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High-frequency trading

High-frequency trading (HFT)

High-frequency trading (HFT) is a much discussed algorithmic trading technology allowing securities transactions to be executed via extremely quick high-performance computers. The technology was developed in the course of the progressing technological evolution of the financial markets. HFT is an important component of electronic markets. HFT participants provide liquidity to markets, dampen volatility and reduce total transaction costs.

HFT also significantly contributes to the reduction of spreads. The resulting improved price quality also benefits companies through lower financing costs. HFT thus plays a major role in efficient and functioning capital markets and has economic benefits.

However, as with other technological innovations, certain risks such as increased volatility, market manipulations or technical errors cannot be ruled out. Deutsche Börse Group effectively counteracts these risks through comprehensive safety measures such as plausibility checks and circuit breakers, thereby safeguarding proper conduct of trading. Additional regulatory measures which contribute to the minimisation of these risks should expressly be supported HFT is regulated at EU level by MiFID II/MiFIR and at German national level by the German High-Frequency Trading Act.

HFT regulation at EU level

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 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 serves 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.

HFT regulation at German national level

The German High-Frequency Trading Act includes many features that have later also been implemented by MiFID II/MiFIR. It requires direct trading participants to flag or designate trading algorithms. At the request of the exchange supervisory authority or market supervision, the trading direct participant must also at any time furnish information on the trading strategies, parameters and concentration limits that underlie the designated algorithms.

Furthermore, the act requires the direct trading participants to guarantee an appropriate ratio of their order entries, modifications and deletions to the transactions actually executed. Stock exchanges are required by the act to change fees for excessive use of the trading systems, especially disproportionately high number of order entries, modifications and deletions.

Timeline

In Germany, HFT has been regulated by the German High-Frequency Trading Act since 15 May 2013.

HFT: the highlighted parts of the value chain are affected


Video: high-frequency trading ... in simple terms

 

High-frequency trading act

Find an overview of a number of key elements of the German High-frequency Trading Act here.

Eurex: HFT connectivity alternatives

Eurex offers various connectivity alternatives designed to meet the needs of high-frequency firms. These popular interfaces provide exchange participants with flexible, low-latency access to Eurex.

Legal basis

Find the most recent publication on this regulation here. [German]