More psychobabble?

The power of ‘thin slicing’ is a phrase used in psychology to explain the human’s ability to make sense of situations based on the thinnest slice of experience. I don’t know if this really works but Brussels appears to be doing exactly that.

In an attempt to prevent systemic risk and another Flash Crash, the latest leaked MiFID II document (dated 7th October) suggests some dangerous last minute changes. Particularly worrisome are the changes to the article on algorithmic trading, stating that firms providing algos also have to provide firm quotes at competitive prices and provide liquidity, regardless of market conditions! All these changes bring more questions than answers with many open to ambiguous interpretation.

Here is my take. Investment firms that provide algo services are going to have to become market makers and ensure that they provide continuous liquidity, regardless of what the market is doing. This changes the whole purpose of an algo strategy with detrimental consequences to European liquidity and the capital markets business. Just like with the infamous Tobin taxes this could mean that market participants will go elsewhere to trade. Algorithms are not designed to be traded continuously and uninterrupted. They are supposed to be triggered and executed only after the occurrence of specific signals. Trust me! It is far more difficult to take words out of a final text than it is to remove them from a draft proposal.

The final draft of the MiFID II paper is expected to be published on 19th October but it will still have to go through a couple more rounds of scrutiny before it becomes legislation so we might be lucky and some of the more worrying proposed changes may be excluded. More questions than answers remain, but if this goes through, then we can say bye-bye to liquidity as we know it.

Comments
2 Responses to “More psychobabble?”
  1. irene galbani says:

    Does the regulator really think that the ‘one size fits all’ approach is the right strategy to pursue for the achievement of a level playing field? This is the question that turns in my mind every time that I read a draft of MiFID II.

    I don’t have a great experience in terms of algo trading but it seems to me that there’s a wide variety of firms using algorithms, including pension funds, with many different purposes. Some of this firms already act as market makers and will not be affected by this provision, but how about the others?

    Even worse is the proposal to impose a tax on financial transactions. Brazil did something similar in 1997 in the attempt to increase revenues and all institutional traders started to trade Brazilian stocks as ADRs in New York. Ask Bovespa if it was a good idea!

  2. Colm Furlong says:

    There is either a huge misunderstanding here or indeed the authors of MiFID II are trying to kill algorithms in electronic trading in Europe. In turn, if that is their objective, they would likely kill elecronic trading in Europe and eventually trading in Europe. There are easier ways to do that such as banning trading and speculation altogether.

    I favour that it is a misunderstanding, muddle or typo that will be rectified. I hope so….

    An algorithm can be deployed to automate any trading activity, algo trading is now the fabric of the markets whether you are an investor or a speculator. To simplify by defining algo trading as market maker activity is at best a misprint or at worst a enormous mistake.

    I think the issue here is that much of the so called market making activity that takes place today does not provide an obligation for a continuous two sided quote and MiFID II will look to catch out HFTs that are trying to operate fast within minutias of the spread while pretending to be market makers – often disappearing when the markets drop.
    I am not sure how you police this however, as all of a sudden the HFTs say that they are not Market Makers just speculators in the spread.

    The vast majority of algos that are active on the electronic markets are not market making style algos and this idea of continuous quoting obligation for that activity makes absolutely no sense at all.

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