In the wake of Michael Lewis’ Flash Boys, the best-seller which claimed high-speed traders were essentially fleecing the public by using sophisticated computer programs to rig the markets in their favour, what was once a complex trading strategy followed only by market experts now receives regular, and usually negative, press attention.

High frequency trading (HFT) has become something of a hot topic and faces a raft of new regulatory restrictions, enforcement action and, at least in the US, litigation. This article focuses on the reality of the new regulatory landscape, the likely impact of this increased scrutiny and the potential risks of litigation for those engaged in HFT.

Defining HFT

HFT is, in essence, a type of trading which uses complex algorithms for automated decision-making, with a large number of orders executed at very high speed. Supporters cite greater liquidity and reduced volatility as key benefits resulting from the presence of HFT, which makes up around one-third of the UK equity market, but it remains controversial. Critics claim that if the algorithms fail, they have the potential to significantly distort the market and create short periods of extremely high volatility – a flash crash. For example, HFT was linked with the May 2010 flash crash and the April 2013 Twitter flash crash.

Increased regulation

Particularly in light of such flash crashes, HFT has attracted the attention of regulators and it is no surprise that the revised EU Markets in Financial Instruments Directive (MiFID II), which will become applicable in the UK on 3 January 2017, introduces a far more intrusive approach to HFT regulation.

MiFID II contains a specific definition of HFT which is deliberately broad, seeking to bring into the scope of regulation a number of currently unregulated firms engaged in HFT which will, among other things, increase their record keeping obligations. MiFID II requires that firms document their algorithms and record the person responsible for them, while trading venues will be required to publish data concerning execution quality for each financial instrument traded. Firms will also need to put in place prescribed measures to ensure trading systems do not contravene regulations on market abuse and to keep adequate records so that information can be provided, on request, to the FCA. 

Jan-Mar 2015 issue

Signature Litigation LLP