A UK-government commissioned working paper on the economic impact of MiFID II has hit out at several key computer trading rule proposals, warning that they could damage economic growth.
The updated guidance to the five-year-old MiFID (Markets in Financial Instruments Directive) offers several proposals designed to curb high-frequency trading.
The Foresight working paper, which brings together 35 academics from nine countries to examine the proposals, backs plans for the use of circuit breakers and a coherent tick size policy across similar markets.
However, it questions the evidence for another key plank of the plans; the imposition of market maker obligations. For some securities, these obligations "run into complications" arising from the nature of high frequency market making, say the academics. Many HFT strategies post bids and offers across correlated contracts. A requirement to post a continuous bid-offer spread is not consistent with this and, if binding, could force traders out of the business of liquidity provision.
Similarly, minimum resting times, while "conceptually attractive", can impinge upon hedging strategies which operate by placing orders across markets and expose liquidity providers to increased 'pick-off risk' if they are unable to cancel stale orders, says the paper.
The evidence for requiring notification of algorithms or minimum order-to-execution ratios is also questioned. Says, the paper: "The proposed notification policy is too vague, and its implementation, even if feasible, would require excessive costs for both firms and regulators."
Meanwhile, an order-to-execution ratio is a "blunt policy instrument" to reduce excessive message traffic and cancellation rates.
Although the Foresight project is sponsored by the UK government, it does not represent its backer's position. Nevertheless, the government's chief scientific adviser, Sir John Beddington, says: "I believe this evidence and analysis will be valuable to policy makers and regulators wanting to maximise the opportunities from computer-based trading while managing the risks. This kind of analysis is vital if a resilient regulatory framework is to be put in place."
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