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Algorithmic trading/HFT

MiFID II/MiFIR identify algorithmic trading where a computer algorithm “automatically determines individual parameters of orders such as whether to initiate the order, the timing, price or quantity of the order or how to manage the order after its submission, with limited or no human intervention.”

Firms engaged must not only ensure that they maintain the necessary technical infrastructure in terms of their systems’ resilience. Their risk control and operational capabilities must enable them to act in compliance with certain algorithmic trading thresholds and prevent them from placing erroneous orders or other ill-doing that creates or increases market distortion, violates market abuse regulation or trading venue rules.

Business continuity arrangements must stipulate that such operational resilience has been tested and is being monitored. Investment firms are obliged to provide competent authorities with a description of the nature of its algorithmic trading strategies, details of the trading parameters or limits to which the system is subject, the key compliance and risk controls that it has in place and details of the testing of its systems at any time upon the authority’s request.

Where such algorithmic trading is part of a market making strategy firms have to make sure that market making takes place continuously “during a specified proportion of the trading venue’s trading hours” – whereas regulatory technical standards shall deliver that specification, taking into consideration the particularities of the financial instrument traded as well as the liquidity, scale and nature of the market it is traded on. Again, adequate systems and controls should be in place.

Trading venues will have to provide their share in preventing distortions caused by algorithmic trading through the building-in of circuit breakers, the regulation of minimum tick sizes and by putting caps on the unexecuted orders in relation to transactions. In addition, they must enable traders on their systems to test algorithms and be capable of identifying algorithmic trading, its patterns and the persons behind it.

For competent authorities to effectively supervise and, where necessary, limit or stop this form of trading, all respective orders have to be flagged accordingly. The flagging shall serve the purposes of identifying algorithmically induced orders, distinguishing them in order to assign them to the different algorithms they come from and evaluating the strategies of algorithmic traders. In that context, MiFID II/MiFIR require ESMA to regularly consult with national experts to keep up with developments in relation to trading technology and practices.

High-frequency algorithmic trading

High-frequency algorithmic trading is a subset of algorithmic trading under MiFID II/MiFIR.

High-frequency algorithmic trading according to MiFID II/MiFIR is a trading technique characterised by

  • an order entry infrastructure aiming at minimising network (and other) latencies via 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 intraday rates of messages which constitute orders, quotes or cancellations.

High-frequency algorithmic trading firms are obliged to accurately store all their placed, executed and cancelled orders and quotations on trading venues, sequenced by time and in an approved form. This information has to be made available to competent authorities upon their request.

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