High Frequency Trading (HFT): Positive for forex market and negative for equities ?

While the AMF and European regulators plan to limit or prohibit HFT, the BSI considers it to be beneficial to the foreign exchange market in normal times and in times of stress...

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At the last AMF conference regarding sanctions, the current president, Jean Pierre Jouyet, felt it was almost impossible to demonstrate any price manipulation related to High Frequency Trading (HFT) because of its opaque structure and data gaps to exploit for a long period via the order book. In the apparent inability to control this practice, he suggested the ban.

In Brussels, the European Commission is working on a reform that would punish some HFT techniques, the quote stuffing, the layering and the spoofing it calls attempted manipulation. From the European markets authority (ESMA) side, it is envisaged to charge canceled orders (99% of orders are canceled through the HFT) or not framing tick sizes.

Is this the end for HF traders ? Maybe not. The Markets Committee of the Bank for International Settlements (BIS) published a report entitled High Frequency Trading in the foreign exchange that tends to favor this practice in the Forex.

The report, prepared by a task force chaired by Guy Debelle, assistant Governor of the Reserve Bank of Australia, examined the evolution of HFT on the foreign exchange, its impact on others participants, his behavior during "calm" market and in times of stress, and major differences with the HFT on the equity market. It also identifies areas that may warrant further investigation.

According to the study, HFT could be considered beneficial for the foreign exchange operation during "normal" period but also in period of stress where it would have changed the market ecosystem by increasing its resilience. The report cites data indicating that HF traders are not less present in volatile markets than traditional FX traders, on the contrary, they (traditional FX traders) would be encouraged to provide more liquidity in their presence.

The "flash crash" of May 2010 on the equity markets suggests that pure HFT (as opposed to the algorithmic execution involving large unidirectional trades) is not inherently a trigger for a systemic risk, but can propagate shocks initiated elsewhere. However, the different nature, structure and size of the foreign exchange market make an event such as the "flash crash" being less likely in this market than in the equity market.

Many predatory or unfair practices attributed to the HFT on the foreign exchange market are not new. For this study’s authors, a key question is to know whether and how the other participants adapt to the presence of HFT. Commercial incentives exist for the various parties, including prime brokerage and traders, so they self-regulate and mitigate the adverse effects.

For the chairman of the BIS Markets Committee, Hirsohi Nakaso, this report is a timely contribution to the ongoing discussion regarding the effects of technological innovation on financial markets, HFT being an example. " the report focusing on the foreign exchange market, complements a discussion that had so far been mainly focused on developments in the equity market", he analyses.

In the U.S., Chilton Bart, a member of the Commodity Futures Trading Commission (CFTC) invited HFT traders to accept a registration process with the authorities in order to increase market stability and clarify their functioning. "Speculation on the role of HFT during the May 2010 Flash Crash are widespread in the financial industry while it has not been the instigator. However, the HFT could be threatened in case of further collapse of world markets if it makes no effort of transparency", he warned.

Maxime Onan October 2011

Article also available in : English EN | français FR




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