Once the realm of individual investors, financial markets are becoming increasingly automated.
Computers are replacing humans. Mathematicians and programmers, once limited to fields such as science and information technology, are now the dominant force in finance.
High-frequency trading, or HFT as it is known in short, is now everywhere in markets. Anyone who has recently conducted a trade – whether in stocks, currencies, commodities or rates – is likely to have transacted to with a robot, rather than a human. And it’s only getting larger.
The rise of HFT is seen as a welcome development by some in financial markets with its growth allowing for increased market participation, greater levels of price discovery and lower transaction costs for investors, they say.
However, that view is not universally popular.
To many traditional investors HFT is seen as a curse. Like the classic 1984 film ‘The Terminator’, the machines are systematically killing financial markets, creating lower levels of market liquidity, increased cross-asset correlations and, as a consequence, heightened market volatility.
One of the chief complaints levelled against HFT is the practice of market “spoofing”, a scenario where traders use a rapid succession of bogus orders to unfairly move the price of a listed asset in their favour.
Many traditional investors deem the practice to be unfair, believing that it is just another form of market manipulation. The argument is that HFT operators are simply flooding markets with orders that are placed simply to move markets, not be executed.
In what will no doubt please those pining for the demise of HFT, China’s financial markets regulator – the CSRC – may be about to introduce some of the toughest regulations governing the operation of HFT, particularly against market spoofing.
According to Bloomberg, the CSRC draft proposal states that “frequently placing and withdrawing orders where the ratio of trades concluded is abnormally low” would be prohibited.
In order to dissuade HFT firms from engaging in such activities, traders who cancel more than 40% of their submitted orders on any one day would be slugged a fee of 2 yuan, or around $0.31, per transaction.
Another proposal includes forcing traders using automated orders to provide a detailed description of their strategy, allowing the regulator time to review the purpose of the trade before they’re allowing the trade to go ahead.
Both – one extremely costly and one that would substantially delay HFT orders – would no doubt limit the level of automated trading conducted on Chinese markets.
They also follow several high-profile instances where the CSRC targeted HFT firms in the wake of the stock market crash that wiped over $5 billion off the value of Chinese listed firms midway through the year.
According to a report on the state-run Caixin website, by early August this year the Shanghai and Shenzhen stock exchanges had identified and punished at least 42 trading accounts that used HFT strategies in a way that distorted markets. 28 were ordered to suspend trading for three months, including accounts owned by US hedge fund Citadel Securities.
The report states that From mid-June to early July, when the Shanghai Composite suffered a decline of more than 30%, hedge funds using HFT reported an average gain of 4%.
Caixin estimates that there are more than 1,000 investment institutions in China who now use HFT with the total value of their investment products now standing at 100 billion yuan.
The draft measures announced by the CSRC are likely to be finalised by early 2016, with the impact likely to be closely watched by markets around the world.
This is especially so in the United States, where SEC claims only 1 in every 27 orders placed is currently executed.