05 June 2014

FCA/Wheatley: Regulating high frequency trading

Martin Wheatley, CEO of the FCA, delivered a speech on the priority challenges for HFT, like the balance between the potential benefits against costs – and how the risk/reward equation should be managed.

There are many interesting questions here for leaders today, in industry as well as in government and the authorities. And a priority challenge for HFT specifically, which I’m not sure has yet been honestly assessed by all players, is where the balance lies between the potential benefits against costs – and how we manage that risk/reward equation. Key areas to consider here: market efficiency; fairness; cleanliness and resilience. On the one hand, there are undoubted benefits to HFT. Most notably, the link between competition and market efficiency, as well as liquidity from reductions in bid/offer spreads and reduced transaction costs.

It’s important to be clear sighted here about the possibilities of HFT. Even if it’s also an imperative to appreciate the potential risks as we move things forward: three key ones strike me. First, looking at market fairness, there’s the inevitable debate around the impact of speed on market fairness, with all those familiar concerns around unfair advantage for the few over the many – as well as nervousness around conflicts of interests. Second, in terms of market cleanliness, it is sensible I think to ask whether this type of trading opens up greater opportunities for abusive behaviour. And third, around market resilience, what price on the possibility that automated trading creates flash crash-type scenarios in the future if algorithms spin out of control?

Italy has introduced a tax at two basis points on orders when the order-to-executed trade ratio exceeds a certain threshold. Effectively, requiring HFT users to pay for the additional noise they’re creating. In Germany, similar charges have been introduced but legislators have gone further. Firms engaged in HFT activity are expected to apply for a licence to operate; fees are being charged for excessive system usage; and other tools, like minimum tick sizes and order-to-trade ratios, have also been introduced.

As we can see then, broadly similar HFT risks playing out differently in terms of global response: reflecting (to some extent) distinctions in markets and market structures as we jump from border to border. For me, one of the clearest of those distinctions has to be market fragmentation, which – judged purely by share of primary trading venue against total market – is an enormously varied picture. Different territories, facing similar types of risk, but with different market micro-structures – lead, in turn, to subtly different solutions.

Full speech

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