U.S. financial regulators should adopt a broad definition of high-frequency trading to prevent “regulatory arbitrage,” according to an advisory committee to the Commodity Futures Trading Commission.
“It is important to recognize that high-frequency trading is a means rather than an end in itself, and that there are many types of market activity that can be potentially labeled as HFT,” members of a CFTC advisory working group said in a report to the agency’s Technical Advisory Committee.
The working group, includes Getco LLC’s Sean Castette, Deutsche Bank Securities Inc.’s Greg Wood and NYSE Euronext’s Colin Clark, presented their draft definition today at a Washington meeting of the technical committee led by Republican Commissioner Scott O’Malia. The definition spurred divisions on the panel underscoring the difficulty regulators may have in writing rules to govern trading on about half of equities and futures markets.
“We wanted to keep it easy to interpret and difficult to game,” Wood said at the meeting. “We deliberately did not want to define types of high-frequency trading strategies.”
The CFTC, with the Securities and Exchange Commission, has scrutinized high-frequency and algorithmic trading since May 6, 2010, when $862 billion in equity value was erased in 20 minutes before share prices recovered from the plunge. The agency has been drafting a release on new rules, a step prior to a formal proposal.
“I think regulators cannot assume that algorithms in the markets are always well-designed, tested and supervised,” CFTC Chairman Gary Gensler said at the meeting. “To give hedgers and investors the confidence in markets that they really need and deserve, I think regulations always need to adapt.”
The draft definition was the subject of months of internal debate and led to disagreements among the panel, said Joseph Saluzzi, a working group member and co-head of equity trading at Themis Trading LLC. Saluzzi dissented on the definition, saying his institutional clients and long-only hedge funds would be affected.
“It’s not designed to capture the potential bad HFT actors,” he said. “To capture market participants who don’t pose a threat to the market doesn’t seem to make any sense at this point. What are you trying to catch? You’re going to catch everbody.”
Requiring registration and audits of automated trading algorithms would be a waste of regulators’ resources because of the cost and complexity of establishing unique identifiers, a separate CFTC advisory working group said in a summary of its findings to be presented at today’s meeting in Washington.
“Market abuse is not fundamentally a function of the means, speed or frequency of order entry and transactions,” according to the summary. “Focus should be on specific behaviors that undermine market integrity irrespective of the means or pace of order entry.”
The agency’s so-called concept release on regulations may include testing, supervision and protections of participants with direct market access, Gensler said in March. The release, which has circulated among commissioners, “never comes to a conclusion about what’s wrong with the market,” O’Malia said at today’s meeting.