The Gateway to Algorithmic and Automated Trading

European Commission official defends order-to-trade concept as debate rumbles

First Published 27th February 2013

Would an order-to-trade ratio be more appropriately called an ordeal-to-trade ratio? The European Commission does not appear to think so, but many in the market do.

(This version corrects an earlier version which incorrectly referred to "higher" order-to-trade ratios in the first paragraph instead of "lower" ratios.)


London - A policy officer for the European Commission argued at a financial conference that efforts to force markets to have lower order-to-trade ratios were in the interest of the wider market, though his views met with scepticism.

"Unlike MiFID 1, MiFID II is not just there to reduce administrative costs for the industry. It's actually a reform of EU market structure in an attempt to get more trading onto organised venues and to make all trading, all kinds of financial instruments pre- and post-trade, transparent," Jasper Jorritsma of the European Commission said in a panel discussion.

As part of that, an order-to-trade ratio was one idea that was being taken up by both the Council of Europe and the European Parliament, Jorritsma said. The concern is that exchange systems are being overloaded and that there is too much "fake liquidity."

"And one of the ways of addressing both of those concerns would be to maximise the ratio between the number of transactions that someone does and the number of orders that they can post," he said.

"In this case, one of the reasons for wanting to regulate is that exchanges have shown that they're not able to manage this risk adequately, possibly because they just make too much money out of all the actual trading so that they don't necessarily have the proper amount of incentives," he added. By introducing regulation, authorities would be helping them in collectively addressing the issue.

Kee-Meng Tan, managing director for electronic trading at Knight Capital, scoffed at that argument.

"That's just like the government telling you that you can only download five megabytes on your phone a day, that's it, because you might bring down the phone company," he said.

Tan said there was "some logic" to having an order-to-trade ratio, but he said the key would be in implementation and not having a uniform approach that failed to take account of various asset classes and types of instruments.

"If we get in a situation where you create a uniform order-to-trade ratio on all stocks listed on the market - liquid versus illiquid - then you're going to have a situation where market makers are going to widen out their quotes … which means that the cost of trading becomes significantly higher. That is just one pure example of what happens when you have a blanket regulation across the board," he said.

He also said market-making firms need flexibility if they're posting liquidity on multiple venues.

"Maybe you just got taken up on Venue A, you have to cancel the same order on Venue B. That's part of that whole decision process. You have to adjust your orders because the market is moving, things are changing. The trading models have a number of inputs into them," Tan said.

Jorritsma said regulators were trying to do what was best for the overall market.

"I think the objectives behind all of these proposed measures are firstly, to protect the market as a whole, and secondly, to protect those who are less smart than the people here in the room," he said.

Professor Philip Treleaven, director at the PhD Centre in Financial Computing at University College London, wondered why firms that did post fake liquidity were not more aggressively pursued through existing laws.

"There are a lot of small firms who have an algorithmic trading strategy based on fake liquidity. I personally consider this market manipulation," Treleaven said in the panel discussion.

Jorritsma said it had been difficult to bring cases both because of the quality of data available and because of the challenge of convincing a judge that such behaviour would qualify as market manipulation.

That, Tan said, illustrated an approach he found questionable, one where regulators, unable to enforce current legislation, resorted to introducing more legislation.