A couple of weeks back I was approached by a HFT magazine editor and he asked me whether I would be interested to write down some of my experiences in HFT. As I am not directly participating in the midst of HFT at this point, I had to give it quite some consideration. Why would I do this? Placing myself in a vulnerable and visible position is not my first nature. Still I strongly believe in taking away the mystique or even – allow me – hysteria regarding this type of Capital Markets business. In my opinion the world of low-latency/hi-freq trading has to try and get rid of the negative image. It deserves some consideration to explain in a bit more detail what HFT is all about. What techniques are being used and – more generally – what the business reasoning behind HFT is.
So why does HFT need more transparency? Very simple. EU lawmakers in Brussels and national regulators have very little knowledge regarding the business and technological concepts driving HFT.
This can automatically lead to potential actions that can harm the trading firms directly.
Secondary effects can be envisaged impacting liquidity and widening spreads on multiple platforms. I will get back to you regarding the implications of losing liquidity and widening spreads some other time.
First the negative effects of lawmakers and regulators not having any clue what HFT is all about.
About a year ago I was invited to be part of a speakers panel at one of the first professional Hi-Freq conferences in London. At the time I was MD at an Algo/HFT market making firm primarily participating in quantified dispersion of volatility and equity arbitrage across multiple venues. We spoke about market access, risk and regulatory influences. I became very enthusiastic recognising attendees from the FSA and the Dutch and French regulators at this conference. On the podium I invited the Hi-Freq world to open up towards each other and break down the barriers. At the same time I invited regulators to step into my office and literally have a look at what we exactly did. It took another couple of phone calls and emails on my initiative before representatives from the Dutch and UK regulator actually did visit the office. I’ll point out two very important remarks they made that will paint us a picture still waking me up in the middle of the night...
Looking at the order books and depth of Nokia quoted on OMX Helsinki and Nokia quoted on Chi-X one of them asked the following: “The order book on OMX we believe, but we are under the impression the order book on Chi-X is not real...”. The other remark was one regarding liquidity providing on multiple platforms: “We consider demanding liquidity providers and arbitrage traders to keep their quotes in the market for a minimum time, for example one second”.
I won’t disclose which regulator came up with what question and to be honest, I am happy with the fact they put their questions forward. At the same time it clearly tells us where they are in understanding the business they have to regulate.
Obviously I spend a bit of time explaining how a multilateral trading platform like Chi-X works and what would happen if arbitrage traders have to keep their quotes in the order book for a minimum time frame. It just goes to show that although MTF’s came to live due to the implementation of MiFID in 2007, the lawmakers and regulators still had to do their homework. On the other hand this is fact of live the Capital Markets business and more specifically the HFT world needs to take into account.
I can already hear you think: “Do we have to educate those regulating us?” And the answer is ‘Yes’, I am afraid. If we would like to continue trading with algorithms on a low-latency infrastructure connecting multiple exchanges to trade extremely tight spreads, we have no choice.
Nobody needs new EU regulations based on a lack of understanding what this business is all about. Fortunately some of the top tier market making firms in Europe and the US understand this difficult situation. They have started to write down specifics regarding the trading techniques used and the ball is definitely moving towards the corner of the regulator. Now it’s up to the national regulators and the European Securities and Markets Authority (ESMA) to pick up from here and start communicating with the HFT world to get a better understanding.
As promised next time I’ll discuss a bit what liquidity means to the financial markets. Don’t hesitate to let me know what you think!
Financial Markets Advisory - fm-advisory.com
17th of January 2011