In the United States High Frequency Trading (HFT) is expected to account for about 48,5% of exchange trade volume in 2014. This percentage has dropped from HFT’s peak of 61% in 2009. In the UK, estimates are that HFT represents approximately 36% of UK stock market transactions.
This is a globally significant volume of trades. It is generally accepted that HFT can improve liquidity in the market, reduce transaction costs and make market pricing more efficient. However, regulators in the US and UK are changing the legislative landscape governing HFT.
What is HFT?
High Frequency Trading uses powerful computer systems to transact a large number of orders at very fast speeds by means of algorithms that analyse multiple markets and execute orders based on market conditions.
Typically, the traders with the fastest execution speeds will be more profitable than traders with slower speeds. In practice this tends to favour the large banks and financial institutions that can afford the best systems and infrastructures.
HFT became popular when exchanges began to offer incentives for companies to add liquidity to the market. The New York Stock Exchange (NYSE) has a group of liquidity providers called supplemental liquidity providers, who attempt to add competition and liquidity for existing quotes on the exchange. As an incentive to the firm, the NYSE pays a fee or rebate for providing the liquidity.
Broadly speaking, the computer algorithm decides on aspects of execution of the order such as the timing, quantity and price of the order. This is often associated with automated observation of market data in real time without pre-trade human intervention.
Is HFT regulated in South Africa?
High Frequency Trading is not regulated separately in South Africa yet.
But it is limited by the JSE, which automatically “throttles” the number of trades a broker may submit into the cash equities market. The threshold is currently 300 orders per second per broker, which is the standard adopted by the JSE.
Which institutions in SA have the technology to actually do it?
The JSE upgraded its technology to improve trading times and embarked on reform of the clearing and settlement timeframe. This opened the door to international high-speed trading firms for the first time in an effort to boost liquidity and increase trade volumes.
In July 2012 the JSE implemented a new trading platform, the Millennium Exchange, in the equities market, while at the same time moving the trading system from London to Johannesburg. This allowed trading firms to physically locate their servers next to the matching engine of the exchange and was part of a broader effort by the JSE to attract higher trade volumes. Following this successful transition trades could be executed up to 400 times faster than under the previous TradElect system.
The JSE improved trading speeds and boosted volumes by launching a co-location facility. This system allows data providers, traders and banks to place their computers next to the computers that drive the market at the JSE. The co-location facility went live in March 2014.
How is HFT regulated in the UK?
The UK House of Commons has proposed the implementation of FTT (Financial Transaction Tax) of publicly listed stocks.
They called for FTT to be set at a level which is the average profit made on a high-frequency trade in the UK. The purpose of the proposed regulation seems to be the eradication of HFT in the UK, even though regulators recognise the benefits of HFT.
A private foreign-exchange platform is currently implementing a one market solution to the concerns about HFT in the UK. The plan is to modify the way in which orders are processed in an effort to take away the advantages of HFTs.
Various complex regulations are under consideration in the US
In the US, several high-profile algorithmic trading failures caused significant market disruption in 2012.
The Commodity Futures Trading Commission (CFTC) issued a concept release proposing potential areas of regulation for both high-frequency and automated traders in general, including pre-trade controls, post-trade controls, system safeguards, mandatory registration and reporting, and efforts to standardise order types. CFTC regulations attempt to create formal regulation and standardisation for practices that traders and exchanges already engage in voluntarily as part of their risk-management strategies.
The Protection from Rogue Oil Traders Engaging in Computerized Trading (PROTECT) bill would amend the Commodity Exchange Act to include requirements for all futures traders using HFT, including requirements for registration with the CFTC and testing their algorithms.