High Frequency Trading (HFT) has been attracting considerable attention this month following the publication of “Flash Boys”, in which bond salesman turned financial writer Michael Lewis suggests that “US stock markets are now rigged by traders who go to astonishing lengths to gain a millisecond edge over their rivals”. With the book’s publication coming just days before the European Parliament voted to adopt HFT regulations under Mifid, the topic of HFT has been generating headlines on both sides of the pond.
The debate over the impact of computerized trading on the functioning of markets is not new (see inCOMPLIANCE issue 5, Autumn 2011). Concerns have long been expressed as to whether HFTs genuinely increase liquidity or simply increase trade volumes. HFTs have most famously been associated with “flash crashes”, while many have argued that they introduce new potential avenues for fraud and market abuse (for example, three traders recently file a lawsuit against futures market CME for allegedly “selling information to high-speed traders earlier than other market participants”.
Post-Flash Boys, it seems the debate will become increasingly centered on the issue of market integrity and ensuring a level playing field between market participants.
This is an extremely complex and contested area, but the column inches that Lewis’s book has already secured mean that the question of how (or whether) to regulate HFTs (until now something of a “slow burner”) has become much more pressing. As a case in point, the SEC has, despite describing HFT as a priority area, been taking its time over the question of whether or how to regulate HFTs. However, reports suggest that (perhaps due to the publicity generated by Lewis’s book) the regulator may be about to leap into action, through a “purge of computerized markets”.
The case encapsulates many of the challenges of regulation. Increased column inches ramp up the pressure for regulatory action. However, this need for speed introduces the potential for knee-jerk reactions and a multitude of potential unintended consequences. As Lewis himself said, speaking on CNBC: “The regulatory process always seems to generate something that ends up being gamed by smart people” whereas market solutions to the problem may already be available (through exchanges such as IEX, which he highlights in his book).
All the while, the regulatory approach to HFT, at an international scale, remains hugely inconsistent, with regulators moving at different speeds and in different directions. And herein lies a most immediate concern, as Christopher Bernard of Linklaters puts it:“Whatever the approach, different regulatory responses implemented on different timescales could have the result of fragmenting markets and create the potential for regulatory arbitrage by pushing HFT into other jurisdictions.”