Is the grass any greener on the other side?

On 30th October the CFTC’s Sub-Committee on Automated and High Frequency Trading Working Group 1 presented its definition of HFT to the CFTC Technology Advisory Committee. This is very interesting, as the European Parliament already published its version on 26th October. Let’s compare notes across the pond. Both approaches define HFT as a sub-category of algorithmic trading. However, the EU Parliament defines HFT and, separately, a HFT strategy. For simplicity, the EU HFT strategy is compared with the CFTC WG1 definition of HFT.

Definition of HFT by CFTC WG1 (Draft October 2012)


Source: CFTC Technology Advisory Committee

Definition of HFT by EU Parliament (26th October 2012)

Created from European Parliament text

Smart Order Routing
The EU Parliament explicitly excludes smart order routing (SOR), while CFTC WG1 does not. Even though SOR uses computer algorithms and operates at high speeds, this exception is very important for Europe because HFT strategies have market making obligations. The US does not have arbitrary market making requirements, thus it can afford to have a persistent and logical definition of HFT.

Messages rates
Both definitions incorporate some form of message rate measurement. However, CFTC WG1 differentiates between different kinds of message rates, stipulating that thresholds should be instrument or instrument class specific and updated on a periodic basis. The EU Parliament takes a much simpler approach. It considers only one all-encompassing message rate measure and it defines the threshold in the Level 1 text. This is like measuring everything by the same yardstick. Whether this is the right approach in a world of apples and pears remains to be seen.

Portfolio turnover
One of the criteria proposed by the EU Parliament is a daily portfolio turnover of at least 50%. In contrast, the CFTC WG1 states that portfolio turnover frequency is deliberately left out of the definition. The US approach seems much more appropriate. Neither slow nor fast market makers earn their income from holding inventory, but rather from providing liquidity and making the bid/ask spread. The mere fact that some traders have less unused inventory should not define them as HFTs.

Maker-taker pricing
According to the EU Parliament, strategies that execute at least 50% of their turnover on markets with a maker-taker pricing policy may qualify as HFT. Luckily, the CFTC WG1 does not mention it, nor does it make any reference to its deliberate omission. That’s understandable, because a list of all the pointless criteria which the CFTC WG 1 did not consider would simply be too long.

Human interaction
The draft by the CFTC WG1 speaks of algorithms that make decisions without human interaction; clear and simple. The EU Parliament talks of “limited or no human intervention”. What is limited human intervention? And how can that still be algorithmic trading or even high frequency trading?

Summary
From a European market perspective, it looks like the grass really could be greener on the other side. The CFTC WG1 draft captures HFT without looking at some arbitrary criteria, but luckily the MiFID II text is not yet final and there may still be time for EU regulators to copy from their US counterparts.

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