HFT Delay Proposals Set To Worsen ETF Liquidity, Say Traders

September 28, 2012


Proposals to slow down high-frequency trading (HFT) on European stock exchanges could have a devastating effect on market liquidity and on exchange-traded fund investors, say traders.

On Wednesday night the European Parliament voted to force trading venues and exchanges to impose a minimum half-second “resting period” on orders in equities and ETFs. This means that market makers placing orders to buy and sell shares will not be able to cancel them in less than half a second. Currently, there are no such restrictions, with traders able to post and remove quotes in small fractions of a second.

The move by EU legislators has apparently been driven by concerns that high-frequency trading causes increased market volatility. The role of electronic trading firms in the equity markets has been under particular scrutiny since the so-called May 2010 “flash crash”, when the Dow Jones Industrial Average fell nearly 600 points in five minutes.

However, the plans to slow down electronic trading in Europe and to make trading safer, which won cross-party support in the vote, could in fact have the opposite effect, said one market-maker, who preferred to remain anonymous.

The trader said: "The high frequency delay that is being proposed is very bad for investors. It is likely to reduce liquidity, widen spreads and thin out the amount of quotes made. Bid and offer prices posted on exchanges are free options provided by market makers to other market participants. If we are forced to offer those options for longer, we will have to do so at much wider spreads between bid and offer prices."

The trader continued: "Regulators are trying to protect investors, but this move will have the opposite effect as those investors will ultimately bear the costs of increased volatility and lower market liquidity."

While European Parliament has now had its say on HFT, EU member states and the European Commission still have to agree the final text of Europe’s revised Market in Financial Instruments Directive (MiFID II), which will set the rules for share trading across the region. MiFID II is expected to come into force in 2013 at the earliest.

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