computers and head to less onerous jurisdictions. The standout anti-HFT proposal in MiFID II revolves around a minimum resting time for orders being introduced so that orders have to remain valid on an exchange for at least 500 milliseconds.

This theme that HFT was not the demon that it was portrayed to be by certain sections of the media resonated at Markets Media’s inaugural European conference in the plush surrounds of the May Fair hotel in central London late last week.

“In terms of retail investors, HFT is a good thing,” Michael Horan, director and head of trading services at Pershing, part of custody bank BNY Mellon’s empire, told delegates at Markets Media’s European Trading Investing Summit on October 11.

“Spreads have tightened and there is more liquidity out there right now, especially during the current market climate where trading volumes have fallen. We should be happy with HFT guys as they are providing liquidity. You shouldn’t bite the hand that feeds you.”

High-profile trading snafus, such as this year’s Knight Capital software glitch and the botched IPOs of both Facebook and Bats Global Markets, have also put retail investors on edge, with some fingering HFT as the culprit.

“When you have electronic markets you sometimes have errors,” said David Miller, senior dealer at Invesco Perpetual, a U.K. investment manager. “HFT is a very useful source of liquidity. A lot of my counterparties I know are high frequency. You have to treat HFT with respect and very carefully, but I think it would be a great shame if high-frequency liquidity was taken away from us.”

And there are real fears of many retail market participants that vast swathes of liquidity will just vanish overnight if MiFID II, which is set to become law around 2015, comes down particularly hard on HFT.

“If you look at the Fese [Federation of European Securities Exchanges] statistics and you map them against the European Central statistics, only 2.3% of the number of orders that get transacted on a daily basis in Europe actually result in a change of beneficial ownership,” said Peter Randall, chief executive of Equiduct Systems, a retail-focused pan-European electronic trading platform.

“So, 97% of activity is effectively flat at the end of the day. If you change the rules and remove some of that 97% then liquidity is going to contract very rapidly.”

However, many institutional investors generally have a less positive slant on HFT, despite trading costs coming down significantly since the advent of the original MiFID document in 2007, which had the intention of harmonizing European markets but, in the end, caused huge change and fragmentation to the marketplace. HFT has also sprung to greater prominence since around the time of MiFID I due to huge technological advancements.

“The fragmentation of liquidity [since MiFID I in 2007] has brought prices down in terms of the cost of trading,” said Horan at Pershing. “It is all very necessary and it has worked out quite well. Everyone has dealt with the market okay. The retail investor is okay. He or she can still trade on the RSP [retail service provider]. Nothing untoward has happened but now this challenge of HFT has sprung up and these guys have come along and looked at the arbitrage opportunities between the MTFs [multilateral trading facilities] and the primary exchanges and realized that they can make a bit of money. There is nothing wrong with that.

“But you get a different response from institutional clients than you do for retail clients on HFT. Institutions that are buying huge blocks of Glaxo, say, over the day don’t really like these guys that are using their trading environment as a playground and gaming them. That is why they tend to have to go in the dark to do their business.”

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