Regulators vs HFT Firms Debate: Who Blinks First?
The firms large and small that execute deals via high-frequency trading and algorithms are stuck in a waiting game. While they continue to trade at millisecond rates and often with complex formulas created by quants, regulators around the globe are deciding what to do with the technological innovation that is as controversial as it is powerful.
[In the midst of the HFT arms race, Nasdaq and CME Group build a super-fast HFT link between Chicago and NYC regions.]
Government financial regulators including the SEC in the United States and lawmakers in Australia, the European Union, Canada and most of the leading markets in Asia have been debating the benefits and the negative impact of HFT and algorithmic trading since the Flash Crash of 2010 when an algo unleashed by a trading firm in the midwestern United States caused the DOW to drop more than 1,000 points within minutes. (It should be noted that when people discuss that infamous trading day, very few commentators note that the markets regained most of those lost trading points by the end of that trading day in May 2010).
To put it mildly, the critics of HFT and algo trading are getting most of the media attention.
Traders who deal in these high speeds are trying to calm down the critics. At a recent Tradetech conference in London this week, Francois Bonnin, CEO of John Locke Investments, said that he expects fears of high-speed trading will ease, as ComputerWorldUK writes, "as a more measured approach is taken to the technology."
"There has been a lot of stress around high frequency trading, where people really did question the value of it. I think it is the scare of the unknown, rather than anything else," Bonnin told attendees. "When it will be understood a little better it will be just another aspect of our industry, nothing to blame, nothing to go against."
[Spurred by bonuses, hedge fund traders feel pressure to break rules.]
It's more than the fear of the unknown, of course. Some US lawmakers have expressed concerns that HFT firms have an unfair advantage against private traders and smaller trading firms, aka 'mom and pop trading shops.' There are also concerns that untested algorithms can begin to behave erratically and other automated trading systems will see this erratic behavior and follow suit. (See Knight Capital, Summer 2012.)
Forthcoming updates to MiFID II, the sweeping financial regulations from the European Union, also have HFT and its inherent risks in its sights.
"What I am concerned about in particular is that as negotiations progress we are still in a world whereby the ability to trade in the dark where it is legitimate to do so, and the ability to trade with algorithms, which everybody does now, may well become suppressed," said Tim Rowe, head of trading platforms, Financial Conduct Authority (FCA) at the same conference this week.
Rowe continued: "There are people in the regulatory community and in the government community who are concerned by HFT, and they are concerned about the level of dark trading, all of which are legitimate concerns. But the perhaps issue is one of scale. The way that it has transferred into the negotiations for MiFID II is to say things like[...] lets impose strict requirements around running algos, as if algo trading is somehow equated to HFT, and HFT is inherently bad."
This is a good point: As my elementary school teacher once said, all cocker spaniels are dogs but not all dogs are cocker spaniels. Not every trade is done via algos even though most trades are done via HFT. Add in the use of dark pools, where the deals are done with little to no knowledge of who is on the other side of the trade, and you have the exact opposite of what regulators want: transparency.
At some point, either regulators are going to have to give in on their push for transparent markets or traders will have to adjust their trading strategies to deal with tighter controls.
One thing is clear, any nation with looser, anything-goes trading laws just might be the next Wall Street.
Phil Albinus is the former editor of Advanced Trading and he currently edits the FierceFinanceIT newsletter. Follow him on Twitter at @philalbinus.
Phil Albinus is the former editor-in-chief of Advanced Trading. He has nearly two decades of journalism experience and has been covering financial technology and regulation for nine years. Before joining Advanced Trading, he served as editor of Waters, a monthly trade journal ... View Full Bio