Regulators are to crack down on automated trading because they believe certain types of traders that use algorithms – known as HFTs – tend to pull out of markets at signs of stress, contributing to a sudden loss of liquidity.
Automated trading firms would be forced to post prices in key markets “on a regular and ongoing basis” even in times of extreme volatility, under draft proposals to be unveiled by the European Commission next week.
The move is a sign that European regulators believe “high-frequency trading”, where dealers use computer programmes to trade at lightning fast speeds, could pose a threat to market stability.
There are large market-making firms that make markets and use algorithms to do so, such as Getco of the US and Optiver of the Netherlands. But they are unlikely to be affected by the proposals as they already post bids and offers throughout the day.
The proposals are likely to provoke an outcry from some traders. They make no distinction between marketmakers, such as Getco, which routinely use algorithms to post prices continuously, and certain firms that use algorithms to carry out sophisticated trading strategies, or even asset managers that use algorithms to carry out trades over specific periods.
One large European market-making firm said: “They seem to be requiring everyone to become market- makers. It’s crazy.”
Any move to force traders to commit to being in the markets would put Europe ahead of the US in regulating automated trading.
The proposals come as efforts to regulate HFTs are moving up a gear amid concern that ultra-fast trading and the use of computer algorithms to generate massive amounts of trades could destabilise markets, especially with the use of “directional” algorithms that critics say can exaggerate price movements.
Such concerns were raised after the “flash crash” in US markets last year, where wild price swings were blamed on the use of certain algorithms.
HFT firms reject such concerns, arguing they provide valuable liquidity to markets. They point out that they are not the only users of algorithms, which are used by asset managers and hedge funds.
The Commission will unveil next week its final proposals for far-reaching reform of the region’s equity markets, including rules for trading over-the-counter derivatives. Those proposals come in a new version of the Markets in Financia Instruments Directive, or “Mifid II”.
A final draft of Mifid II, to be presented to EU member states, says traders using algorithms must ensure quotes are posted “at competitive prices with the result of providing liquidity on a regular and ongoing basis to [trading venues] at all times, regardless of prevailing market conditions”.
