European Economic Area consists of 31 countries in Europe including 28 countries which are part of the European Commission. It follows common European Union Laws under various domains such as the constitution, administrative, international treaties, labour, social and market, public regulation.
Amongst these, the financial markets regulation under market laws is called Markets in Financial Instruments Directive (known as MiFID).
MiFID came into force in 2004 as an attempt to create EU as a single market for financial services. In 2011, MiFID-II Directive and MiFIR (Regulation on markets in financial instruments) came into existence with updated rules.
MiFID is applicable to all companies providing investment services, such as asset managers, banks and investment service companies and their clients. By bringing greater competition across Europe in the provision of services to investors and between trading venues, MiFID has helped contribute to deeper, more integrated and liquid financial markets. MiFID has also driven down costs for issuers, which has resulted in better and cheaper services for investors leading to economic growth and job creation in Europe.
Despite MiFID having met its original objectives there still was room for improvement. In December 2010, the European Commission published a consultation paper setting out proposals to amend MiFID, after reviewing it. The MiFID review addressed specific weaknesses in financial markets that emerged during the financial crisis. It also took account of technological developments and trading patterns that have significantly changed the structure of equity secondary markets since MiFID was first implemented.
What is MiFID-II?
In October 2011, the European Commission published its much-anticipated proposal for the Markets in Financial Instruments Directive 2 (MiFID 2).
MiFID-II legislation is the hub of a series of new regulations that will come into force over the next few years and will dramatically reshape the way firms operating in the financial services sector conduct their business.
MiFID-II for Algorithmic & High-Frequency Trading
Based on the proposal sent by European Securities and Markets Authority (ESMA), the intense political debate between the European Parliament, the Council of the EU (the Council), and the Commission took place last year. An informal agreement between the EU institutions was finally reached in February 2014. The final MiFID II and MiFIR texts were published in the Official Journal of the EU (OJ) on 12 June 2014 and entered into force 20 days later on 2 July 2014. Entry into the application will follow 30 months after entry into force on 3 January 2017.
An updated MiFID has introduced new safeguards for algorithmic and high-frequency trading activities which have drastically increased the speed of trading and pose possible systemic risks. The new safeguards include for all algorithmic traders to become systematically regulated, provide appropriate liquidity and rules to prevent them from adding to volatility by moving in and out of markets. Conditions for competition will be improved by the proposals in essential post-trade services such as clearing, which may otherwise frustrate competition between trading venues.
Regulations for High-Frequency Trading as per new MiFID-II
Definition of High-Frequency Trading
Before introducing regulations over HFT, the text needs to define what exactly comes under the gamut of HFT. High-Frequency Trading is described as either:
- Submission of at least 4 messages per second with respect to all instruments traded on a trading venue OR
- Submission of at least 2 message per second with respect to any single instrument traded on a trading venue
Implications for traders
- Authorization required: A firm engaging in a High-Frequency Algorithmic Trading (HFAT) technique will have to become authorized to continue to trade using an HFAT technique.
- Store historical data: HFAT investment firms will be required to store time sequenced records of their algorithmic trading systems and trading algorithms for at least five years.
- Market Making: HFT firms who use market making strategies on trading venues will be required to enter into market making agreements with the venues. This design ensures that they provide liquidity on a consistent basis.
Implications for trading venues
- Tick Size: Limits will be placed on how many orders per transaction participants can place as well as on how far venues may compete in attracting order flow for example by reducing the size by which prices may rise or fall (“tick size”) or through the design of their fee structures. The order to transaction ratio and the minimum tick size needs to declare.
- Test Algorithms: Trading venues will be required to provide facilities for their members to test algorithms.
- Track Algorithmic Trading: Trading venues will also be required to be able to identify orders generated by algorithmic trading, different algorithms used and the persons initiating the orders.
- Encourage market making: They must have schemes in place to ensure a sufficient number of firms enter into such agreements which require them to post firm quotes at competitive prices, providing liquidity to the market on a regular and predictable basis, where this is appropriate to the nature and scale of trading on that market.
- Venue Pricing: Venues to be able to halt trading in case of significant price movements (“circuit breakers”) in a harmonized fashion.
High-frequency trading techniques comprise as much as half of all activity in European equity markets, depending on how they are defined, according to a European Securities and Markets Authority paper published in December.
“We should not create regulation, which could be counterproductive for the markets and negative for the economic growth that we so desperately need.” said Olle Schmidt, Member of European Parliament.
There are several studies on algorithmic and high-frequency trading, to which we can refer. There are some studies showing that this is extremely bad for the market but there are also studies saying that is very good for the market: the price setting and the liquidity.
If you’re a retail trader or a tech professional and want to learn high-frequency trading, begin with basic concepts like high-frequency trading architecture, history of HFT, market microstructure, MiFID-II, HFT’s impact on market quality and order management system. You can also consider enrolling in EPAT, one of the most extensive algorithmic trading courses available in the industry.