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European Legal Framework for Algorithmic and High Frequency Trading (Mifid 2 and MAR)

A Global Approach to Managing the Risks of the Modern Trading Paradigm

Published online by Cambridge University Press:  22 March 2018

Tilen ČUK  and
Arnaud VAN WAEYENBERGE
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Abstract

Algorithmic and high frequency trading use computer algorithms to execute strategies and the confluence of trends in computer hardware, programming, mathematical modelling, and financial innovation have pushed the limits of trading speed to unprecedented levels. Algorithms are fast and automatically spread disruptions through the financial system. Over the last decade, the ensuing systemic risk called for new regulations. This article attempts an early assessment of the new European legal framework (Mifid 2 and Market Abuse Regime) intended to tackle the technological risks of the modern trading paradigm.

Type
Reports
Information
European Journal of Risk Regulation , Volume 9 , Special Issue 1: Special Issue on Judge-Made Risk Regulation and Tort Law , March 2018 , pp. 146 - 153
Copyright
© Cambridge University Press 

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Footnotes

*

Researcher – Perelman Center for Legal Philosophy (ULB).

**

Associate Professor – HEC Paris (Law and Tax Department).

References

1 IOSCO is an international organisation of world’s securities regulators and a global standard setter for securities regulation. It works intensively with the G20 and the Financial Stability Board on the global regulatory reform agenda <www.iosco.org>

IOSCO, Regulatory Issues Raised by the Impact of Technological Changes on Market Integrity and Efficiency (Consultation Report, CR02/11, July 2011).

2 Event studies are a statistical method for establishing correlation between an event, eg an algorithm’s activity and its supposed effects on markets. Since correlation is not causation, other circumstantial evidence is normally used as well, such as telephone calls, messages, etc. Event studies only found their place in securities litigation in the late 1980s but have been progressively used since. The problem of algorithmic and HFT is that, although the standards of proof vary from administrative, civil, to criminal procedures, event studies and their questionable correlation estimates might soon be the only available evidence.

3 Directive (EU) 2014/65 of the European Parliament and of the Council on markets in financial instruments (Mifid 2) [2014] OJ L173. Mifid 2 is applicable from 3 January 2018 and replaces parts of the framework put in place by the Directive (EC) 2004/39 of the European Parliament and of the Council of 21 April 2004 on markets in financial instruments (Mifid 1) [2004] OJ L145.

4 The new Market Abuse Regime consists of a Regulation (EU) 596/2014 of the European Parliament and of the Council on market abuse (MAR) [2014] OJ L173 and an accompanying Directive (EU) 2014/57 on criminal sanctions for market abuse (CSMAD) [2014] OJ L173, both applicable as of 3 July 2016.

5 Harris, JH and Schultz, PH, “The Trading Profits of SOES Bandits” (1998) 50(1) JFE 39 CrossRefGoogle Scholar.

6 The term used to describe this zero risk trading in two books that first shed light on HFT: Patterson, S, Dark Pools, The Rise of the Machine Traders and the Rigging of the U.S. Stock Market (Random House 2012)Google Scholar; Lewis, M, Flash Boys, A Wall Street Revolt (WW Norton & Company 2014)Google Scholar.

7 Directive 2004/39/EC of the European Parliament and of the Council of 21 April 2004 on markets and financial instruments, OJ L 145, 30/04/2004 p 0001–0044.

8 For a recent study of dark pools and the role of HFT see Monica Petrescu and Michael Wedow, Dark pools in European equity markets: emergence, competition and implications (European Central Bank, Occasional Paper Series No 193, July 2017).

9 Concentration rules gave the national exchanges a monopolistic right to match orders related to certain financial instruments.

10 The Regulatory Technical Standards (RTS) are endorsed by the Commission through Art 290 TFEU delegated acts and Implementing Technical Standards (ITS) are endorsed by the Commission through Art 291 TFEU implementing acts.

11 Securities and Exchange Commission, Concept Release on Equity Market Structure (17 CFR PART 242, 21 January 2010) 3606.

12 European Securities Markets Authority, High frequency trading activity on EU equity markets (Economic Report, December 2014).

13 Swift offered access to London markets to 3,000 traders based in 150 different locations worldwide, see Financial Services Authority, Decision Notice: 7722656 Canada Inc formerly carrying on business as Swift Trade Inc (6 May 2011) 2.6.

14 Market manipulation is only one type of market abuse as defined by MAR, alongside insider trading.

15 Avramovic, A, We’re all high frequency traders (Crédit Suisse, Market Commentary, 15 March 2017)Google Scholar.

16 There was a general turn towards principles-based approach after 2007 because previous more rules-based regimes allowed for significant leeway in interpretation and avoidance of regulations. See for example, Black, J, “Forms and paradoxes of principles-based regulation” (2008) 3(4) CMLJ 425 Google Scholar.

17 Autorité des Marchés Financiers, Décision à l’égard des sociétés Euronext Paris & Virtu Financial Europe (4 December 2015).

18 See Financial Conduct Authority, “Regulatory sandbox”, available at <www.fca.org.uk/firms/regulatory-sandbox>.