ALGO-TRADING
GIANLUIGI GUGLIOTTA
Poland, 9 March 2012
DEFINITIONS
• No common agreed definition in economic literature: use of sofisticated tecnology to:
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Define orders parameters (timing, price, quantities, …);
Interpret market signals
Exploit (guess) the functioning of algorithms used by competitors
Quasi-market making
• French FTT: Automated trading includes any trading system in which a computer
algorithm determines automatically some parameters of the order (algorithms used
to “optimize execution conditions” or to route orders towards platforms or used for
order confirmation are expressly excluded from this definition)
• ESMA Guilines: Trading algorithm means computer software operating on the basis
of key parameters set by an investment firm or by a client of an investment firmthat
generates orders to be submitted to trading platforms automatically in response to
market information
• MAR: algorithmic trading means trading of financial instruments using computer
algorithms within the meaning [to be set forth by] MiFID2;
• MiFID2: Algorithmic trading means trading in financial instruments where a computer
algorithm automatically determines individual parameters of orders such as whether
to initiate the order, the timing, price or quantity of the order or how to manage the
order after its submission, with limited or no human intervention
• BENEFITS
• POTENTIAL RISKS
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• Decrease of transaction sizes
• Poor quality of liquidity provided
• Technological issues:
Narrower spreads
Better price discovery
Increased liquidity
Reduced short term volatility
Better execution of orders
▫ Overloading of trading system
▫ Duplicative/erroneous orders
▫ Overreacting to market events
• Abusive behaviours
• Disorderly markets
PROPOSAL FOR A REGULATION ON MARKET ABUSE
• Strategies which are likely to consitute market abuse:
▫ The sending of orders to a trading venue by means of algorithmic trading without
an intention to trade but for the purpose of:
 disrupting or delaying the functioning of the trading system of the trading venue;
 making it more difficult for other persons to identify genuine orders on the trading system
of the trading venue; or
 creating a false or misleading impression about the supply of or demand for a financial
instrument;
▫ Quote stuffing: entering large numbers of orders and/or cancellations/updates of
orders so as to create uncertainty for other participants, slowing down their
process and to camouflage their own strategy;
▫ Layering and Spoofing: submitting multiple orders often away from the touch on
one side of the order book with the intention of executing a trade on the other
side of the order book (once that trade has taken place, the manipulative orders
will be removed);
▫ Momentum ignition: entry of orders or a series of orders intended to start or
exacerbate a trend, and to encourage other participants to accelerate or extend
the trend in order to create an opportunity to unwind/open a position at a
favourable price.
MiFID2 / MiFIR
INVESTMENT FIRMS
• Technological standards:
▫ Resilience and continuity
▫ Trading thresholds/limits
▫ Prevention of unlawfull conducts
• Reporting requirements to CA:
▫ Strategies and parameters
▫ Details of key controls
▫ Data stored on orders + TR
• Market making obligations:
▫ Continuous operation
▫ Quotation of competitive prices
• DEA surveillance responsibilities
▫ Suitability
▫ Respect of thresholds and rules
▫ Risk management
TRADING VENUES
• Techological standards:
▫ Resilience and continuity
▫ Thresholds limits, trading halts and
cancellation
▫ Prevention of disorderly trading
▫ Mere possibility to
 Limit order to transaction ratio
 Slow down order flow
 Limit minimum tick size
• DEA surveillance rsponsibilities
▫ DEA limited to authorized firms
▫ Suitability
▫ Responsibility of member firms
MiFID2
EU COMMISSION RESPONSIBILITIES
• Delegated acts to armonise in further detail
▫ Organisational requirements on firms performing different investment
services of activities
▫ Resilience requirements on trading venues
▫ Trading halts
▫ Ortedr to transaction ratio
▫ Minimum tick size
▫ Controls on DEA
▫ Co-location services and fee structure
• Report on the impact of requirements regarding automated and
HFT trading (2 yy after entering into force of new provisions)
Borsa Italiana’s fee on desplayed orders (2-04-2012)
• Scope: desplayed orders exceeding pre-defined order-to-trade ratios
▫ 100:1 as to equities traded on the main market segment (MTA)
▫ 40:1 as to equities traded on thei SMEs market (AIM)
• Tax Rate: progressive:
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From 1 to 5 times the ratio  0.01 euro
From >5 to =10 times the ratio  0.02 euro
As from >10  0.025 euro
Upper daily threshold  1,000,00 euro per market segment (MTA / AIM)
• Exemption: market making (specialist)
French FTT on HFT (1-08-2012)
• Scope: orders cancelled or modified within 1 second (or shorter time limit
to be specified by ministerial decree) by an HFT firms trading on own
capital and with operations in France where they exceed an order-to-trade
ratio to be defined by ministerial decree;
• Definition of automated trading: any trading system in which a computer
algorithm determines automatically some parameters of the order
(algorithms used to “optimize execution conditions” or used to route orders
towards platforms or used for order confirmation are expressly excluded
from this definition)
• Tax Rate: 0,01% of the value of the cancelled or modified orders
• Exemption: market making
PROPOSAL FOR AN FTT DIRECTIVE
• Policy goals: … to create appropriate disincentives for transactions
that do not enhance the efficiency of financial markets thereby
complementing regulatory measures aimied at avoiding future
crises
• Risk of delocalisation:
▫ Coordinated approach … in line with the ambitions for G20 co-operation;
▫ Broadly defined tax scope
▫ State of residence (or establishment as for branches) of at least on of
the financial actors involved in the transaction (independently from the
place of trade of the financial instrument)
• Exemptions:
▫ Primary markets (securities and currencies)
▫ Central banks
▫ Ring fencing of lending and borrowing activities
ESMA GUIDELINES ON AUTOMATED TRADING (1-5-2012)
To promote fair and orderly trading
INVESTMENT FIRMS
• Block or cancel orders
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That do not meet specific parameters
On instruments that traders cannot trade
That compromise the firm’s risk
management thresholds
Not consistent with applicable rules
Procedures to override autom. blocks
Inform authorities:on risks & incidents
Rekord keeping
Training on order entry procedures
Controls:
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Real time monitoring procedures
Close scrutiny by compliance staff
Messaging traffic to individual platforms
• Manage operational risk
• IT compatibility
TRADING VENUES
• Controls
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Due diligence on non licenced firms
IT compatibility
Pre and post trade controls
Trader access and knowledge
• Preventative policing
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Cancel, amend or correct transactions
Excessive flooding of the order book
Breaches of capacity limits
Capacity to constrain or halt trading
Obtaining information from members
Monitoring
Record keeping and cooperation
ESMA GUIDELINES ON AUTOMATED TRADING (1-5-2012)
To prevent market abuse
INVESTMENT FIRMS
TRADING VENUES
• Understanding, skill and authority of
compliance staff
• Training in market abuse for traders
• Monitoring activities
• Identification and reporting of
suspicious transactions and orders
• Periodic reviews and audit of
procedures and arrangements
• Record keeping on alert management
• Staffing (sufficient and knowledgeable)
• Monitoring systems on orders and
transactions
• Identification and reporting of
suspicious transactions and orders
• Periodic reviews and audit of
procedures and arrangements
• Record keeping on alert management