Too Fast to Fail: A Snapshot of High Frequency Trading

High Frequency Traders (HFT) have largely lived in the underbelly of Financial Services, operating in a rare and often complicated world performing trades at speeds the human brain will never match. Regulators and governing bodies have not had the capability or the resource to fully understand and grasp these complex business models, which includes Hedge Funds and dark pools, leaving them to operate within looser parameters compared to the heavily regulated Investment Banking sector.

In November 2010 the ‘Flash Crash’ – where a trillion dollars was wiped off the U.S stock market in minutes only for it to rebound just as rapidly – made the global regulatory world take note as it sent shock waves throughout the market. Following this seismic event, it became clear that HFT’s operate in a digital age technologically but are largely governed by “Depression era-legislation”and there has been a significant reaction from regulatory bodies across the globe.

Since 2012 a wave of new rules have been implemented, including the revision of MiFID II adapted to ultimately de-risk the sector and the approach of HFT’s, although there still remains a stigma that these firms are not ultimately market makers. Significant banking institutions who essentially provide the market places for HFT’s to trade have never fully accepted their standing within the market, and coupled with their high risk gung-ho approach has led to a strained relationship. So much so, that banks are now turning their back on HFT firms, regardless of their profitability and platform, purely because of the risk attained with dealing with these institutions.

Banks and Hedge Funds have also made a strategic decision to focus on developing their own trading systems to be faster, with the use of algorithms, encroaching on the pure HFT houses such as Getco, Hudson River and Jump Trading. This has created a technological arms race with the biggest firms spending millions to find that nanosecond of time and be ahead of their competitors. This has separated the ‘haves’ from the ‘have-nots’, as smaller trading firms have been forced to think laterally and to have a more sophisticated strategy and business to remain profitable.  Investment banks have to be more commercial with their capital to enable it to stretch across its complex and diverse business areas, and are renowned for having antiquated technology not able to compete with HFT’s. This adaptive strategy has meant that the smaller trading houses have had to learn how to execute their strategy over a relatively longer period, which would perhaps not classify them as HFTs at all.

Regulators have struggled to keep up with this pace of development, to ensure that the new technology models are capable of delivering to the stricter regulation imposed on HFTs. Technology vendors such as Fidessa are not regulated themselves, and it is a question of whether they should be when they provide the technology to regulated entities.

It has now become increasingly difficult for firms to operate with Banks, Exchanges and Regulators clamping down on the marketplace in which HFTs operate. However, it does not seem to have slowed profits as they continue to develop ingenious ways to better their competitors. It is only recently that plans to build a tower taller than The Shard were submitted to transmit trades within one-millionth of a second to Europe’s markets and stock exchanges. Even with these increased regulatory challenges, the focus of High Frequency Traders to stay at the forefront of change is apparent, as remaining to be seen as approved market participants is integral for global footprint.

By Barrie Lee and Max Alfano, Consultants at Fides Search.

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