ALGO-TRADING

GIANLUIGI GUGLIOTTA

Poland, 9 March 2012

DEFINITIONS

• No common agreed definition in economic literature: use of sofisticated tecnology to:▫ Define orders parameters (timing, price, quantities, …);▫ Interpret market signals▫ Exploit (guess) the functioning of algorithms used by competitors▫ Quasi-market making

• French FTT: Automated trading includes any trading system in which a computer algorithm determines automatically some parameters of the order (algorithms used to “optimize execution conditions” or to route orders towards platforms or used for order confirmation are expressly excluded from this definition)

• ESMA Guilines: Trading algorithm means computer software operating on the basis of key parameters set by an investment firm or by a client of an investment firmthat generates orders to be submitted to trading platforms automatically in response to market information

• MAR: algorithmic trading means trading of financial instruments using computer algorithms within the meaning [to be set forth by] MiFID2;

• MiFID2: Algorithmic trading means trading in financial instruments where a computer algorithm automatically determines individual parameters of orders such as whether to initiate the order, the timing, price or quantity of the order or how to manage the order after its submission, with limited or no human intervention

• BENEFITS

• Narrower spreads• Better price discovery• Increased liquidity• Reduced short term volatility• Better execution of orders

• POTENTIAL RISKS

• Decrease of transaction sizes• Poor quality of liquidity provided• Technological issues:

▫ Overloading of trading system▫ Duplicative/erroneous orders▫ Overreacting to market events

• Abusive behaviours• Disorderly markets

PROPOSAL FOR A REGULATION ON MARKET ABUSE

• Strategies which are likely to consitute market abuse:▫ The sending of orders to a trading venue by means of algorithmic trading without

an intention to trade but for the purpose of: disrupting or delaying the functioning of the trading system of the trading venue; making it more difficult for other persons to identify genuine orders on the trading system

of the trading venue; or creating a false or misleading impression about the supply of or demand for a financial

instrument;

▫ Quote stuffing: entering large numbers of orders and/or cancellations/updates of orders so as to create uncertainty for other participants, slowing down their process and to camouflage their own strategy;

▫ Layering and Spoofing: submitting multiple orders often away from the touch on one side of the order book with the intention of executing a trade on the other side of the order book (once that trade has taken place, the manipulative orders will be removed);

▫ Momentum ignition: entry of orders or a series of orders intended to start or exacerbate a trend, and to encourage other participants to accelerate or extend the trend in order to create an opportunity to unwind/open a position at a favourable price.

INVESTMENT FIRMS

• Technological standards:▫ Resilience and continuity▫ Trading thresholds/limits▫ Prevention of unlawfull conducts

• Reporting requirements to CA:▫ Strategies and parameters▫ Details of key controls▫ Data stored on orders + TR

• Market making obligations:▫ Continuous operation▫ Quotation of competitive prices

• DEA surveillance responsibilities▫ Suitability▫ Respect of thresholds and rules▫ Risk management

TRADING VENUES

• Techological standards:▫ Resilience and continuity▫ Thresholds limits, trading halts and

cancellation▫ Prevention of disorderly trading▫ Mere possibility to

Limit order to transaction ratio Slow down order flow Limit minimum tick size

• DEA surveillance rsponsibilities▫ DEA limited to authorized firms▫ Suitability▫ Responsibility of member firms

MiFID2 / MiFIR

EU COMMISSION RESPONSIBILITIES

• Delegated acts to armonise in further detail▫ Organisational requirements on firms performing different investment

services of activities▫ Resilience requirements on trading venues▫ Trading halts▫ Ortedr to transaction ratio▫ Minimum tick size▫ Controls on DEA▫ Co-location services and fee structure

• Report on the impact of requirements regarding automated and HFT trading (2 yy after entering into force of new provisions)

MiFID2

Borsa Italiana’s fee on desplayed orders (2-04-2012)

• Scope: desplayed orders exceeding pre-defined order-to-trade ratios▫ 100:1 as to equities traded on the main market segment (MTA)▫ 40:1 as to equities traded on thei SMEs market (AIM)

• Tax Rate: progressive:▫ From 1 to 5 times the ratio 0.01 euro▫ From >5 to =10 times the ratio 0.02 euro▫ As from >10 0.025 euro▫ Upper daily threshold 1,000,00 euro per market segment (MTA / AIM)

• Exemption: market making (specialist)

French FTT on HFT (1-08-2012)

• Scope: orders cancelled or modified within 1 second (or shorter time limit to be specified by ministerial decree) by an HFT firms trading on own capital  and with operations in France where they exceed an order-to-trade ratio to be defined by ministerial decree;

• Definition of automated trading: any trading system in which a computer algorithm determines automatically some parameters of the order (algorithms used to “optimize execution conditions” or used to route orders towards platforms or used for order confirmation are expressly excluded from this definition)

• Tax Rate: 0,01% of the value of the cancelled or modified orders• Exemption: market making

PROPOSAL FOR AN FTT DIRECTIVE

• Policy goals: … to create appropriate disincentives for transactions that do not enhance the efficiency of financial markets thereby complementing regulatory measures aimied at avoiding future crises

• Risk of delocalisation: ▫ Coordinated approach … in line with the ambitions for G20 co-operation;▫ Broadly defined tax scope▫ State of residence (or establishment as for branches) of at least on of

the financial actors involved in the transaction (independently from the place of trade of the financial instrument)

• Exemptions: ▫ Primary markets (securities and currencies)▫ Central banks▫ Ring fencing of lending and borrowing activities

INVESTMENT FIRMS

• Block or cancel orders ▫ That do not meet specific parameters▫ On instruments that traders cannot

trade▫ That compromise the firm’s risk

management thresholds▫ Not consistent with applicable rules

• Procedures to override autom. blocks• Inform authorities:on risks & incidents• Rekord keeping • Training on order entry procedures• Controls:

▫ Real time monitoring procedures▫ Close scrutiny by compliance staff▫ Messaging traffic to individual platforms

• Manage operational risk• IT compatibility

TRADING VENUES

• Controls▫ Due diligence on non licenced firms▫ IT compatibility▫ Pre and post trade controls▫ Trader access and knowledge

• Preventative policing▫ Cancel, amend or correct transactions▫ Excessive flooding of the order book▫ Breaches of capacity limits

• Capacity to constrain or halt trading• Obtaining information from members• Monitoring• Record keeping and cooperation

ESMA GUIDELINES ON AUTOMATED TRADING (1-5-2012)To promote fair and orderly trading

INVESTMENT FIRMS

• Understanding, skill and authority of compliance staff

• Training in market abuse for traders• Monitoring activities• Identification and reporting of

suspicious transactions and orders• Periodic reviews and audit of

procedures and arrangements• Record keeping on alert management

TRADING VENUES

• Staffing (sufficient and knowledgeable)

• Monitoring systems on orders and transactions

• Identification and reporting of suspicious transactions and orders

• Periodic reviews and audit of procedures and arrangements

• Record keeping on alert management

ESMA GUIDELINES ON AUTOMATED TRADING (1-5-2012)To prevent market abuse