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Electronic trading increasingly uses programmes in which a computer algorithm makes autonomous decisions according to predefined rules, and determines, adapts and transmits the related order parameters in line with these rules (algorithmic trading). Some algorithmic trading programmes are capable of generating, amending or cancelling a large number of buy and sell orders within extremely short time intervals. This is referred to as high-frequency trading. As a rule, market participants engaging in high-frequency trading only enter into positions in financial instruments for a short time.
High-frequency trading has increased the speed and complexity of trading. This is associated with risks: for example, large order volumes may place a heavy burden on trading systems. Algorithms may also react to market events and trigger additional algorithms as a result, which may in turn trigger even more algorithms (cascade effect), leading to an increase in volatility.
In order to curb the potential risks associated with algorithmic high-frequency trading, the German federal government agreed on a draft High Frequency Trading Act (HFT Act) at the end of September. The Bundesrat and the Bundestag must still consider the draft before the final act is passed. This article provides an overview of the content of the planned requirements.
High-frequency traders to be supervised
High-frequency traders who are currently not supervised by BaFin either as a credit institution or as a financial services institution will in future need authorisation from BaFin. To date, high-frequency traders were not subject to any authorisation requirement if they only traded financial instruments for their own account and did not provide financial services or conduct banking business.
The future authorisation requirement will apply not only to high-frequency traders who are admitted to trading on a trading venue as trading participants, but also to those firms to which trading participants grant direct electronic access to the trading venue. Direct electronic access exists when a trading participant allows another person to use its identification (trading ID) for directly and electronically transmitting orders to the trading venue. Unfiltered access in which the order does not pass through the trading participants’ pre-trade controls is prohibited.
The authorisation requirement will be introduced as part of the planned expansion of the definition of proprietary trading in section 1 (1a) sentence 2 no. 4 of the German Banking Act (Kreditwesengesetz – KWG). As long as a firm is domiciled in another EU or EEA Member State and has approval there that includes trading on own account, it does not need any additional authorisation in Germany because of the European passport under the Markets in Financial Instruments Directive (MiFID).