High-frequency traders in the European Union (EU) are set to face some of the toughest rules in the world, as legislators backed rules that they said would curb volatility and make markets safer.
The limits include standards meant to keep the price increment for securities from being too small, mandatory tests of trading algorithms, and requirements that market makers provide liquidity for a set number of hours each day. The curbs are part of revamped EU markets legislation approved by the European Parliament voting in Strasbourg, France.
The price increment rules and other measures requiring trading to stop if “price volatility goes beyond a certain level” will slow down high-frequency trading “to a more manageable pace,” Markus Ferber, the legislator who led the assembly's work on the standards, said in an email before today's vote.
High-frequency trading in stocks grabbed headlines after the plunge known as the flash crash in May 2010, during which the Dow Jones Industrial Average briefly lost almost 1,000 points. Controversy returned with the publication of Michael Lewis's book “Flash Boys” on March 31. Lewis argues that the $22 trillion U.S. stock market is rigged in favor of speed traders, whom he says prey on slower investors by getting faster access to information.
High-frequency trading involves using powerful technology and computer programs to execute orders in thousandths or even millionths of a second, profiting from fleeting discrepancies in security prices across different trading venues.
“Traders can move billions within milliseconds and thus enforce market volatility and even bring down whole stock exchanges, as the 2010 flash crash has shown,” Ferber said. “This set of new rules will make European financial markets safer and more resilient.”
Under the EU measures, traders must have their algorithms tested on venues and authorized by regulators. Michel Barnier, the EU's financial services chief, has said that the standards will be “one of the strictest set of regulations for high-frequency trading in the world.”
The assembly's vote paves the way for national governments in the 28-nation bloc to give their final sign-off on the legislation, which in addition to high-frequency trading covers topics ranging from commodity-derivatives speculation to the establishment of a new type of trading platform.
The measures overhaul the EU's existing financial-market rulebook, known as Mifid. While the law is set to apply two and a half years after it's published, some individual measures have longer transition periods.
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