On December 17, the European Securities and Markets Authority (ESMA) published a report on high-frequency trading (HFT) in EU equity markets.
The European Union has already included the following new definitions of “algorithmic trading” and “high-frequency algorithmic trading technique” in the updated Markets in Financial Instruments Directive (MiFID II):
- “algorithmic trading” – trading in financial instruments 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, and does not include any system that is only used for the purpose of routing orders to one or more trading venues or for the processing of orders involving no determination of any trading parameters or for the confirmation of orders or the post-trade processing of executed transactions [Article 4(1)(39) MiFID II].
- “high-frequency algorithmic trading technique” – an algorithmic trading technique characterized by:
(a) infrastructure intended to minimize 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;
(b) system determination of order initiation, generation, routing or execution without human intervention for individual trades or orders; and
(c) high message intraday rates which constitute orders, quotes or cancellations [Article 4(1)(40) MiFID II].
These definitions are significant as under MiFID II high-frequency traders operating within the European Union will be required to be authorized (i.e., licensed) by their EU home state regulators. However, as ESMA’s report notes, HFT and algorithmic trading are practices that are relatively recent and are still evolving. Under MiFID II, ESMA is required to provide technical advice to the European Commission to provide for a more detailed definition of HFT.
ESMA’s report analyzes the extent of HFT trading activity across major EU trading venues based on a sample of 100 stocks from nine EU countries conducted during May 2013. ESMA’s report:
- finds that HFT activity ranges from 24 percent to 43 percent of equity value traded, using alternative methodologies (under a direct approach based on identifying HFT activity as the primary business of firms, and an indirect approach based on the lifetime of orders);
- notes that the level of HFT activity varies widely between trading venues and is linked to market capitalization; and
- recommends further research to:
(a) identify the drivers of HFT activity;
(b) assess the actual contribution of HFT to liquidity; and
(c) analyze potential risks and benefits linked to HFT activity.
ESMA’s report is available here.
MiFID II is available here.