Europe Begins Push To Ban HFT: Calls "Quote Stuffing" Market Abuse, Dark Pools "Tragic Error", And "Explicitly Rules Out" Flash Orders

The push back against the HFT market-propping travesty is finally starting to gain steam...but for now only in Europe. After all, the Fed realizes all too well that it needs all the resources it can get in its bid (no pun intended) to keep stocks as artificially high as possible, of which the HFT upward biased feedback loop is a critical one (the PD POMO monetization circuit being a second one... and when both fail, there is always the Citadel dark pool direct purchasing channel). Reuters reports thet "Britain and France flagged on Thursday a looming crackdown on ultra-fast share trading that featured in May's brief "flash crash" freefall on Wall Street, alarming regulators and investors globally. French Economy Minister Christine Lagarde said a form of computerized trading known as high-frequency trading (HFT) may need banning in some cases." Lagarde, who has recently shown a willingness to be seen as not part of the Bernanke mold, told reporters that her "natural tendency would be at least to regulate, to oversee it very strictly and after a cost-benefit analysis of these methods, maybe to forbid it." Elsewhere, a European Parliament November 16 report on MiFID "Calls for the practice of ‘layering’ or ‘quote stuffing’ to be explicitly defined as market abuse." This is something Zero Hedge has been demanding for about a year now, and obviously something that the corrupt regulators at the SEC, headed by the galactically incompetent Mary Schapiro continue to pretend does not exist. Lastly, in an attempt to make the life of the NYSE easier, whose primary source of revenue, now that Chinese IPOs have been uncovered to be a pathological, unauditable scam, has collapsed, the target has now shifted to dark pools: "The proliferation of dark pools was a tragic error and I would like us to come back to it" according to Bank of France Governro Christian Noyer. The latest onslaught against dark pools is not at all surprising: after all the NYSE is pushing hard to preserve some semblance of relevance (and EPS) as it is now attempting to create "a global network of as many as 40 "liquidity hubs" in data centers around the world." All in all, this smells like the role of HFT right here in our own back yard is about to get seriously curbed. Add the fact that Prett Bharara is about to open at least one criminal case against a domestic HFT outfit, and the robotic permabid behind the market may soon be very, very scarce.

More on the upcoming HFT ban from Reuters. Then again, Europe may not exist long enough to be able to enforce anything soon as corporation soon take over Europe.

Bank of France Governor Christian Noyer told the same French parliamentary panel on Wednesday evening that HFT was a real problem.

"I would only see advantages if it was scrutinized as much as possible," Noyer said.

Industry officials said HFT takes place on regulated markets.

Of course, you can't have HFT bashing without the firm that made sure GM would not trade below $33 in the first two weeks coming to its defense:

Jim Farachi, director at Getco, a key player in HFT, said: "High frequency trading firms are market makers who utilize technology to provide liquidity to the market in a more efficient way than pit or phone trading."

The U.S. Securities and Exchange Commission, the FSA's equivalent on Wall Street, said this month it will take further steps to make markets more stable after the flash crash by zeroing in on lightning-fast Computerized trading that could "go crazy.

Elsewhere, in a totally separate dynamic, one in which exchanges continue to lose market share to dark pools, Europe made it clear that it would do all it can to side with the NYSE:

"The proliferation of dark pools was a tragic error and I would like us to come back to it," France's Noyer said, noting that it was up to market supervisors to address the matter.

This comes on the heels of news that the NYSE plans to offer a la carte global collocation services, in an attempt to make up for plunging profits by increasing volume.

NYSE Euronext said it was creating a global network of as many as 40 "liquidity hubs" in data centers around the world.

The "hubs" will be located in facilities operated by data center specialists such as Savvis, Equinix and Telx, according to Stanley Young, the chief executive of NYSE Euronext’s technical services arm, NYSE Technologies.

The exchange operator and supplier of exchange technology said it did not plan to build more large data centers like those it has just opened in Mahwah, N.J., and Basildon, England. Those two facilities, which it considers to be its “anchor hubs,’’ have cost NYSE Euronext more than a half-billion dollars to build.

The new "hubs" for providing market access, market data and risk management services to banks and trading firms will be radically smaller. Each is likely to require less than 1,000 square feet of space at the start, Young said.

By contrast, the Mahwah facility, built from scratch, spans 400,000 square feet. Each of its operating "pods" are 20,000 square feet.

Expansion of each “liquidity hub” will be determined by customer demand for services, which eventually is likely to include the co-location of trading firms’ and vendors’ servers in the space.

About 20 of these hubs will be set up in the next two years, Young said, and as many as 20 more by the end of 2013.

In the first quarter of next year, liquidity hubs will be set up to serve banks, brokerages and trading firms in Frankfurt, Lisbon, Paris and Milan, Young said. Sao Paolo, Brazil, and Toronto, Canada, are coming in the second quarter. Tokyo, Hong Kong and Singapore are all potential second quarter startups as well.

"Each of the hubs will have their own communities attached to them, depending on what the local need is. Those local communities will link together to be a global community,’’ Young said.

On the other hand, if retail withdrawals persist at the current run rate, there will be nobody left trading except the big banks, which already have their own fat pipes direct to the exchanges (not to mention their own dark pool ATS infrastructure, see - REDI) thus making any attempt by the NYSE to generate incremental profits moot.

Lastly, and most importantly, a report on the regulation of trading in financial instruments issued by the European Parliament had some very scathing remarks about all that is broken in today's market structure. The key recommendations from the report (link):

  • Insists that post-’flash crash’, all trading platforms must be able to demonstrate to national supervisors that their technology and surveillance systems are able to withstand the kind of barrage of orders experienced on 6 May so as to ensure that they could successfully deal with the activity associated with HFT and algorithmic trading in extreme circumstances and show that they are able to re-create their order books by end of day so that causes of unusual market activity can be pinpointed and any suspected market abuse identified;
  • Calls on ESMA to conduct an examination of the costs and benefits of algorithmic and high-frequency trading (HFT) on markets and its impact upon other market users, particularly institutional investors, to determine whether the significant market flow generated automatically is providing real liquidity to the market and what effect this has on overall price discovery, as well as the potential for abuses by manipulation of the market leading to an uneven playing field between market participants, and its impact on overall market stability;
  • Calls for the practice of ‘layering’ or ‘quote stuffing’ to be explicitly defined as market abuse;
  • Calls for an investigation into whether to regulate firms that pursue HFT strategies in order to ensure that they have robust systems and controls with ongoing regulatory reviews of the algorithms they use, the capacity for intra-day monitoring and interrogation about real-time outstanding positions and leverage, and the ability to demonstrate that they have strong management procedures in place for abnormal events;
  • Calls for an examination of HFT’s challenges in terms of market monitoring; recognises the need for regulators to have the appropriate means to detect and monitor potential abusive behaviour; with this in mind, calls for the reporting to the competent authorities of all orders received by regulated markets and MTFs, as well as of trades done on these platforms;
  • Calls for all trading venues allowing co-location of servers, whether directly or through third-party data providers, to ensure that equal access for all co-located clients is maintained and where possible under the same infrastructure latency arrangements in order to comply with non-discriminatory practice outlined in MiFID
  • Takes the view that, in order to comply with the principle that all investors should be treated equally, the practice of flash orders should be explicitly ruled out;
  • Asks for ESMA supervision and definition by implementing acts of robust volatility interrupts and circuit breakers which operate simultaneously across all EU trading venues in order to prevent a US-style ‘flash crash’ event;

And HFT is not the only thing that is being targetted:

  • Calls for proprietary trading activities conducted via algorithmic trading strategies by unregulated entities to be transacted solely through a regulated financial counterparty;
  • Calls for the extension of the scope of the MiFID transparency regime to all ‘equity-like’ instruments including depository receipts (DRs), exchange traded funds (ETFs), exchange traded commodities (EDCs) and certificates;

Our friends at Themis Trading will be happy to know that Europe is now openly blasting fraud-facilitating market fragmentation:

Market fragmentation has led to poor post-trade transparency as a result of spreading trading over various venues and in particular on the quality of the post-trade data. A more effective regulatory framework for consolidated post-trade information is required which encompasses new technical codes in the settlement process to better reflect an environment where traders can execute on multiple venues. Regulators need to ensure that they can, at any time, recreate the order book in order to understand the market dynamics and participants involvement. Regulatory intervention also seems necessary to remove the outstanding barriers to the consolidation of post-trade data in order to establish a privately run European Consolidated Tape system.

And a broader narrative on how HFT straegies are nothing but parasitic:

Any well functioning market requires firms willing to provide liquidity and make public prices. Traditionally, specialists and market makers have carried out this function by quoting 2 way prices and generating revenue from the spread. As the market has evolved, the way in which the provision of liquidity is implemented has changed. In particular, with the advent of technology, algorithmic trading firms are now providing liquidity in the markets by posting 2 sided orders onto electronic order books and making a public price. Market makers typically do not hold investments for any length of time and therefore HFT strategies have evolved to capitalise on this function. It would seem appropriate that further analysis be done on the obligations and responsibilities that may be required of these informal market makers. If they are benefiting from a market maker pricing structure they should be obligated to provide a market price when required.

HFT is not a trading strategy in itself but can be applied to a variety of trading strategies which all have high portfolio turnover in common; many can process up to 33,000 trades per second, with sub microsecond roundtrip times for trading. They all have a requirement for speed and are therefore latency sensitive, requiring high capacity market data feeds and trade matching and quoting engines. They typically fall into two categories: electronic market making and statistical arbitrage. It is estimated that the volume of trading conducted by HFT traders is in excess of 35% and rising. This is compared to 70% of volume transacted in the US markets where it is less expensive to operate a HFT strategy. It is expected that the costs in the EU of clearing and settlement are a barrier to further expansion and so any reduction in costs is likely to have an additional effect on the market dynamics.

Little data is available for the impact these HFT strategies are having on the market and in particular as to whether the aggregate impact of technology could impact the resilience of the market itself. It would seem that HFT has increased liquidity and has tightened the spreads for investors; however, further investigation needs to be carried out to ascertain whether the quality of this liquidity is useful as often there is little volume at the touch and questions arise over the validity of the depth shown on order books. Analysis also needs to be carried out to determine whether price formation has also been impacted negatively by the increase in HFT.

An observation has been made that many of these HFT players are operating as proprietary trading houses and are as such unregulated entities and therefore do not need to comply with MiFID rules. Given that there is a political mood for all significant market participants to be appropriately regulated, we suggest that this should apply to these firms, with the expansion of MiFID reporting rules to cover these entities being required as a matter of urgency. In particular there needs to be oversight of the systems and risk management of these firms as demonstrated by the US ‘Flash Crash’ on May 6th. Stress testing of platforms should be carried out to ensure that they are capable of dealing with a ‘runaway algorithm’. Data capture of all market participants’ activity needs to be prioritised to enable regulators to reconstruct order books, when necessary, to monitor the functioning of safe and efficient markets. Given the volume of transactions, it would seem that they may pose a systemic risk to the system which needs to be investigated pan-EU.


In conclusion, it seems that a significant consequence of the competition brought about by the implementation of MiFID has been market fragmentation which has in itself encouraged the explosive growth of HFT strategies. Regulation needs to recognise that these technological advances are in need of suitable provisions in the legislation in order that they do not fall through regulatory gaps and inadvertently cause systemic risk to the overall functioning of the markets.

All this is great. Then again, the SEC idiots banned flash trading in the summer of 2009... And it is still occurring every single day. Nothing except the termination of Schapiro as head of the most criminally corrupt and incompetent regulator in the world at this point can allow a real regulatory reappraisal of the broken markets to take place.

h/t Mark's market analysis and James