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Algorithmic trading to be subject to greater control as MEPs back MiFID II

Out-Law News | 16 Apr 2014 | 3:27 pm | 1 min. read

The trading of assets based on high-speed computer algorithm-based data crunching is to be subject to greater controls under proposals backed by the European Parliament.

MEPs voted to support reforms to the Markets in Financial Instruments Directive (MiFID II) earlier this week. The proposals they support aim to ensure that changes in technology that have allowed for higher speed trading of assets to happen are subject to greater controls and new liquidity requirements. 

Algorithmic trading is a term used to describe the ultra high-speed computer-based process of analysing market data and determining the timing, prices or quantities of orders that traders should place on assets. 

A UK government report previously warned that the nature of high-frequency trading can lead to "periodic illiquidity". It said, though, that the use of "circuit breakers" across the different financial markets could help resolve the problem. In addition, it said that the industry could help to agree on the minimum numerical increment at which it is appropriate to denote changing asset values. 

The MiFID II proposals backed by the European Parliament contain similar safeguards to those suggested by the Government Office for Science (GOS) in its 2012 report.

 "Algorithmic traders must be registered as an investment firm and have in place effective systems and risk controls in place," the European Commission said in a statement summarising the aspects of the MiFID II reforms that relate to algorithmic trading. "When engaged in a market making strategy they are required to post quotes at competitive prices to provide liquidity on a regular basis which will contribute to more orderly trading."

"Trading venues will also be required to have robust controls against problems such as disorderly trading, erratic price movements, and capacity overload. To mitigate the latter, restrictions on how far venues may compete in attracting order flow will be imposed for example by reducing the size by which prices may rise or fall ('tick size') or through the design of their fee structures," it said. 

In addition, trading venues will be required to halt trading when the price of trades in assets fluctuates significantly. Regulators would also be handed powers to demand information from traders about their trading strategies and have greater oversight of 'direct electronic access' – where trading firms allow other traders deploying algorithms to "access public markets through their systems", under the plans. 

"Currently, regulators do not know which kinds of strategies are being used, by which strategy an order is generated, and members may not check what sort of strategies the persons using their systems are using and how those persons control their strategies," the Commission said. 

The MiFID II reforms still need the formal backing of the EU's Council of Ministers before they can become law, however the Council and the Parliament reached informal agreement on the text, now voted through by the Parliament, in January.