PJ Di Giammarino
Chief executive, JWG Group
Although these are not the first set of rules on High Frequency and Algorithmic Trading (HFAT), they hold new terms, definitions and concerns. One of the key implementation issues surrounding the new rules on HFAT has been in trying to fully understand the concepts, in light of the broad definitions in MiFID II.
So, what definitions have ESMA provided?
A High Frequency Algorithmic Trading Technique (HFATT) is defined as:
"An algorithmic trading technique that is characterised by:
- Infrastructure intended to minimise network and other types of latencies, including at least one of the following facilities for algorithmic order entry: co-location, proximity hosting or high-speed direct electronic access;
- System-determination of order initiation, generation, routing or execution without human intervention for individual trades or orders; and
- High message intraday rates which constitute orders, quotes or cancellations."
Where algorithmic trading has been defined under the latest draft delegated acts as:
"… For any automatic order or quote generation process or any process to optimise order execution by automated means once a buy or a sell decision has been made by human intervention, the system makes decisions at any of the stages of initiating, generating, routing orexecuting orders or quotes according to pre-determined parameter …"
ESMA was mandated to clarify the definition of High Frequency Trading (HFT) and, in its Consultation Paper (see page 233 for full details), it considered two options when deciding how to do this, noting that HFT is a subset of algorithmic trading.
It has been alleged that the European Commission (EC) have chosen option 2. As a result, a high message intraday rate is rumoured to be defined as the submission on average of at least 4 messages per second with respect to all instruments traded on a trading venue, or at least 2 messages per second with respect to any single instrument traded on a trading venue.
According to Conor Foley at Norton Rose Fulbright's eighth annual markets infrastructure group seminar, option 2 implies that the high message intraday rate will only include messages for liquid instruments in the calculation, but messages under the Continuous Quoting Obligation (CQO) will be included. However, although the draft delegated acts have shed some more light on the definition of HFT, the precise definitions for co-location and proximity hosting have not been provided so far.
Market industry experts have suggested that, although option 2 is not currently a political favourite, they are leaning in favour of the relative approach. With the HFT definition still unclear, many feel that it may well be impossible to define for regulatory purposes. There is no doubt that more clarity will be obtained once the Level 3 work has been completed and guidelines have been produced, although these are not expected until 2016 at the earliest.
What is the verdict on the HFT industry?
At the end of the day, more intensive controls require more expert controlling and firms may well need to revisit their fee structures and record keeping systems. Due to the disproportionate impact on cost income ratios, small boutique HFT firms would fare a great deal worse. Even so, all HFT firms will have to check off a number of boxes before 3 January 2017.
On the recognition of third country HFT firms, the jury is still out. There is an ongoing debate about where exactly these firms would lie under MiFID II. Some have suggested that this would fall under MiFID II's third country access rules (Article 39 MiFID II) - if so, this would result in differing treatment of HFT firms across Europe, with some countries proposing not to exercise their discretion to elect into the Article 39 MiFID II regime and others choosing to.
Over the next few months, participants in the HFT industry will be closely watching for further developments in MiFID II. ESMA has a significant degree of control over the final verdict of HFT as it continues to develop the technical standards due at the end of September.
The challenge for regulators, so far, has been on how to keep up, monitor and challenge harmful trading within these innovative financial markets - although, market participants are concerned that an inadequate regulatory response could leave clients without sufficient investor protection against market abuse and volatility. As it stands, onerous requirements, coupled with uncertainty, are leaving some HFT firms questioning the viability of their business models.
The full suite of microstructural issues, including HFAT, serves as the context for this week's MIG meeting on Thursday. Members can find the conclusions of the meeting in the JWG MIG members' area.
To learn more about our MiFID II offerings and how we approach training, please get in touch and don't forget to join our MiFID II LinkedIn group to be part of the online dialogue.