Europe's financial regulator has set out a consultation paper on MiFID II and MiFIR and the initial attempts to define HFT are sure to receive major scrutiny.
Industry association FIA EPTA (European Principal Traders Association) is currently organising its members into working groups to respond to relevant areas of some 800-pages of proposals released at the end of May. Its view is not expected to change from previous hearings and consultations.
With regards to the proposals, vice chair of FIA EPTA Mark Spanbroek told Automated Trader that ESMA should be focusing on the definition of all trading and algorithmic trading, not HFT specifically.
Ultimately, it does not bode well for lit markets, market makers and liquidity providers in general, Spanbroek said. "This may turn into overregulating and loss of liquid markets whilst other markets like FX are still not regulated at all."
He expected that smaller firms are going to feel it most.
"In a way, (the regulators) are creating their own problems. If you look at the liquidity provider world in equities, there are a limited number of firms that do this in Europe and we need more. Overregulation makes the chances of getting more, zero," he said.
In defining HFT, the European regulator presents two options.
In the first, ESMA would consider techniques where there is an "infrastructure intended to minimise network and other types of latencies" in place under specific circumstances, such as algorithms are processed on servers co-located to a venue's matching engine. Also, if high bandwidth is used, with the fastest identified in the range of 10 GBit/s, compared to standard access within the same venue.
ESMA said it "is conscious of the fact that a high bandwidth is subject to technological change and therefore should be covered in a qualitative manner".
In addition, ESMA will consider the level of message intraday rates, with HFT defined as at least two messages per second submitted to the trading venue over the trading day. If this approach were followed, a significant volume of intra-day messages would be in the range of 75,000 messages or more per trading day on average over the year.
The main advantage, the regulator said, is that the identification of parameters is straightforward. ESMA acknowledged however some of the limitations, like it's relatively easy to get around, there would need to be reviews to compare with market practice, and some types of HFT would escape the net.
The alternative HFT definition would ask venues to periodically analyse the median daily lifetime of cancelled or modified orders and compare it to the median average for the entire market. If it falls below the median, implying daily lifetime of the orders is shorter, it's HFT. The caveats are that ESMA currently believes only liquid products should be considered and orders with a lifetime longer than one day should not.
Some of the benefits to this approach are that trading venues are already making these calculations, the method cannot be easily circumvented and it won't have to be revised frequently so as to keep pace with the latest technological developments, the regulator added.
Regardless of the option followed, the identification of a high frequency trading technique has to be made at the member or participant level. And what's classed HFT in one market will apply across the EU.
There will also be guidelines issued to catch manipulative practices such as spoofing, layering and quote stuffing. A proposed list lays out indicators targeting an automated trading environment, which are related to order entries, updates and cancellations.
The closing date for responding to ESMA's consultation is 1 August and public hearings will be held in July. Spanbroek said that it will present a time constraint.