HFT: Separating fact from fiction

February 25, 2014

–Hugh Cumberland is solution manager, financial services at Colt Technology Services. The opinions expressed are his own.–

Over the last few years, every time a stock, sector or index takes a sudden, sharp and unexpected dip, almost every commentator with a passing knowledge of capital markets declares it a high frequency trading (HFT) inspired flash crash. But this judgement has more to do with the negative connotations associated with HFT than the reality, as very few such corrections have definitively been ascribed to HFT.

To its credit, there is no denying that HFT has reduced transaction costs, narrowed spreads and increased liquidity. And there are pro-HFT arguments that say that it can mitigate the impact of sentiment driven sell offs. But it is still seen as an evil force and regulators are pushing against an open door when they introduce new measures intended to curb or completely arrest HFT. We’ve seen two examples of this recently: the European Union earlier this year agreed to introduce a number of new regulations governing HFT, and in February, Germany introduced new regulations requiring HFT firms to be licensed with the country’s regulator, BaFin.

Being closer to, or faster to, the market has been a desire since we started trading in centralised markets. Criticising HFT firms for gaining an advantage over the man in the street purely by exercising spending power is absurd. The man in the street is not in a position to open a car factory, build a nuclear power station or launch his own ocean-going liner either – it’s an economic fact that capital expenditure can be used to create advantage over those who don’t have access to the same levels of capital.

Can anything be done to address the negativity that surrounds HFT? Well, politicians, regulators and market commentators are not exactly queuing up to argue HFT’s corner, and there are still some that would have it that HFT firms are the root of all evil. HFT firms themselves are notoriously publicity-shy, not overly concerned by the bad reputation they have acquired as long as they are making money. Like the gold rush miners of the Wild West, they mine a seam of profitability until it’s exhausted – whether through competition or regulation – and then move on to the next seam. HFT firms have shown themselves to be highly nimble, and have the ability to move swiftly on to new opportunities in other asset classes or other trading centres, perhaps with a preference for those that have a lighter regulatory regime. Who can blame them?

The danger is that the benefits of HFT will be completely lost if it is regulated out of existence. If that should happen we may – with the benefit of hindsight – come to think that we have gone too far, much like Sweden did when it saw the impact the financial transaction tax had on its capital and derivatives markets back in the 1980s.  We should just be very careful in Europe to make sure that we are not throwing the baby out with the bath water.

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