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High-frequency traders attract regulator’s interest

Big-iron trading systems face crackdown

Internet Security Threat Report 2014

Financial authorities in the UK and US are considering a new batch of regulations to limit the use of high-frequency trading computer systems by investment houses.

The chairman of the US Commodity Futures Trading Commission (CFTC), Gary Gensler, said that the UK and US are actively looking at regulations on high-frequency trading systems as a way of minimizing any potential harm in terms of market stability and unequal trading practices. The possible measures include forcing all companies engaging in such trades to register, and changing the way stock orders are processed.

High-frequency trading systems use massively beefed up servers with fast data connections and specialized software algorithms to identify arbitrage opportunities, place huge orders for stocks, and then cancel most of them dependent on where the value of the stock goes. The trades themselves make tiny amounts of money, but the volume and low-risk nature of the business have made such trading systems highly attractive to banks.

Last year, an architect of such systems from Goldman Sachs was sent down for eight years after attempting to take the trading system he helped develop to a rival. During the trial it was revealed that high-frequency trading had made the bank over $500m since 1999, and it is now estimated that high-frequency systems make up the majority of trades in the US exchanges, and hardware manufacturers are designing systems specifically for the practice.

The downside is that the systems may cause problems for the market. The Securities and Exchange Commission and CFTC report into the so-called Flash Crash of May 6, 2010 (when the Dow Jones Industrial Average lost nine per cent of its value, and then regained most of it in minutes) found that high-frequency traders were part of the problem behind the market volatility. Most high-frequency operations also sell all holdings at the end of the day, and so contribute nothing to stock price stability

At the moment, the proposed regulations look to be minor, but they will be unwelcome in this notoriously publicity-shy area of market trading.

"In my experience, those who talk about high-frequency trading the loudest are quite often the ones who know the least," said Andreas Preuss, deputy chief executive of Deutsche Börse AG, told The Wall Street Journal. "In my personal view, on the technological scene, they are the most professional and have the highest standards that exist." ®

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