German HFT proposals earn buy-side support
Institutional investors have expressed support for controversial new proposals in Germany to control high-frequency trading, including a requirement to obtain a licence or stop trading.
The German parliament’s finance committee is currently reviewing the draft regulation, which includes measures to impose minimum tick sizes, order to trade ratios, and an obligation for HFT firms to submit their algorithms and trading strategies to the regulator.
“I think it is a good start,” said Adrian Fitzpatrick, head of dealing at UK-based asset management firm Kames Capital. “The Germans probably can see the damage that a rampant HFT could do to their market. We all want to trade against genuine liquidity not spoof orders. We should do something similar here in the UK.”
HFT has long been the subject of intense debate between regulators, politicians and market participants. Supporters of HFT argue that it has reduced spreads and brought liquidity to the markets. Detractors argue that HFTs are nothing more than predatory “vultures” that prey on institutional flows and extract profits by exploiting genuine investors.
Industry association the FIA European Principal Traders Association voiced its support for the German proposals, based on its desire to support transparent, robust and safe markets with a level playing field for all market participants.
“We generally endorse the proposal and believe a reasonable regulation of HFT to be appropriate, such as requirements on minimum tick sizes, enhanced transparency and order to trade ratios based on the respective class of instruments,” said Mark Spanbroek, secretary general at FIA EPTA.
Many of the measures in the German proposal pre-empt MiFID II, the European Commission’s upcoming single European rulebook that will set out the terms for capital markets across the European Union once it comes into effect in 2015/16. However, political pressure in Germany has been pushing for a quicker solution. Similar moves have already taken place in Italy, where Borsa Italiana introduced an order-to-cancel ratio of 1:100 in April last year to counter concerns that HFT firms are sending out hundreds of orders and then cancelling the majority – making it difficult for traditional investors to discern genuine liquidity.
“All we want is a level playing field,” said Fitzpatrick. “Currently the market is skewed towards HFT. The regulators need to decide who and what the market is for – a playground for HFT, or a genuine market place for retail and institutional investors.”
Other senior buy-side representatives agreed, but expressed some concerns about liquidity. European equity trading volumes have fallen from €1.4 trillion in January 2008 to just €485.5 billion in December 2012, according to figures provided by Thomson Reuters equity market share reporter.
“The increased governance is unsurprising and welcome, particularly in highlighting the order to trade ratio,” said Paul Squires, head of trading at AXA Investment Managers in London. “It shows that some regulators are not prepared to wait for the tri-partite MiFID II process to reach any conclusions before implementing their own national directives on some issues like HFT. The downside is that it is further squeezing liquidity – HFTs account for around 40% of European volumes.”
France has also unilaterally enacted a financial transaction tax, which has hit HFTs by making it less profitable for them to enter and exit small positions. HFTs typically make a portion of their profits by arbitraging tiny price differences between stocks listed on different venues. But the tax means that HFT firms must pay more than the value of the price difference, in theory putting a dampening effect on the practice.
However, Frederic Ponzo, managing partner at capital markets consultancy GreySpark Partners recently told Banking Technology that BNP Paribas and Société Géneralé are the only two firms in France that conduct any significant HFT activity, and since both are covered by market making exemptions from the rules, the French tax was unlikely to make any material difference to French markets.
Despite the debates in different national jurisdictions and its overall support for current German HFT proposals, FIA EPTA has warned Germany’s rulemakers against going too far with the new rules, saying that excessive controls would risk driving liquidity away by excluding EU and US trading firms from trading on German markets.
“FIA EPTA strongly supports the opinion of the Bundesrat to regulate HFT in the Borsengesetz instead of in the Banking Act,” said Spanbroek. “Regulating HFT in the Borsengesetz ensures all trading activities taking place on German markets by all trading participants is covered in a very effective way regardless of where in the world the trading firm is located and whether the firm is a direct or an indirect member of an exchange. Automated trading has facilitated efficient access to capital for companies at low costs, and these positive aspects should also be recognised within the German proposal.”
The German Bundestag Finance Committee will meet tomorrow to discuss the new rules.