High-Frequency Traders May Win Reprieve in Flash-Crash Rule

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High-frequency traders may win a partial reprieve from proposed European Union rules designed to prevent a repeat of the so-called flash crash after banks and exchanges including Deutsche Bank AG and NYSE Euronext warned they could damage markets and lead to an exodus of traders.

The European Parliament may scrap plans to force firms that use algorithmic-trading programs to continue trading throughout the day, said Markus Ferber, the lawmaker writing the assembly’s response to the proposals. The measure was meant to prevent them creating volatility by diving in and out of the markets.

“We are really rethinking on the whole approach the European Commission has proposed,” Ferber said in an interview. The all-day trading rule was intended to promote market liquidity by ensuring a steady supply of buyers and sellers. “No one can answer me” why such firms should be expected to provide liquidity throughout the trading day, Ferber said.

High-frequency traders came under increased regulatory scrutiny following the so-called flash crash in May 2010, during which the Dow Jones Industrial Average briefly lost almost 1,000 points. The liquidity rule is one of several curbs proposed by Financial Services Commissioner Michel Barnier last year as part of a wider overhaul of an EU markets law, known as Mifid.

Continuous Trading

High-frequency trading, often used by hedge funds, entails using powerful technology and complex computer programs to execute orders in milliseconds to profit from fleeting discrepancies in the prices of shares across different trading venues.

Barnier’s proposals would require algorithmic trading strategies to be in continuous operation during trading hours and to offer quotes at competitive prices regardless of prevailing market conditions, according to a copy of the plans published on the commission’s website.

“This proposal defied logic from the outset,” Etay Katz, regulatory partner at law firm Allen & Overy LLP in London, said in an e-mail. “If anything, it would act to decrease liquidity -- due to many market participants withdrawing -- and substantially increase market risk for frequent traders.”

The liquidity rule may increase costs for high-frequency trading companies and place them at a disadvantage to other traders who are allowed to withdraw from the market, NYSE Euronext warned when the plans were announced last year. This may encourage firms to shift their activities out of the 27-nation EU, it said.

‘Significant Problems’

The rule would “cause significant problems” and should be reworked or scrapped, the Association for Financial Markets in Europe, which represents banks including Deutsche Bank, UBS AG and BNP Paribas SA said in a statement last month.

“We believe that this would have grave consequences for the markets -- in terms of systemic risk with increased order-flow and for credit risk -- as firms are forced to provide quotes,” the Federation of European Securities Exchanges, also said last month.

Barnier’s proposals need to be approved by national governments and lawmakers in the European Parliament before they can be implemented.

FESE’s members include NYSE Euronext and Deutsche Boerse AG, the exchanges whose planned merger was blocked by EU regulators last week.

Ferber said the EU Parliament will also consider scrapping part of the Mifid overhaul that would create a new kind of trading platform known as organized trading facilities.

Regulated Markets

Under the commission’s proposals, these OTFs would handle derivatives that are currently traded over-the-counter, so away from regulated markets. They would be subject to similar rules as other kinds of trading venues, the commission said.

Jean-Pierre Jouyet, chairman of France’s financial market regulator, has warned that new venues risk diverting trading away from more heavily regulated venues, such as exchanges.

“The question we have to answer in the European Parliament is whether a new venue is really necessary,” Ferber said. “Is there a need for a new platform with less transparency in some areas?”

Ferber said the Parliament’s economic and monetary affairs committee will discuss Mifid when it meets on Feb. 13 in Strasbourg, France.

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