RBA’s Debelle Says High-Frequency Trades May Reduce Liquidity Amid Stress

High-frequency trading, in which firms use computers to buy and sell thousands of times securities a second, may reduce liquidity amid market stress, Reserve Bank of Australia Assistant Governor Guy Debelle said.

“While liquidity is improved in normal times, HFT is causing changes in the ecology of the market which result in a worsening of liquidity in stressed circumstances,” Debelle said in prepared remarks for a speech in Sydney today.

High-frequency traders came under increased regulatory scrutiny following the so-called flash crash in May of last year, during which the Dow Jones Industrial Average briefly lost almost 1,000 points. Debelle chaired a Bank for International Settlements study group that examined such trading in currency markets, in particular around the Dow Jones incident and when the yen soared in March of this year.

“The general sense of the evidence from May 2010 is that HFT participants were very active in the foreign-exchange market before, during and after the time of the flash crash,” Debelle told the ACI High Frequency Trading Conference.

“However, while they were present, it is an open question about the quality of the liquidity being provided,” he said. “This episode also supports the proposition that while not necessarily being the initiator of the shock, HFT can propagate a shock brought on by a rogue or poorly specified (non-HFT) algorithm.”

Yen Movements

In examining the yen on March 17, when the currency jumped 4.5 percent in 26 minutes, Debelle said there were indications that HFT traders acted in similar fashion to traditional participants who withdrew from the market.

The European Union is planning to impose limits on high- frequency trading firms to prevent a glut of trades from “overloading the systems of trading venues,” generating “erroneous orders” or “otherwise malfunctioning” in a way that may create a disorderly market, according to a draft version of the measures scheduled to be formally proposed later this month.

Debelle also said discussions with participants in the market suggest that “diminishing returns to speed” have well and truly set in, such that the value of future gains may not be worth the investment cost.

“Indeed, there was a general sense that HFT was reaching a mature phase, where greater returns were more likely to be had from moving into new market segments rather than spending more on enhancing speed,” he said.

Debelle, assistant governor responsible for financial markets, said his speech was based on a recent report by the Markets Committee of the BIS that presented the results of a study group he chaired consisting of foreign-exchange market experts from 14 central banks.

To contact the reporter on this story: Michael Heath in Sydney at mheath1@bloomberg.net

To contact the editor responsible for this story: Stephanie Phang at sphang@bloomberg.net

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