The World Federation of Exchanges reports on High Frequency Trading (HFT)

May 29, 2013

The World Federation of Exchanges (WFE) today released a review on High Frequency Trading (HFT), describing it as a technology that financial firms are embracing around the world. Besides, the study notes the many initiatives and risk management practices that exchanges have adopted to enhance the safety, stability and integrity of the markets. The review was directed by the WFE Board of Directors. 

"Exchanges have enacted many safeguards to ensure orderly markets. The WFE is committed to coordinating information and sharing principles among market operators on surveillance and risk management practices which may also be applied to HFT." said Hüseyin Erkan, Chief Executive Officer of WFE.

Among the key points in the review:

• All around the world and across all markets, economic pressures and competition are pushing businesses to find the most effective ways to invest and hedge risks. Today, strategies using algorithmic trading and HFT play a central role on financial exchanges, alternative markets, and some banks' internalized (over-the-counter) dealings.
• Exchanges have adapted to the speed and automation of today's markets by deploying sophisticated risk mitigation and surveillance technology, and are continuing to innovate in these areas to further enhance the safety, stability and integrity of the markets.
• Today's exchange markets are unquestionably faster, more transparent and more efficient than the market structures that preceded them. The substantial majority of the empirical research has concluded that HFT has had measurable beneficial impacts on a variety of core market quality metrics^[1], including tighter spreads, increased liquidity, more efficient price formation, reduced transaction costs for market participants and lower market volatility in most circumstances.
• In markets where automated trading and highly advanced technology infrastructures have been prevalent for some time, HFT, while still forming a large part of market activity, appears to have plateaued. HFT levels in the U.S. and Europe are estimated by consultancy Tabb Group[2] to be trending even slightly downward in recent years.
• While the trend is flat to down among the earliest markets to adopt HFT, the Tokyo Stock Exchange, for example, has seen HFT activity grow over the past three years to levels comparable to the U.S. and European venues. In developing markets, HFT still appears to be growing relatively rapidly, albeit from a smaller base, in correlation with advances in the technology environment.
• There is a considerable library of academic literature on HFT and critics have focused on qualitative issues concerning fairness and systemic risk. While the rules concerning HFT are clearly defined on transparent or 'lit markets' such as exchanges, it is difficult to find rules or statistics about the ways that HFT is used in some dark pools, over-the-counter markets, and by brokers who internalize their order flow.
• International cooperation among market operators is important to accelerating shared learning and promoting high standards for enhancing the safety and integrity of markets. WFE and its member exchanges will continue to work with IOSCO and other regulators to ensure that policies are not imposed which would damage market liquidity or limit other market quality benefits provided by automated trading and HFT.

"We recognize the growing importance of automated trading and HFT to markets around the world," Mr. Erkan said. "WFE encourages regulators to continue to work with the industry to identify the critical risks and effective, balanced solutions that will enhance the safety of markets without compromising the quality of markets."

ABOUT THE WFE:

The World Federation of Exchanges is the trade association for the operators of regulated financial exchanges. With 57 members from around the globe, the WFE develops and promotes standards in markets, supporting reform in the regulation of OTC derivatives markets, international cooperation and coordination among regulators. WFE exchanges are home to more than 46,000 listed companies.

[1] December 2012 - Joel Hasbrouck and Gideon Saar "Low-Latency Trading"

http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1695460##

July 2012 – Jonathan Brogaard, Terrence Hendershott and Ryan Riordan "High Frequency Trading and Price Discovery"

http://faculty.haas.berkeley.edu/hender/HFT-PD.pdf

February 2011 - Terrence Hendershott, Charles Jones, and Albert Menkveld "Does Algorithmic Trading Improve Liquidity?"

http://faculty.haas.berkeley.edu/hender/Algo.pdf 

[2] TABB Group uses a combination of proprietary and public information to derive its estimate. For more details, please contact [email protected]

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