Automated and High Frequency Trading, Latency, and Financial Regulation

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High-frequency traders (HFTs) can trigger cascades and spirals, due to their highly correlated algorithmic trading strategies, thereby exacerbating market shocks, particularly in stressful times. It may also be problematic if HFTs succeed in crowding out long-term risk-bearers, slower traders from the market.

There is a lot of complaining from the buy side about HFTs, especially from institutional investors, but further ‘good faith’ discussions on how best to cope with these technological and market changes are needed. HFTs need to have the buy side around, with their occasional trade orders, to actually make a profit. And one should not forget that HFTs connect buyers and sellers that happen to arrive at different times on different trading venues, which is critical for smooth functioning in the securities markets. Nonetheless, one should not overlook the fact that there are two categories of HFTs, the so-called ‘HF makers’, but also the ‘HF bandits’.

As for the contribution of HFTs to liquidity in Europe’s fragmented equity markets, internal research by ESMA has revealed that there are more duplicated orders across several trading venues for HFTs (around 30%), compared to non-HFTs (around 10%). It was also noted that many regulators and policy-makers are currently focusing on latency measures to slow things down so as to remove this advantage of HFTs, e.g. minimum quote life, adjusting time stamps. Recent empirical studies showed that trade platform latency and volatility are highly correlated and recommended mandatory disclosure of information on latency on an on-going basis.

At EU level, the MiFID II provisions on the calibration of circuit breakers/trade halts to the liquidity of asset classes and the wide-market coordination were positively received. Some concerns were voiced, however, on the use of circuit breakers, e.g. there is no need to shut down the entire market, five-second trade pauses when one cannot submit/modify/cancel orders should suffice.