EU lawmaker turns screw on ultra-fast trading


Banks should be banned from giving outside brokers direct access to markets as part of a sweeping crackdown on computerised high-frequency trading, reads a European Parliament report to be presented to the Economic and monetary committee on 24 April. 

The report was the assembly's initial response to a draft law aimed at reining in computerised or algorithmic trading and other advances in technology which have made it harder for supervisors to see the full picture and control markets.

The European Commission proposed the draft law – known as MiFID II – last year and it is now before parliament and EU states for approval, with changes expected.

Markus Ferber, the German centre-right lawmaker who is the rapporteur steering the measure through Parliament, said in his report that a tougher crackdown on high-frequency trading was needed than outlined in the draft law.

High-frequency trading is seen by some policymakers as having an unfair advantage over other investors. Fast computerised trading also played a role in the "flash crash" when Wall Street blue chips briefly went into freefall in 2010.

High-frequency traders often use bank and brokerage systems to access markets directly and favour tactics such as inputting many quickly cancelled orders, a technique nicknamed "quote stuffing".

"Your rapporteur suggests a more differentiated approach and proposes definitions for high-frequency trading and a high-frequency trading strategy to identify a particular subset of algorithmic trading, and in addition a ban of direct electronic access," Ferber said in his report.

He defined high-frequency trading as trading at speeds where "the physical latency" (or speed of processing an order) of the system for sending orders becomes "the determining factor".

The high-frequency trading strategy would include four or more elements such as a trader whose servers are next to those of the exchange; a daily portfolio turnover of at least 50%; a ratio of orders to trades that exceeds 4 to 1; most orders being unwound on the same day; or where at least a fifth of orders placed are cancelled.

Orders should also stay in the market for at least 500 milliseconds before they can be cancelled, and exchanges should slap higher charges on traders who cancel many of the orders they place, the report added.

High-frequency trading has increased volume on many exchanges and the Federation of European Securities Exchanges has urged caution about taking such radical measures.

"We need to do some homework first. I don't think Ferber wants to kill the market but wants to be on the safe side," FESE Secretary General Judith Hardt told reporters.

Other exchange officials said a ban on direct market access and requiring minimum periods for orders would damage liquidity and force people to risk their capital when they don't want to.

All trading platforms should also have "circuit breakers" in place to cut or slow down trading that becomes disorderly, Ferber said, in another lesson from the "flash crash". 

OTF limited to non-equities

The planned new breed of Organised Trading Facility (OTF) platform for trading contracts currently handled between banks should be limited to non-equities, meaning mainly derivatives and commodities.

This would force shares currently traded off an exchange to move onto bourses or similar platforms that are likely to be more heavily regulated than OTFs, a development stock exchanges welcomed.

"I think Ferber's taken the right steps. Equities are much too fragmented and OTFs would have introduced another layer of fragmentation," Hardt said.

But exchanges were dismayed that Ferber wants to harden controls on the size of positions commodity traders can hold, a step policymakers say could help cool what they see as speculation pushing up oil and food prices in recent years.

All commodity derivatives platforms should have position limits, Ferber said. Other controls, such as risk management systems would be "an addition" and not an alternative, as was foreseen in the draft law. Ferber pushes the draft closer to the US rule of pre-set position limits in many commodities.

He also proposes a ban on a person holding more than one executive or two non-executive directorships at different trading venues at the same time.

Ferber rejects a proposal to ban investment advisors from accepting commission on sales of financial products, in contrast to the UK which plans to ban such commissions from 2013.

Other members of parliament are set to challenge some of Ferber's proposals, as will EU states like Britain. The aim is to approve a final text by the end of this year or early in 2013.

Marc Olivier Herman, Oxfam's EU policy advisor, said:

"As the battle over EU commodity derivatives market regulation kicks off this week, member states must follow Ferber’s resolve to prevent excessive speculation from fuelling food price volatility. Europe must not give in to UK-led attempts to replace position limits with position management as this would amount to markets regulating themselves."

"Europe must use the review of the European financial regulation to stop excessive speculation that drives food price volatility and has a devastating impact on poor people. For many, food prices are a matter of life and death."

Drawing lessons from the 2008 financial crisis, the G20 agreed at the 2009 Pittsburgh summit on the need to improve the transparency and oversight of less regulated markets – including derivatives markets - and to address the issue of excessive price volatility in commodity derivatives markets.

In response, the European Commission has tabled proposals on 20 October 2011 to revise the Markets in Financial Instruments Directive (MiFID). These proposals consist of a Directive and a Regulation and aim to make financial markets more efficient, resilient and transparent, and to strengthen the protection of investors.

In force since November 2007, the original Markets in Financial Instruments Directive (MiFID) governs the provision of investment services in financial instruments (such as brokerage, advice, dealing, portfolio management and underwriting) by banks and investment firms and the operation of traditional stock exchanges and alternative trading venues ( so-called multilateral trading facilities). While MiFID created competition between these services and brought more choice and lower prices for investors, shortcomings were exposed in the wake of the financial crisis.

The new framework will also increase the supervisory powers of regulators and provide clear operating rules for all trading activities. Similar discussions are taking place in the United States and other major global financial centres.

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