1. Exchange Perspective on the Rise of High Frequency
Trading – Challenges and Responses
International Conference on “Trading Environment of Stock Markets –
Changes and Challenges”
Korea Exchange, 4 October 2010
Matthias Stötzel, Deutsche Börse Group, Legal Affairs

2. Deutsche Börse Group, 4 October 2010
Overview
What is high frequency trading?
 Confusion of Terms
 What others say about high frequency trading
 What is high frequency trading …
 … and what is high frequency trading not?
 How does high frequency trading work?
What is the impact of high frequency trading on capital markets and exchanges?
 Benefits of high frequency trading
 Risks claimed to be associated with high frequency trading
 Impact of high frequency trading on exchange level
Regulation of high frequency trading
 Measures in connection with high frequency trading on exchange level
 High frequency trading in the regulator„s focus
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3. Deutsche Börse Group, 4 October 2010
Confusion of terms
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4. Deutsche Börse Group, 4 October 2010
What others say about High Frequency Trading
Andrew Bowley, head of electronic trading product management for Europe, the
Middle East and Africa at Nomura: "High frequency trading is just technology –
whoever spends more will be able to get to the market and trade quicker. You
can’t legislate against technology and so it‟s not something regulators are
getting too excited about.”
Lord Myners, UK financial services minister: “The danger is that nobody really
seems to think of themselves as owners. It has gone too far. It has now lost its
supporting function for the provision of capital to business and has become a
game to be played”.
Ronald Kent, NYSE Euronext’s head of international listings for Europe, the
Middle East, Africa and Asia: “High frequency traders and algo traders serve an
important function of the market. It is important that we engage with, and reach
out to, these customers and ensure they are being well served by our markets.
There is a lot of myth and a lack of understanding surrounding high-frequency
traders – in much the same way that hedge funds were not well understood 10
years ago.”
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5. Deutsche Börse Group, 4 October 2010
What is High Frequency Trading …
 Trading practise more frequently interacting with the market.
Speed as
competitive  Often carrying arbitrage down to miniscule differences between
edge prices traded on different venues and at different points of time, at
speeds much faster than the movement of an eyelid.
 Use of computer programmes with the computer algorithm deciding
on aspects of the order such as the timing, price or quantity of the
Automation of order.
trading
decisions  Computers make elaborate decisions to initiate orders based on
information that is received electronically, before human traders are
capable of processing the information they observe.
 Natural evolution of technological development.
Development of
technology and
 Embedded in the automation of the trading value chain.
trading
environment  Handling of explosion in trading data available electronically.
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6. Deutsche Börse Group, 4 October 2010
… and what is High Frequency Trading not?
 A trading strategy in itself - although high frequency traders typically pursue a
certain trading strategy.
 Flash trading: Certain trading members are informed fractions of a second before
other trading members about orders and thereby have the opportunity to accept
these orders. However, usually high frequency trades are involved in flash trading.
 Co-location placing the trading engine of a trading member not only virtually but
physically close to the exchange back end resulting in a reduction of data travel
time - although co-location is predominantly used by high frequency traders.
 Direct electronic access generally referring to customers being given direct
access to the market through a registered trading member‟s system/infrastructure
(order routing) or customers of a trading member being given direct access to the
market without going through the trading member‟s system/infrastructure
(sponsored access) - although direct electronic access is typically used by high
frequency traders.
 Demarcation of High Frequency Trading and Algorithmic Trading: High
frequency traders computerize the decision and execution process, whereas the
conventional term algorithmic trading encompasses only the automation of order-
execution.
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7. Deutsche Börse Group, 4 October 2010
How does High Frequency Trading work?
 Use of sophisticated systems and algorithms to generate
trading profits. Speed all along the value-chain, i.e. from data
reception, internal processing, trade decision making and order
Technology sending.
and speed
 Investment into IT systems, capacity and dedicated highly
specialised staff with a deep technical understanding of IT
infrastructures down to the level of bits and bytes.
 Market making: Placing limit sell and buy orders in order to benefit
from the bid-ask spread.
Examples of  Statistic arbitrage: Arbitrage strategy involving several securities
trading making profits of different market prices sufficiently different from
strategies those implied in the model to cover transactions cost.
 Event arbitrage: Strategy that counts on a specific event to change
the price or rate relationship of two or more financial instruments.
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8. Deutsche Börse Group, 4 October 2010
Benefits of High Frequency Trading
Provision of quotes at a very high speed. As their margin is typically
Liquidity
ultra-low, high frequency trader need massive volumes to make their
provision
strategies sufficiently profitable.
Narrowing High frequency traders compete for order flow, and thereby have to
spreads provide better spreads than the ones they base their quotes on.
Fostering
competition High frequency trader typically act on several markets, and markets
between trading compete for high frequency trader‟s liquidity.
venues
High frequency trader act on several asset classes and regions of
Increasing
the world, thus increasing the global market efficiency. Globally
global market
speaking in combination with other types of order flow, the HFT flow
efficiency
brings significant value in terms of liquidity into the market.
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9. Deutsche Börse Group, 4 October 2010
Risks claimed to be associated with high frequency
trading
Given the speed of high frequency trading and due to the fully
Fat finger errors electronic nature of the equity markets today, a "rogue" algorithm
and malfunction entering the market could wreak havoc (if trading venues have no
safeguards in place like volatility interruptions).
Several manipulative trading practices (such as layering, pinging and
Manipulative others) are claimed to be related to high frequency trading. However,
trading these trading practices are not new and not inherent to high
practises frequency trading, but can also be performed by any market
participant without high-speed trading abilities.
The claim is made that high frequency traders, by buying when
Reinforcement
markets go up, and selling when they go down, reinforced market
of market
volatility (which, however, can be restricted by safeguards like volatility
volatility
interruptions).
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10. Deutsche Börse Group, 4 October 2010
Potential impact of High Frequency Trading on Exchange Level
Exchanges and other trading venues compete for high frequency
Competition
traders liquidity.
Overall effect of high frequency trading is increased system load.
Exchanges need to process an ever greater number of transactions at
an ever greater speed – while maintaining the levels of availability
Trading system
their customers are used to. Whereas trading times used to be
measured in seconds, they have now fallen to milliseconds and are
coming down to micro-seconds.
Exchanges need to stress their surveillance systems and ensure
Trading they can cope with the activity associated with high frequency trading,
surveillance whereas taking into account that the broker‟s responsibility is
replaced by computer programs.
Implementation of measures avoiding impact of malfunction of
high frequency trading on the price discovery process such as
Price discovery volatility interruptions. Apparently, sufficient measures were not in
place during the so-called U.S. flash crash on 6 May 2010, however,
are considered by the SEC in answer to the flash crash.
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11. Deutsche Börse Group, 4 October 2010
Measures in connection with high frequency trading on
exchange level (1)
 High frequency trading is a evolution of technological development
No specific and not a certain new trading strategy.
regulation  At this stage no specific regulation on high frequency trading
has been implemented.
 No flash trading, i.e. no preliminary information of certain trading
Pre-trade members about order situation.
transparency  Access to pre-trade information for all trading participants according
to the MiFID pre-trade transparency regime.
 Xetra has a trade interruption mechanism which kicks in when the
potential execution price of an order lies outside the dynamic or
static price range around a reference price.
 Once a volatility interruption has been initiated, continuous trading is
Safeguards for
halted and an auction format is triggered. Market participants are
price discovery
kept informed.
 Given the circuit breaker mechanism in place, it would be
impossible for an event similar to the May 6 flash crash to occur
on Xetra.
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12. Deutsche Börse Group, 4 October 2010
Measures in connection with high frequency trading on
exchange level (2)
 Co-location services predominantly used by high frequency
traders are offered on a non-discriminatory basis to all trading
participants.
 The basic principle of exchange trading remains that all orders are
Co-location available equally and simultaneously to all trading participants.
 Whether trading participants make use of co-location
services is up to them, as is the general decision how trading
participants equip themselves, be it through investments in analyst
capacities, smart order routing systems, or in sheer speed.
 Regular updates of the performance of the Xetra trading system,
by now having reached the area of microseconds in terms of
Trading system order round-trip times.
 At the same time maintaining the availability levels of far more
than 99.99 per cent.
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13. Deutsche Börse Group, 4 October 2010
High frequency trading in the regulator’s focus
MiFID review by the European Commission and the European Parliament
 European Commission acknowledges the benefits of high frequency trading,
however, voiced fears about the possibility of malfunctioning of low-latency
trading programmes.
 Depending on the assessment of the risks and benefits of high-frequency trading
additional regulatory intervention might be considered.
 Swinburne Report (own initiative report addressing “Regulation of Trading in
Financial Instruments – dark pools etc”) to be discussed in the European Parliament
makes proposal to charge orders generated by high frequency traders with 1
EUR/order.
Evaluation of the US flash crash by the SEC
 In answer to the flash crash on 6 May 2010, the SEC adopted a circuit breaker
programme.
 Stocks to which the circuit breaker programme applies would trigger circuit breakers
that halt trading when the market is gripped by extraordinary volatility.
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