High Frequency Trading Regulation - White Papers

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Timeline, Interpretive Guidance on Disruptive Practices
Proposal Date Comment Deadline Final Rule Issue
March 18, 2011 May 17, 2011 May 16, 2013

Futures Market Volatility: What Has Changed? - August 2013

August 2013

On August 27, 2013, two professors from the Owen Graduate School of Management, Vanderbilt University, released a study on futures market volatility amid advances in technology and whether futures return volatility has changed through time. The study looks at two benchmarks for intraday futures return volatility - one that looks at implied volatility and one that considers real price movement or "realized volatility."

From the paper:

"Taken together, these two results indicate that, after controlling for changes in the rate of information flow, there is no evidence to suggest that realized return volatility in electronically-traded futures markets has changed through time, at least with respect to the fifteen contract markets that were examined."

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The Trading Profits of High Frequency Traders - Baron/Brogaard/Kirilenko - November 2012

December 3, 2012

On December 3, 2012, CFTC Chief Economist Andrei Kirilenko, along with professors Matthew Baron and Jonathan Brogaard, released a preliminary draft of a research paper, "The Trading Profits of High Frequency Traders." Commissioner Bart Chilton said that the study would make it easier for regulators “to put forth regulations in a streamlined fashion. It’s a key step in the process and it should fuel-inject the regulatory effort going forward.” [1]

Among the paper's findings:

"Using data that identify individual firms, this paper examines the profitability of HFTs. This paper has three key findings. First, HFT is highly profitable (before incorporating operating and trading costs) but not without risks. The magnitude and consistency of their profits as well as their risk-return tradeoff demonstrate unusually strong performance. Second, HFTs are a heterogeneous set of firms that have different trading and profit characteristics. Third, we describe different market conditions and firm characteristics that are associated with profitability, such as aggressiveness, speed, and newness. Our findings shed light on the competitiveness of the HFT industry and provide insight into the determinants of HFT profitability."

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The Rationale for AT 9000, August 2012

August 6, 2012

On August 6, 2012, three professors from Illinois Institute of Technology, Ben Van Vliet, Andrew Kumeiga and Rick Cooper, along with Jim Northey of FIX Protocol, Ltd., released a paper that outlines a quality management system for high-frequency trading based on commonly-accepted engineering standards. The paper, entitled The Rationale for HFT 9000: An ISO 9000-style Quality Management System for High Frequency Trading, details the reasoning, framework and implementation of a set of proposed industry best practices for HFT.

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Finance Watch - Investing not Betting, April 2012

April 2012

On April 24, 2012, Finance Watch, a Brussels-based international public interest group established in 2011 to counter financial industry lobbying, published a position paper that advocated a tough stance on MiFID II, and called for enhancements on the regulation of: [2]

The position paper offers its key points, and makes several recommendations on the above topics.

To view the report, along with a summary of the report and its conclusions, click the link below.

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SIFMA - Impact of High Frequency Trading and Considerations for Regulatory Change, December 13, 2011

December 13, 2011

The SIFMA white paper highlights some of the regulatory measures that have been put into place or are currently being considered, as well as other areas that warrant further study and possible regulatory action. Those areas include:

  • Limits on excessive market data traffic;
  • Ensuring market data quality;
  • Maker-taker pricing/rebates and access fees;
  • Market maker incentives and obligations; and
  • Additional empirical studies in areas such as micro-level volatility and the identification of certain HFT behavior that may exacerbate market volatility.

The white paper also points out certain proposals that have been suggested by regulators that may have unintended negative consequences, such as:

  • Transaction taxes;
  • the banning of high-frequency trading or other forms of computer-based trading;
  • imposing artificial limits on technological advances; and
  • a "trade at" rule.
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Bank for International Settlements - High-frequency trading in the foreign exchange market, September 2011

September 2011

The report presents the results of a fact-finding exercise conducted by a Study Group consisting of FX market experts from 14 BIS Markets Committee member central banks. It consists of the following six sections:

  • Section 1 describes the characteristics of HFT, how HFT features in the FX market landscape and its relationship with other market participants such as FX prime brokers and major FX dealing banks.
  • Section 2 discusses the effect of HFT on price discovery and liquidity.
  • Section 3 examines the behaviour of HFT in two recent episodes of volatile market conditions.
  • Section 4 highlights the key similarities and differences between HFT in FX and HFT in equities.
  • Section 5 discusses the current practices of self-regulation of HFT in FX.
  • Section 6 concludes with lessons learned in areas such as market functioning, systemic risks, market integrity and competition.
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Guidelines on systems and controls in a highly automated trading environment for trading platforms, investment firms and competent authorities - July 2011

July 2011
Contents of the paper:

  • The background to the draft guidelines in the context of ESMA’s work on microstructural issues.
  • The draft guidelines on organisational requirements which are relevant in a highly automated trading environment for electronic trading systems, fair and orderly trading and dealing with market abuse (in particular market manipulation). There are separate standards in each of these areas for trading platforms (regulated markets and multilateral trading facilities) and investment firms executing orders on behalf of clients and/or dealing on own account.
  • The draft guidelines covering direct market access (DMA) and sponsored access (SA). Again, there are two separate sets of standards relating to trading platforms and investment firms.
  • Seven annexes consisting of relevant MiFID regulations, cost-benefit analyses, academic evidence on high frequency trading, and related issues.

ESMA accepted public comments on this paper until October 3, 2011.

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The Brattle Group: Trading at the Speed of Light: The Impact of High-Frequency Trading on Market Performance, Regulatory Oversight, and Securities Litigation - 2011

Conclusions from the white paper:

"In principle, high-frequency trading should not have a large impact on prices, given that HFT firms control very little capital and take minute, very brief positions in securities. Moreover, high-frequency traders can provide greater liquidity and market efficiency, either by acting as market-makers or as statistical arbitrageurs across markets. On the other hand, errant or poorly designed HFT programs without necessary risk controls could lead to occasional shocks or disruptive events, such as those we have witnessed globally over the past year. In addition, the implementation of certain HFT strategies has raised concerns about their fairness, given the availability of certain tools to high-frequency traders that are not widely available to other types of investors.

As a result of the controversies surrounding HFT and other less transparent corners of the markets, the CFTC and SEC are conducting ongoing investigations of the impacts of these strategies, and proposing solutions to address their potentially adverse side-effects. Finally, the increased volume of HFT over the past decade creates several possible ramifications for securities litigation in the future, to the extent that it changes our understanding of market efficiency and other metrics that affect liability and damages estimation in lawsuits."

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Deutsche Bank Research: High Frequency Trading:Better than its Reputation? - February 7, 2011

February 7, 2011

The white paper offers a summary of algorithmic and HFT terminology, strategies, impact analysis, economic perspective, and potential regulatory challenges.

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Optiver: High Frequency Trading Position Paper - December, 2010

December, 2010

From the white paper:

Recent scientific research has shown that, when used for market making activities or employed in statistical arbitrage, HFT generally increases liquidity to the markets and reduces the volatility. Furthermore it reduces the spreads, leads to lower tick sizes and thus improves the overall market quality. These effects of HFT benefit all market participants, from small retail investors to large brokers and institutional investors.

Despite scientific research showing that HFT is generally beneficial to the market, there are many misconceptions. HFT is for example accused of withdrawing liquidity when markets are volatile, although the facts show that this is not the case. Examples of other misconceptions are HFT firms are sometimes accused of front running, that they benefit from quote stuffing strategies or that they have an unfair advantage over other market participant by using sponsored access or co-location.

Based on such misconceptions some regulators and politicians have recently proposed introduce additional regulations to limit the effect of HFT. Of all these proposals introducing a financial transaction tax will have the most dramatic impact on the quality of the market. Trading volumes would reduce significantly and liquidity and price discovery will be seriously impacted, thus harming not just HFT but all market participants. Other measures, such as imposing quoting obligations or minimum quote durations and reducing the speed with which HFT firms can trade will either result in wider spreads or reduced liquidity.

One proposal that Optiver believes will truly work and will not harm the quality of the market is the introduction of circuit breakers, which have already been implemented by several exchanges.

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Jonathan Brogaard, Kellogg School of Management: High Frequency Trading and its Impact of Market Quality - July 16, 2010

July 16, 2010

Conclusions from the white paper:

  • HFT make up a large majority of all trades. They supply liquidity in about half of all trades and demand liquidity in about half as well. Their activities in the market, both in initiating trades and in providing liquidity, are stable over time.
  • There is no evidence of abusive front running occurring.
  • The HFT firms are profitable, making around $3 billion between the 26 of them, and prefer to trade in large stocks with lower volume, lower spreads and depth, and companies that are considered value firms. They tend to make more money in volatile times. *HFT prefer to demand liquidity in small amounts, usually in value between $1,000 and $4,999, and they tend to have lower time between trades than non-HFT.
  • They provide the best quotes about 45% of the time. They provide more inside quotes for larger value firms, with lower volume, lower volatility, lower spreads and depth, and with greater number of trades.
  • From the different Hasbrouck measures, the evidence suggest HFT play a very important role in price efficiency and the price discovery process. In fact, they provide more useful information to the price generation process than do non-HFT.
  • HFT activity either has no impact on volatility or tends to decrease it.


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References

  1. High-Speed Traders Profit at Expense of Ordinary Investors, a Study Says. New York Times. Retrieved on December 10, 2012.
  2. Investing not Betting. Finance Watch. Retrieved on June 25, 2012.

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