The European Securities and Markets Authority’s (Esma’s) proposals for defining high frequency trading have prompted concern among industry participants.
The proposals come as part of the Paris-based securities watchdog’s wide-ranging consultation on the implementation of MiFID II.
The consultation is the first step in the process of translating requirements of the Markets in Financial Instruments Directive (MiFID II) and its corresponding regulation (MiFIR) into practical rules to address the effects of the financial crisis.
Under Esma’s first approach to defining high-frequency trading (HFT), every firm using co-location techniques and high bandwidth to achieve faster messaging or executions, with high-message intraday rates, defined as a trading frequency of two messages per second, would be recognised as a HFT firm.
“The fact that Esma will consider a trader to be a high-frequency trader if they generate two or more messages per second is arbitrary and could be problematic,” said Irene Aldridge, managing partner of research, development and implementation of high-frequency algorithms at Able Alpha Trading.
Jim Myers, of Sapient Global Markets, agreed that the proposals will likely catch individuals that aren’t engaged in so-called abusive practices.
The quality of technology and co-location isn’t just the domain of the high-frequency traders, said Myers. “When I was an options market maker, I would make over 500 quotes per second at various times during the day,” he said. “I was not a high-frequency trader.”
KEY TAKEAWAYS
Recent proposals from Europe for defining high frequency trading have prompted concern that the definitions will catch too many traders;
Under Esma’s first option, every firm using co-location techniques and high bandwidth to achieve faster messaging or executions, with high-message intraday rates, defined as a trading frequency of two messages per second, would be recognised as a HFT firm;
Lawyers have said told IFLR that, if Esma chooses option one to define HFT, it should be accompanied by a consultative periodic review of the definition.
But Sam Tyfield, a London-based partner with Vedder Price, believed that the first definition has some merits.
“Option one is essentially the German HFT law,” he said. “It has its downsides and it’s quite difficult to operate in practice, but the market now understands the two messages per second parameter and how it’s going to be measured.”
He did however question Esma’s conception of an immediate or cancel order as two messages, saying that it’s one exchange supported order.
“If every immediate or cancel is two messages, the message count that you thought you had under the German law is going to be significantly higher,” he added.
The alternative
Esma’s second definition is based on the high-frequency nature of intraday messaging rates. Under this proposal, trading venues should periodically analyse the average daily lifetime of their orders that have been modified or cancelled.
Because HFT firms are frequently involved in putting orders in the market-place and cancelling them on a short time frame to uncover price differences, they would fall below the average daily lifetime.
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" Regulators shouldn’t be focussed on putting labels on who is a high frequency or low frequency trader " |
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“I was surprised that the second option only tracks high frequency trading in most liquid instruments,” said Aldridge.
“It will force any malicious market participants out of most liquid securities and into less liquid securities where they’re not going to be monitored,” she added.
But Aldridge, who has been working with the US Commodity Futures Trading Commission to create a definition for HFT, recognised the difficulty Esma faces in its task.
According to Aldridge, it would be more productive to consider behaviours in the market that can be attributed to high-frequency traders. “Regulators shouldn’t be focussed on putting labels on who is a high-frequency or low frequency trader, it’s really a question of who is doing what in the markets,” she said.
Tyfield too was resistant to defining HFT. “To a large extent, HFT is defined by the current state of technology, which regularly changes,” he said.
But he did advocate that, if Esma pursues the first option for defining HFT, it should go one step further than Germany.
Germany defines HFT as 75, 000 messages a day, per firm, per exchange, down a 10 gigabit line from a co-located server, on the basis of its understanding of the latest current technology.
I’d like to see Esma commit to a formulaic consultative periodic review of that definition, said Tyfield. “If Esma determines that its information is out of date, it should hold a consultation and refine the definition.”
The deadline for submitting responses to Esma is August 1.
See also:
Maijoor: MiFID II liquidity easier to recognise than define