Disruptive HFT: Legislation, taxation or industry solution?

High-frequency traders are in the news again…

In financial markets, it’s not uncommon to hear whispers about high-frequency traders (HFT), and their so-called ‘bad behavior’. Amongst the chatter, officials are busy pounding their gavel as they race to govern HFTs.

The HFT community has, rightly or wrongly, developed somewhat of a reputation problem and is firmly in the crosshairs of international regulators seeking to crack down on what they see as nefarious behaviour.

However, with no international body coordinating efforts, there is a divergence appearing in different international regions, with a variety of different measures being proposed.

Presidential candidate Hillary Clinton has long called for a tax on high frequency trading transactions during her campaign. In recent weeks, however, the Japanese Financial Services Agency (FSA) reignited the debate over how officials should handle the growing presence of HFT in public markets. With the practice accounting for about 70% of all order flow on the Tokyo Stock Exchange in 2016, the regulator has proposed plans that would require HFT to register their risk management measures.

More recently, a report from Bundesbank analysed HFT patterns in Germany’s stock and bond markets and suggested, amongst other recommendations, a trading delay or ‘speed bump’ that could reduce the incentive for some market participants to engage in a technological arms race.

But in a twist of events, the European Central Bank’s report on Tuesday arrived at a different conclusion, suggesting the best way to monitor HFT was to use existing tools provided by the industry instead of rigorous rules.

Both reports agree that HFTs boost liquidity, making it easier for investors to buy or sell an asset. Contrary to the ‘Flash Boys’ image, academics have produced research reiterating this view and highlighting how HFTs reduce trading costs, improve market depth and stability. Jonathan Brogaard, a professor at the University of Washington, told Bloomberg: “as a whole, the literature strongly supports HFTs being a net positive.”

Despite this, the debate rages on: should there be greater regulation? Is that really the best approach, or can market-led solutions provide the answer?

In recent years, industry-led solutions have certainly become increasingly prominent. In spot foreign exchange, for example, an electronic spot FX platform called ParFX has employed a number of tools, including a randomised pause on all order submissions, amendments and cancellations, to prevent disruptive trading.

Dan Marcus, CEO of ParFX, shares the view that the market can create its own solutions. “Rather than an ineffective and expensive cure in the form of legislation or taxation on trades, which will take years to implement and almost certainly result in regulatory arbitrage, a proactive preventative, market-led solution is required.”

With other trading venues such as IEX and Chicago Stock Exchange adopting “speed bumps”, this idea certainly seems to be gaining momentum.

So what’s the right answer? Should we increase regulation? Implement a “speed bump”? Impose a tax on transactions, as suggested by Hillary Clinton? Looks like the jury is still out for now.

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