How Europe failed to regulate high frequency trading

Article based on a blog(opens in new window) by Benoît Lallemand, Finance Watch(opens in new window)

Super-fast trading in micro-seconds on financial markets (“high frequency trading”) has been one issue in the revision of the Directive on Markets in Financial Instruments (MiFID II(opens in new window) ). As a recent Bundesbank report(opens in new window) found, this trading can, in turbulent times, amplify market volatility. The high frequency traders have, however, succeeded in being perceived as liquidity providers in many places, though they only provide additional liquidity for those securities that are already very liquid!

On 25 April 2016, the European Commission issued a technical standard, “delegated act(opens in new window) ” on how to implement the articles on high-frequency trading (HFT) in MiFID II. The directive already set a very low benchmark in restricting HFT through regulation. One major problem has been that the proposed standard adds a definition of HFT that goes against the one used by experts and academics. It is so broad that over 90% of all financial traders fall into the HFT category! The Parliament did not object to the delegated act, as it could not amend part of it and would have had to reject the entire technical standard.

Consequences

The overall result is that the MiFID II financial markets directive has not questioned the usefulness of HFT in terms of speculating. MiFID II has rules that are limited to a prudential or supervisory perspective, i.e. to avoid havoc. Moreover, providing a definition of HFT would not have even been necessary if the trading regulations had been changed so that abusive and parasitic practices (e.g. constant modifications of orders) had been prevented or disincentivised.

Now that almost anyone is considered a high-frequency trader, strict regulation of true HFT seems to be increasingly unlikely. Indeed, such measures would affect almost all commercial actors and hence punish traditional dealers. As a result, there will be no tighter regulation of these practices for a (very) long time – a double success for the lobbyists of the HFT firms and investment banks.

Legislative texts that are being pushed forward are decidedly quite opposite to the political rhetoric that supported them.

Why is everyone remaining silent?

Since HFT is a complicated subject area with details that are difficult to understand, technical standards do not get much public or media attention when issued. This also applies to members of the European Parliament, who have other priorities.

HFT traders, in turn, are cautious to celebrate their victory, because it is only in their interest to no longer hold the debate in public, where HFT is condemned as useless speculation. Also, the process of developing the technical standard was questionable on several points. For instance, the person overseeing the area of high frequency trading in the financial supervisory authority of the Netherlands (base and origin of many large HTF firms), an expert in the preparation of technical standards, was appointed as the secretary general of the biggest HFT lobbying group.