Regulators Should Avoid Choking HFT Benefits, Study Says
European regulators should coordinate controls on high-frequency trading to prevent disruptions in markets without choking off its benefits, the U.K. government’s lead scientific adviser said.
His report recommended pan-European circuit breakers to halt trading when swings become too great and proposed minimum trading price increments to boost liquidity. Tighter restrictions, such as forcing traders to hold orders for a certain period or limiting how often they may be canceled, are “likely to be problematic,” it said.
While computerized trading has increased liquidity and lowered costs, regulators should work on managing instances of sudden instability and disruptions,John Beddington, Britain’s chief scientific adviser, said at a presentation in London yesterday. The recommendations follow research his group published in September 2011 that found high-frequency trading isn’t spurring broad increases in volatility even as it sometimes creates “instability” that may lead to crashes.
“The commonly held negative perceptions surrounding high- frequency trading are not supported by the available evidence, but policy makers’ concerns are justified about the effect the practice may have in some specific circumstances,” Beddington said. The two-year study, produced by about 150 people from more than 20 countries, found no direct evidence that faster trading increased volatility or market abuse.
High-frequency trading is the broad label applied to computerized strategies that rely on the rapid placement of orders, many of which are immediately updated or canceled, for purposes such as market making and statistical arbitrage. The practice accounts for about 30 percent of transactions in the U.K. and probably more than 60 percent in the U.S., according to the report.
HFT came under increased scrutiny after the so-called flash crash in May 2010, during which the Dow Jones Industrial Average briefly lost almost 1,000 points. While high-frequency traders didn’t cause the rout, their habit of buying and selling rapidly led to the sudden removal of liquidity from futures markets, kicking off a related plunge in stocks, a report by the U.S. Securities and Exchange Commission and Commodity Futures Trading Commission said on Sept. 30, 2010.
Following the flash crash, U.S. exchanges instituted curbs that halt stocks when they move 10 percent in five minutes. The SEC in July refused to recommend larger minimum tick sizes on American equity markets, saying more discussions may generate ideas for a pilot study to test bigger increments for some stocks. Critics have argued that ever-narrowing spreads on securities transactions have hurt smaller companies because making markets in them is less profitable.
Today’s paper, “The Future of Computer Trading in Financial Markets,” was produced by Foresight, a division of the Government Office for Science. The program provides evidence to aid the formulation of policy and doesn’t reflect the views of the government.
The report called for the adoption of software for forensic analysis of extreme market events, including synchronized timestamps that could allow regulators in different countries to detect the sequence of trades.
Regulating the algorithms used by computer traders would be too costly and cumbersome, according to the study’s contributors, who include Dave Cliff of the University of Bristol, Jean-Pierre Zigrand of the London School of Economics and Oliver Linton of the University of Cambridge.
To contact the reporter on this story: Alexis Xydias in London at firstname.lastname@example.org
To contact the editor responsible for this story: Andrew Rummer at email@example.com