High Frequency Trading Regulation

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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

High frequency trading (HFT) is the general term for a type of algorithmic decision making strategies used by firms to take advantage of miniscule price discrepancies in financial markets. Proponents of such quantitative strategies claim they are simply reacting to market information in a manner similar to the way trading firms have traditionally reacted to market information, only much more quickly. However, regulators such as the CFTC and SEC have begun to investigate certain HFT tactics such as "spoofing," "flash trading," and "quote stuffing." Quote stuffing, in which large numbers of orders are sent and immediately canceled, has been suspected as one of the reasons behind the May 6, 2010 "Flash Crash."[1][2]

In the wake of the "Flash Crash" of May 6, 2010, the SEC and CFTC formed a joint committee to study emerging regulatory issues. Its conclusions and recommendations, which were released on February 18, 2011, included several areas addressing HFT, including:

  • the implementation of minimum quoting requirements by market makers;
  • restrictions on co-location and direct access;
  • liquidity rules such as penalties for rapid order cancellation; and
  • a request for further study and potential regulatory changes.

HFT participants, including the FIA Principal Traders Group generally supported the study's findings and recommendations. According to the group's press release, the PTG "agrees with the committee’s conclusion that market-based incentives are more effective than mandatory obligations in promoting well-functioning markets", and "looks forward to working with the regulators and the exchanges on developing safeguards that will prevent clearly erroneous trades and other market malfunctions."[3]

Some regulators, however, voiced concerns that HFT still poses systemic risk. One staunch critic of HFT is CFTC Commissioner Bart Chilton, who in June 2011 said that "regulators have largely failed to police high-frequency trading, which accounts for roughly 50 percent of European trading and about a third of activity in the United States markets."[4]

Proponents of high frequency algorithmic trading, however, point to several studies and white papers that highlight HFT's contribution to enhanced market liquidity, greater price efficiency, and reduction in volatility.[5]

At a meeting of the CFTC Technology Advisory Committee meeting on June 20, 2012, a subcommittee working group submitted its draft definition of HFT. According to the subcommittee, high frequency trading is a form of automated trading that employs:

  • algorithms for decision making, order initiation, generation, routing, or execution, for each individual transaction without human direction;
  • low-latency technology that is designed to minimize response times, including proximity and co-location services;
  • high speed connections to markets for order entry; and
  • high message rates (orders, quotes or cancellations). [6]


Contents

HFT Regulation in the News (Reverse Chronology)

  • In April 2014, the New York Attorney General's office sent out its first wave of subpoenas in its HFT investigation. The subpoenas went to Chopper Trading, Jump Trading and Tower Research Capital.[7]
  • In March 2014, New York Attorney General Eric Schneiderman announced an investigation into HFT which he said gives such firms "unfair advantages that give them early access to key data."[8] Two weeks later, author Michael Lewis' book "Flash Boys," which highlighted the tactics and profits of HFT, ignited controversy about such trade practices and, in a segment on CBS News' 60 Minutes program, Lewis called the U.S. stock market "rigged." [9]
  • On October 22, 2013, the European Union agreed to a preliminary compromise deal on MiFID rules regarding HFT that would drop the requirement that quotes stay on the book for 500 milliseconds, in exchange for other concessions. These agreements tentatively include a binding agreement on minimum tick size, the implementation of a time synchronization system across markets, and restrictions on direct market access.[10]
  • On July 22, 2013, U.S. and U.K. regulators fined Panther Energy Trading and its owner, Michael Coscia, $4.5 million to settle charges of market manipulation.[11] This marked the first use of the CFTC's rules on disruptive trading practices.
  • At a March 7, 2013 meeting, the SEC proposed its Regulation SCI, improving system compliance and integrity. Under the proposed rules, self-regulatory organizations, certain alternative trading systems, plan processors, and certain exempt clearing agencies would be required to carefully design, develop, test, maintain, and surveil systems that are integral to their operations.[12]
  • In February 2013, a German parliamentary committee approved a bill requiring firms that use the computer- driven strategies to register with banking authorities. The requirement would likely make global trading firms participating in German markets pay the European Union’s proposed financial transaction tax (FTT).[13] This law will affect firms trading outside of Europe who trade on German markets by requiring that they establish locations in Europe and apply for licenses from German regulators and other regulators in EEA countries.[14]
  • 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.” [15] View the paper
  • On October 30, 2012, the CFTC’s Technology Advisory Committee (TAC) met in Chicago to hear updates from its Subcommittee on Automated and High Frequency Trading. Among the issues discussed were HFT definition, marketplace quality and quality management systems, information sharing and risk controls. For a summary and commentary by Zach Ziliak, click here.
  • On October 2, 2012, the SEC held a roundtable on HFT in the wake of the August 1, 2012 Knight Capital disruption. For a summary and commentary by Zach Ziliak, click here.
  • On Aug. 1, 2012, Knight said its market-making unit suffered “a technology issue” that affected the routing of trades on around 150 stocks on the New York Stock Exchange.[16] The following day, Aug. 2, 2012, Knight acknowledged that it expected the previous day's algorithmic glitches to cost $440 million, and that the firm was "seeking ways to strengthen its capital base."[17]
  • On June 20, 2012, the CFTC held a public meeting of its Technology Advisory Committee. For a summary and commentary on the meeting by TAC member John J. Lothian, click HERE.
  • On May 25, 2012 Nasdaq and DirectEdge announced the introduction of fees on high-frequency traders who send a large number of order cancellations into the exchanges, effective June 1, 2012. [18] Such rules had been under consideration for some time, but calls for action increased after a large number of order cancellations was blamed for order matching glitches surrounding the IPO of Facebook, Inc. on May 18, 2012.
  • On February 29, 2012, CFTC Chairman Gensler announced that the commission will soon be issuing a "concept release" on the regulation of HFT, to "address potential market disruptions that high-frequency traders and others who have automated market access can cause."[19]
  • On February 9, 2012 the CFTC Technology Advisory Committee (TAC), under the direction of Commissioner Scott O'Malia, announced the formation of a new subcommittee on HFT.[20] The subcommittee consists of four working groups, with each group assigned to study specific HFT and algorithmic trading issues.


Video

Raj Mahajan, Allston Trading CEO, Talks HFT and the Business of Prop Trading, April 2013

Raj Mahajan took the reins at Allston Trading as CEO in September 2012 and has spent a good deal of his time looking at the issue of high frequency trading (HFT). Allston has been one of the proprietary trading firms who has been willing to publicly discuss HFT, regulation and the future of that form of trading. Mahajan spoke with JLN’s editor-in-chief Jim Kharouf about HFT as well as the business challenges and opportunities for prop firms.

HFT Rules: Rules for the Algo Highway, January 2013

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Customer confidence has been hit by a number of different events over the past several years and high frequency trading (HFT) problems have been among them. Ben Van Vliet, assistant professor of finance, Stuart School of Business, Illinois Institute of Technology has been looking the creation of a standard set of rules high frequency trading participants can use to ensure safer markets. Van Vliet has helped initiate the AT 9000 system, which would implement standards for HFT design, backtesting, implementation and portfolio and risk management. Van Vliet says its important that the industry support such a project, rather than wait for regulators to dictate new standards and rules for participants.

Published January 22, 2013. Watch at MarketsWiki.tv

HFT Rules: Three Part HFT Harmony, January 2013

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High-frequency trading (HFT) has been in the financial press a lot over the past several years. From the Flash Crash of 2010 to the collapse of Knight Capital in 2012, trading glitches and the negative impact of HFT on markets and investor confidence is well-documented. In this segment of the Restoring Customer Confidence series, Mayer Brown attorney Zachary Ziliak outlines the three sources that will address HFT and help restore customer confidence.

Ziliak says regulatory bodies will likely continue to address HFT guidelines, exchanges are imposing new fees on HFT practices and AT 9000, standards system for HFT practices, will help establish a higher bar for HFT participants.

Published January 22, 2013. Watch at MarketsWiki.tv

David Ruder – Northwestern University School of Law (Part 1) [INTERVIEW]

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Northwestern Law School professor emeritus David Ruder talks to editor/producer Nicole V. Rohr about his experience as SEC chairman during Black Monday in 1987, and also about what stemmed from the subsequent flash crash in May 2010. Ruder was a part of the President's Working Group on Financial Markets in 1988 and more recently worked on the Joint CFTC-SEC Advisory Committee on Emerging Regulatory Issues. He discusses findings and changes to rules surrounding circuit breakers, dark pools and naked access. Published February 27, 2012. For more video, visit MarketsWiki.tv.

References

  1. How speed traders are changing Wall Street. CBS News. Retrieved on June 20, 2011.
  2. Regulator Takes Aim at High Frequency Traders. Forbes. Retrieved on June 20, 2011.
  3. FIA PTG Responds to Joint CFTC-SEC Advisory Committee Recommendations (Feb. 18, 2011). FIA. Retrieved on June 23, 2011.
  4. Regulator Warns of ‘Cheetah’ Traders. New York Times. Retrieved on June 20, 2011.
  5. What if High Frequency Trading Is Really a Good Thing?. Seeking Alpha. Retrieved on June 20, 2011.
  6. CFTC Technical Advisory Committee Sub-Committee on Automated and High Frequency Trading. CFTC. Retrieved on June 22, 2012.
  7. N.Y. Attorney General Sends Subpoenas to High-Speed Firms. WSJ.com. Retrieved on April 16, 2014.
  8. New York's Schneiderman seeks curbs on high-frequency traders. Reuters. Retrieved on April 3, 2014.
  9. Michael Lewis Explains His New Book "Flash Boys". CBS News. Retrieved on April 3, 2014.
  10. EU agrees preliminary deal to rein in speed traders. Reuters. Retrieved on October 23, 2013.
  11. Panther, Coscia Fined Over High-Frequency Trading Algorithms. Bloomberg. Retrieved on July 25, 2013.
  12. SEC Proposes Rules to Improve Systems Compliance and Integrity. SEC. Retrieved on March 8, 2013.
  13. Germany Steps Up HFT Scrutiny With Draft Bill. Bloomberg. Retrieved on March 8, 2013.
  14. Regulating Hochfrequenzhandel: Germany Enacts HFT Law. Futures Industry Magazine. Retrieved on June 20, 2013.
  15. High-Speed Traders Profit at Expense of Ordinary Investors, a Study Says. New York Times. Retrieved on December 10, 2012.
  16. Knight Capital shares sink after algorithm glitch. MarketWatch. Retrieved on August 1, 2012.
  17. Knight Looks to Bolster Capital After Trading Glitch. Wall Street Journal. Retrieved on August 2, 2012.
  18. More Fallout From the Facebook Fiasco. CNBC. Retrieved on May 25, 2012.
  19. CFTC seeks to tighten regulation on ‘algos’. Financial Times. Retrieved on March 7, 2012.
  20. Commodity Futures Trading Commission Votes to Establish a New Subcommittee of the Technology Advisory Committee (TAC) to focus on High Frequency Trading. CFTC. Retrieved on April 5, 2012.

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