08 November 2011

FESE Response to ESMA Consultation Paper systems and controls in a highly-automated trading environment for trading platforms

FESE supports efficient, fair, orderly and transparent financial markets that meet the needs of well-protected and informed investors and provide a source for companies where to raise capital. In Europe, capital markets have greatly changed since the implementation of the Markets in Financial Instruments Directive (MiFID). This has resulted in more competition among trading venues as new types of them (Multilateral Trading Facilities - MTFs, and Systematic Internalisers - SIs) now compete with one another.

Significant technology advancements have been implemented by trading venues, in a bid to provide the investor with improved access to and interaction with the market. One of them is high frequency trading (HFT), which allows more accurate, granular and faster pricing of securities.

It is important note that HFT makes a positive contribution to market quality; nonetheless, it is also vital to deal with the concerns surrounding HFT activity and its effect on market safety and integrity. Recent research conducted on the subject of HFT and market efficiency found that, to date, there is no direct evidence that HFT trading has increased volatility. In this regard, FESE welcomes this opportunity to outline the provisions taken by its members to foresee potential problems and the tools that they have put in place to safeguard against them.

i. HFT definition and provisions for market integrity

FESE agrees with the view that HFT is not a strategy in itself, but a sub-set of automated trading and eoncompasses many different trading strategies. In this regard, FESE agrees with the provision for enhanced organisational requirements to safeguard the efficient and functioning integrity of the markets indicated by the European Commission.

ii. Limited scope of the consultation

FESE has understood that the purpose of ESMA’s work is to provide an immediate set of guidelines that can be implemented with the current MiFID Directive. However, there are other areas on which ESMA could also consult and issue guidelines that could be introduced under the existing framework.

Such a vital issue would be HFT rules for the operation of trading platforms under the OTC license. FESE believes that ESMA could use its guideline powers to consult and rectify this issue. As ESMA states: "the Review will take some time and urgent issues should be addressed within the existing framework at least as much as possible". In fact, without this set of guidelines, the current guidelines will be inadequate, as any quantity of HFT happening on OTC platforms, and therefore are not labelled as Regulated Markets or MTFs, would fall outside the scope of the current consultation paper. In this context, FESE believes that all venues operating either with a Systematic Internalisation license or as OTC should be covered. It is proposed that the guidelines in this consultation paper are to be imposed on trading platforms and investment firms. The guidelines are very different depending on which group you are in, which makes sense if every trading venue is classified as a trading venue. However, the consultation only refers to Regulated Markets (RMs) and MTFs as trading platforms. FESE considers this focus to be too narrow. There is the question as to why ‘trading platforms’ does not also include Systematic Internalisers (SIs), which according to MiFID 1 are regulated trading venues. Moreover, MiFID does not include any definition of a ‘trading platform’, only a ‘trading venue’ or ‘execution venue’. By definition, SIs are doing systematic trading and are subject to various trading venue rules. Indeed, some brokers could potentially use their SI licence to interact with HFT as well to expand to trading venues and execution venues.

Much of the current policy debate on HFT is focused on the lit markets and, when it refers to dark venues, tends to focus on regulated dark trading venues. Less considered is the issue of interaction of HFT in the OTC space. By contrast, some recent researchers have suggested that HFT exists in the OTC space, probably in particular in the platforms known as Broker Crossing Networks (BCNs) in Europe which are currently regulated as OTC. Whether the HFT trading in the OTC space has the same trading strategies as in RMs or MTFs may not yet be known (due to the limited public information about OTC trading in Europe); however, it is known that the proprietary desks of the crossing system providers often act as market makers applying strategies that are largely comparable to HFT market making on lit markets. Any regulatory approach focusing on specialised players alone risks (i) undermining a level playing field and (ii) excluding a relevant part of HFT strategies. FESE supports this recommendation.

Moreover, the exclusive focus of this consultation is on trading platforms and investment firms when acting as routers of orders to other platforms. This consultation does not examine the HFT firms themselves or investment firms acting as HFT. The focus of the consultation appears to place the responsibility on the trading platforms and the investment firms routing orders and not on the HFT  firms overall.

iii. Responsibility

FESE believes that it is essential that any proposed guidelines contain no ambiguity on what entity with which the eventual responsibility rests. There needs to be a clear and well-defined division of labour in order for market participants to understand their role in ensuring a fair and orderly market. An example of such a need for a clear distinction of responsibility is the issue of Direct Market Access (DMA) and Sponsored Access (SA). It must be made clear that due to the nature of the business, it is the intermediary offering either DMA or SA that must bear the ultimate responsibility for orders sent to the trading platforms.

iv. Level of flexibility

ESMA must ensure that it achieves the right balance between the correct level of details contained in the guidelines and the need for flexibility in how trading venues are allowed to execute these guidelines. This flexibility must be based on the business model and the financial instrument being traded. FESE believes that an excessive level of detail would hinder trading platforms ensuring a fair and orderly market and fulfilling their functions correctly.

v. Access to trading platforms

These guidelines must take into account that different trading venues facilitate different investor profiles. Therefore, they may desire to be more restrictive to firms using algorithmic trading strategies accessing their platforms. In principle this should be allowed.

Full consultation letter

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