European Union lawmakers are poised to approve some of the toughest restrictions in the world on high-frequency trading, the first crackdown in the aftermath of Michael Lewis’s latest book, “Flash Boys.”
The curbs are part of revamped EU markets legislation ranging from commodity derivatives speculation to investor protection. The high-frequency trading limits include standards meant to keep the price increment for securities from being too small, mandatory tests of trading algorithms and requirements that market makers provide liquidity for a set number of hours each day.
“With these rules the EU is putting in place one of the strictest set of regulations for high-frequency trading in the world,” EU financial services chief Michel Barnier said in an e-mail. “While HFT trading might bring some benefits, we need to make sure that it doesn’t cause instability, and isn’t a source of market abuse. That’s what these rules set out to achieve.”
High-frequency trading in stocks grabbed the headlines after the plunge known as the flash crash in May 2010, during which the Dow Jones Industrial Average briefly lost almost 1,000 points. Controversy returned with the publication of Lewis’s book on March 31. Lewis argues that the $22 trillion U.S. stock market is rigged in favor of speed traders, who he says prey on slower investors by getting faster access to information.
Members of the European Parliament will vote tomorrow on EU rules that also include a requirement for traders to have their algorithms tested on venues and authorized by regulators. The assembly in Strasbourg, France, is set to endorse a tentative deal reached with governments on the measures earlier this year.
The draft rules, which predate Lewis’s book, are “the most comprehensive regulatory response yet to HFT,” Christopher Bernard, financial regulation lawyer at Linklaters LLP in London, said in an e-mail.
High-frequency trading involves using powerful technology and computer programs to execute orders in thousandths or even millionths of a second, profiting from fleeting discrepancies in security prices across different trading venues.
The curbs “strike a decent balance,” the FIA European Principal Traders Association, a group that represents high-frequency traders, said in January when a political accord on the law was reached.
The group had warned that more sweeping measures initially demanded by the parliament would lead to higher transaction costs and boost market volatility.
“Mifid has a strong focus on creating transparency in the markets, which electronic trading helps to create,” Mark Spanbroek, vice chair of FIA EPTA said in an April 13 e-mail.
“Automated trading is the most transparent form of trading available, as every single action is recorded electronically,” he said. “Our records mean that regulators can police the market better than they ever have before, which can be harder to do in some other forms of trading.”
The Mifid law will also link overseas-based firms’ market access to whether they are subject to regulations as tough as the EU’s from their home regulator.
While the assembly will vote on the measures this week, their ultimate impact will depend “to a large extent” on technical measures to flesh out the law that are still under discussion, Bernard said.
This week’s vote is a key step toward formal adoption of the law by the parliament, which oversees draft legislation proposed by the European Commission, the EU’s executive arm. After the vote, EU governments will also have to formally sign off on the plans.
The measures will take effect 2 1/2 years after they are adopted and published in the EU’s official journal.
The speed-trading curbs are part of an overhaul of EU markets legislation, known as Mifid.
German legislation on high-frequency trading which entered into force last May preempts some of the updated Mifid standards and “may need to be amended in order to be consistent” with the EU law, Bernard said.
“Whatever the approach, different regulatory responses implemented on different timescales could have the result of fragmenting markets and create the potential for regulatory arbitrage by pushing HFT into other jurisdictions,” he said.
In a bid to reach a deal with governments, parliament negotiators were forced to scrap plans for the law to set a minimum waiting time of half a second for orders to be left on the market.
While the parliament had also said that high-frequency traders, when carrying out market making, should have to run their algorithms throughout the trading day, the final deal goes less far.
Under the accord, firms will have to run algorithms “during a specified proportion” of the day, agreed in writing with the trading platform. The firm can be granted leeway “under exceptional circumstances.”
Market making is the practice where a bank or other investment firm issues simultaneous buy and sell orders for the same security.
“Most of our ideas were taken into the final text,” Sven Giegold, a German lawmaker who represented the assembly’s Green group in the Mifid talks, said in an interview.
“We don’t have the minimum holding period, but we do have the tick-size regime, which will have a similar effect,” he said. “We think it will limit HFT substantially.”
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