Treasury to probe high-frequency tradingBy Jeremy Grant...

Treasury to probe high-frequency trading
By Jeremy Grant

Published: September 29 2010 22:53 | Last updated: September 29 2010 22:53

The UK Treasury has commissioned a study into the practice in markets of ultra-fast automated trading because of concerns that a computer-generated error could have significant impact on the economy.

The move is a sign of rising concern about the rapid growth of computer algorithms and so-called high-frequency trading, which allows traders to buy and sell shares, derivatives and foreign exchange in fractions of a second.

The practice now accounts for up to 60 per cent of US equity markets, while the London Stock Exchange estimates that more than a quarter of its trades are driven by high-frequency trading. But it has generated controversy in the wake of the flash crash in the US on May 6, when the Dow Jones index plunged 1,000 points in 20 minutes before recovering.

Critics such as asset managers say some high-frequency strategies unfairly reap profits for traders at the expense of others in the markets. They also say that malfunctioning algorithms could destabilise markets.

Defenders of high-frequency trading say most of it has helped increase liquidity since the days of pit trading and it has narrowed bid-ask spreads, making it cheaper and easier for investors to get better prices.

The Treasury is to sponsor a study by a group led by Lucas Pedace, in the Government Office for Science, part of the Department for Business, Innovation and Skills.

It will explore how computer-generated trading and failures might evolve in the future and impact on financial stability, the integrity of financial markets, market efficiency for allocating capital and the future role and location of capital markets, according to an e-mail from an official in the department, seen by the Financial Times.

This flash crash exposed the vulnerability of high-frequency algorithmic trading, which was a contributory factor to the decline in confidence that is still being felt across markets, the e-mail said. The possibility remains of a computer-generated trading failure occurring in the UK and having a significant economic impact.

The Treasury said it was working with the Government Office for Science to look into the application of scientific advances in financial markets.

This will involve working with leading academics and industry leaders in this important field of research. Further details will be released in due course.

In the US, the Securities and Exchange Commission is due to release a report into the flash crash, possibly as early as this week.

The European Commission is also studying high-frequency trading as part of a review of the Markets in Financial Instruments Directive, which sparked competition in share trading in the region, helping to attract high-frequency traders from the US.

Maria Velentza, a senior Commission official, said on Tuesday: We think we dont have to ban [high-frequency trading], we shouldnt demonise technology. But we should look to improve ways to prevent market abuse.