Germany is taking the lead in Europe by imposing stricter
regulation on algorithmic trading but many futures firms are
still ignorant of this, fuelling concerns over performance and
trading volumes, writes Joe Parsons.
Under the German High Frequency
Trading (HFT) law firms will be required on April 1 to uniquely
identify each algorithmic order sent to a German exchange with
a key/flag, detailing in real time the entire decision process
behind that order.
Firms will also have to ensure all
orders must reference the history of the decision making
process behind that order and any other algo that was
Regulators and exchanges have
argued that algo trading has made surveillance of the markets
more difficult and abusive behaviour harder to spot, and algo
flagging is one way in which Eurex, Germanys derivatives
exchange, and BaFin, Germanys financial regulator, aims
to deal with this issue.
However, the industry is concerned
over the negative implications this could have on firms, which
will have to make dramatic changes to their algos to ensure
that they are able to provide the necessary data to the
There is the possibility it will
impact on firms performance, as to report the entire decision
path of an algo order in real time is a complex
If market participants are
forced to focus on correctly tagging their algorithmic decision
processes, rather than collaborating their algorithms to
respond more adeptly to changing market circumstances, it may
hamper their performance, said PJ Di Giammarino, founder
and CEO of JWG Group, a regulatory think tank.
The sheer diversity of some
algorithms will present a huge task for firms to report all the
necessary data related to that algo.
It is a complex and
complicated requirement to deal with because there can be many
inputs that can go into algorithmic decisions
particularly when it comes to market-making and statistical
arbitrage strategies, added Di Giammarino.
"Firms that were not high
frequency traders under the German HFT law will not
have realised they are required to flag their algos,"
said Sam Tyfield, Vedder Price.
In addition, according to Rob
Boardman, CEO of ITG, a broker: Firms have had to divert
resources to ensure they come under the algo flagging
Unaware of scope of
There is also a large amount of uncertainty amongst some
futures traders, many of which are unaware of their obligations
to flag their algorithmic trading activity.
A lot of firms that were not
high frequency traders under the German HFT law
will not have realised they are required to flag their algos,
when in reality, all firms who use algos are required to flag
under the law, said Sam Tyfield, a partner at law firm
Many futures traders believe that
because they are not defined as a high frequency trader, they
are exempt from the flagging requirements, and this shows many
are still unaware over the scope of the requirements.
Tyfield also argued there are
certain practical issues on how firms will have to make their
If a NCM
(non-clearing member) uses a GCM (general clearing member) for
execution through the GCMs FIX gateway, since neither can
control how the other flags its algos, it is possible the flag
used by the NCM could conflict with a separate flag used by the
GCM, added Tyfield.
regulator is going to insist on unique algo flags but the
industry is going to need to find solutions for this (and
other) practical issues.
Determining "new trading
Whether trading firms direct
orders away from such markets to other jurisdictions
remains to be seen, but its a certain
possibility, said Christian Voigt, Fidessa.
Firms will have to apply flags for the lifetime of an
algo which cannot be altered unless the algo changes in such a
way that constitutes new trading behaviour. The
issue here is that firms will have to continually determine
Market participants are
faced with the very difficult prospect of balancing innovation
with compliance. As they [firms] evolve their algos to better
provide liquidity ... they must continually determine if
theyre creating new trading behaviour,
said Andrew Lisy, algo product manager at OptionsCity.
Furthermore, the issue of determining new trading
behaviour could also affect the regulators' ability in
overseeing high frequency and algorithmic trading.
Regulators are going to have
a very difficult time drawing a line as far as determining what
constitutes new trading behaviour, as even
seemingly minor changes in the parameter inputs to certain
algorithms can dramatically alter how that algo places orders
in the market, added Lisy.
Finally, algo flagging
requirements could potentially hurt trading volumes, as traders
could look to other derivative exchanges in the search for
innovation and to evolve their algos.
The requirement to flag
algos currently only covers exchanges regulated in Germany.
Whether trading firms direct orders away from such markets to
other jurisdictions remains to be seen, but its a certain
possibility, said Christian Voigt, product management,
Despite these issues, algo
flagging is set to come into force on April 1, and
Germanys derivatives and securities exchanges are making
sure its members are prepared for the requirements.
Eurex issued guidance to its
members in January detailing the provisions of algo flagging,
and has created a new field in its trading systems for members
to use in identifying their firms.
Deutsche Boerse said in a
statement: We are working with our members to ensure that
they are fully compliant with the new flagging