In finalizing the
Mifid II directive and Mifir regulation, EU law makers have
heeded the calls of some market participants not to impose
speed limits, or resting periods, designed to slow down
automated trades and prevent large-scale errors.
Provisions that would have required a minimum 500
millisecond pause on incoming trades have been dropped,
alleviating some of the concerns about the potential impact on
liquidity, and trading shifting to other jurisdictions.
However, participants engaged in high-frequency algorithmic
trading will need to be licensed, and trading facilities must
limit the ratio of unexecuted orders to transactions in their
Trades generated by algorithms will have to be flagged. The
tag will contain an identifier code linking the trade to a
specific algorithm to allow regulators to trace and
crack down on trading strategies that are abusive or pose
risks to the market.
Providers of direct electronic access will be responsible
for ensuring clients’ trades executed through
their systems comply with the new rules.
The changes – which the EU estimates could cost as
much as 732 million to implement – come despite
widespread agreement that trading technology has enabled wider
participation in markets, increased liquidity, narrowed
spreads, reduced volatility and enhanced execution of
The arguments that high-speed trading is in some way
damaging to markets have all now collapsed, says Simon
Gleeson, partner at Clifford Chance. Nobody has ever managed
to demonstrate that high-frequency trading poses any particular
risk to participants. It is not necessarily high risk, yet it
is capable of being extremely risky. But then the same is true
of real estate development lending.
Frankly, something that goes wrong once every five years is
not the most inherently risky activity imaginable.
Having escaped mandatory speed limits and resting periods
imposed by law, elements within the sector are proposing to do
just that of their own accord.
EBS, one of the two big foreign exchange trading platforms,
called for first in, first out execution of orders to be
jettisoned, arguing that it gives an unfair advantage to
participants with the highest computing-processing power and
ParFX, a new platform backed by large European universal
banks which launched earlier this year, already operates a
system of random pauses on incoming orders, saying it ensures
This is a very important development that demonstrates that
FX market practitioners are taking active steps to find a
solution around latency, says Stephane Malrait, chair of ACI
FX Committee. The main difference with the equity market is
that the FX market needs to serve many different client types
across the globe.
To be able to deliver a global service, banks need to
access liquidity without being impacted by latency or location
of their technology. The idea to implement randomized pauses
for incoming orders is a good way to solve that issue.
Attention has focused on incidents such as the one involving
Knight Capital last summer when a rogue algorithm landed the
firm with billions of dollars of unwanted shares, but
algorithmic high-frequency trading is increasingly employed in
According to FX settlement system CLS, average daily global
foreign exchange turnover stood at $5 trillion in April. That
is an increase of $1.7 trillion in the past five years. The
Aite Group estimates that by the end of next year more than 25%
of FX trade will be algorithm-driven.
And while the new regulations do not apply to spot FX, trade
in other FX instruments, which is worth at least $2.5 trillion
a day, will be impacted.
As market-makers, banks make up the largest single category
of participants in the FX market, but other financial
institutions are catching up.
Non-reporting banks, hedge funds, pension funds, mutual
funds, insurance companies and central banks account for
three-quarters of the non-spot market, according to the Bank
for International Settlements.
The compromise rules appear to provide a strong regulatory
framework that reduces risk while allowing the market to
benefit from the latest advances in trading technology, but
critics remain unconvinced.
The lesson we have all been taught painfully, and to our
cost, over the years is that with all regulation the question
is: will the impact that it has have sufficient economic
consequence to justify a change in behaviour, says
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