EBS's Plan to Slow Down HFT in FX Could Influence Other Regulators

High frequency trading has become a major part of the foreign exchange market, but now one major electronic trading platform is said to be looking at slowing down the practice.

According to a story in today’s Financial Times, EBS, one of two dominant electronic trading platforms – the other being Thomson Reuters — is reportedly speaking to clients about “scrapping the first-in, first out” trading, which gives participants with the fastest computers and networking technology an unfair advantage. This in turn has led to an arms race in technology spending, which is not necessarily related to the peoples’ trading strategies.

As an alternative, EBS is contemplating a plan to batch orders together, which then would be dealt with in a random order, target="_blank"> reports the FT via CNBC. Such a plan could become a “template” for installing regulatory speed bumps as way to control automated traders.

EBS’s CEO Gil Mandelzis, told the FT: “It is a technology race to the bottom, and a huge tax on the industry, since people are having to make significant investments in speed without any connection to their trading strategy.” Mandelzis also told the FT that speed is not the reason why many participants come to the foreign exchange markets. Serious players actually come to the market “to exchange risk; they do not come to race.”

Many large institutions trade foreign exchanges to hedge their portfolios in international equities, so they are not interested in speed alone. But they must use algorithms to place orders within microseconds get to the top of the order book, and they may use colocation to place their servers close to the matching engines of the FX trading platforms. The two popular platforms in the $4 trillion a day market are EBS, operated by interdealer broker ICAP and Thomson Reuters, which also acquired FXall, an institutional platform, in 2012.

But EBS is facing competition from a third system, called ParFX, launched this month, which uses a similar method to impose randomized pauses on incoming orders to offer a “ fair trading system for all,” reports the FT. Large banks, such as Deutsche Bank and Barclays formed ParFX, maintaining that EBS favors HFT. As a sign of the growing appetite for speed, in August 2011, add FX trading capabilities to the Elektron hosted platform, a move designed to capitalize on the growth in global currency trading.

Other platforms include Knight Capital’s Hotspot, an ECN for institutional foreign exchange trading, which was recently acquired by Getco, a global electronic market maker and high frequency trading firm.

Since 2000, HFT has become a rapidly growing phenomenon in foreign exchange. Aite Group estimated that high-frequency FX trading strategies would account for more than 40 percent of all FX trading volume by the end of 2012.

Before taking action, EBS is said to be consulting with clients this week. If it were to implement its plan, it would batch incoming orders after a few milliseconds and roll out the new method slowly across different currencies, according go the FT.

No doubt other regulatory bodies will be watching the steps that are being taken by EBS. The SEC has been studying high frequency trading in equities since the flash crash of May 6, 2010. The Commodity Futures Trading Commission has a Technology Advisory Committee that is working on definitions of high frequency trading for futures. The topic has sparked controversy since academic studies backed by industry firms contend that HFT adds liquidity and lowers tarading costs. So far, neither agency has taken steps to curb high speed trading.