Since the “Flash Crash” of May 2010 regulators have been concerned to establish just how dangerous algorithmic trading, and in particular high-frequency algorithmic trading, might be. For example, can algorithms used by one firm be provoked by antagonistic algorithms used by another firm into panic selling?
Under MiFID II, which comes into force in January 2018, investment firms will have to certify that their electronic trading systems will not create disorderly market conditions, and they will face stringent fines if they contravene the rules.
However, two new reports, published in June by European market regulatory agencies – the Danish Finanstilsynet and the Dutch AFM – find no substantial evidence that algo traders actually have the ability to manipulate markets, for example by being able to spot liquidity in markets, or indeed by creating illiquidity.
The Finanstilsynet report says that the proportion of algorithmic trading on the NASDAQ Copenhagen exchange has risen from 10% in 2007 to 50% in 2014, with high frequency trades accounting for 15% of the volume. However, the report finds: “No indication that systemic risk has risen in line with the increase in percentage of trading volume generated from ago trading.” In particular, the agency says it does not find evidence of widespread use of trend-initiating strategies executed with altos. By contrast, the narrowing of market spreads over the same period points to improved liquidity in the market, credited in large part to the algo traders. The Finanstilsynet report can be found here.
The report by the Dutch markets regulator, the AFM, suggests that complaints against algo traders may over-state their ability to profit from market illiquidity at the expense of other investors. In its report, based on investigations into trades on Dutch and UK exchanges, the AFM says that: “The fragmented stock market landscape and the far-reaching rise of technology in trading proses a real challenge to obtaining a reliable understanding of liquidity.” And that does mean that institutional investors such as pension funds struggle to minimise the market impact of their trades. But the AFM says it found no evidence that HFTs were using liquidity detection strategies to make profits. The AFM report can be found here.
