LONDON/AMSTERDAM Europe's top banks are warning global regulators against curbs on high-frequency trading firms (HFTs), insisting that so-called "market bandits" are vital for efficient markets.
U.S. and European regulators plan next year to introduce new rules to restrict the trading activities of these traders -- tech-savvy hedge funds that generate huge volumes of orders -- to prevent a repeat of last year's U.S. "flash crash".
But a panel of managing directors from major European investment banks told the Reuters Future Face of Finance Summit on Wednesday that punishing these traders was risky because they were a key source of liquidity that benefits all trading firms.
"If they are somehow going to outlaw or make it disadvantageous to be a market-maker, they are going to take liquidity out of the market," Jack Vensel, global head of wholesale services at Citigroup, told the Reuters Summit, in London.
These traders use super-fast computers to engage in various trades such as "shaving" -- buying and selling in nanoseconds to chase tiny margins -- and often collect a rebate from the exchange for creating liquidity as they go.
More traditional investors worry such speedy traders are effectively engaging in a legal, computerized version of front running -- where firms glean information about rivals trading plans.
The regulators are considering rules to slow them down and impose extra risk management requirements on them.
But the trading industry, that reaps healthy revenues from high-tech traders, is fearful of over-bearing regulation.
"Risk controls are sensible but putting artificial controls on how people trade is not the solution to the problem," said Richard Semark, head of European client trading at UBS.
Andrew Bowley, responsible for electronic trading product management at Nomura said: "This is a competitive environment, the idea that innovation and technology can be regulated out of the market is a hard one to deal with."
High frequency traders have hit the headlines in the past year after being partly blamed by U.S. regulators for the "flash crash" on May 6, when the Dow Jones Industrial Average plummeted 700 points before rebounding in a matter of minutes.
A single, computer-driven sale worth $4.1 billion by U.S. money manager Waddell & Reed Financial Inc sparked a sell-off that was exaggerated and accelerated by the high frequency traders.
A panel of U.S. regulatory experts last month proposed a raft of rule changes, which included imposing extra fees on HFTs -- a suggestion the top U.S. securities regulator, the Securities and Exchange Commission (SEC), acknowledged on Tuesday.
"The idea of a fee on cancellations is one that we have been very informally talking about internally with certainly no proposal to look at or contemplate," SEC Chairman Mary Schapiro told the Reuters Future Face of Finance Summit in Washington.
Some of these traders effectively "test the market" before trading, offering to sell positions only to cancel orders before they are executed and opting to buy instead.
Brussels is proposing that they should be regulated more tightly if they trade above a certain volume as well as imposing extra risk controls that could slow down trading.
"High frequency trading is a very substantial economic activity. We need to look at the pros and cons," said Steven Maijoor, the incoming chairman of European Union watchdog the European Securities Markets Authority, at the Summit.
"There are also possible negatives - first of all, what are the risk management policies at these HFTs? We know that automated trading can result in systemic risks and things like a flash crash can happen if the technology doesn't work properly," Maijoor said.
But Alasdair Haynes, chief executive of trading platform Chi-X Europe, has questioned the basis of the regulators' plans.
"What we want to see is evidence-based regulation and where is the evidence that says HFT is damaging the marketplace? The academic evidence suggests that HFTs are good for markets," Haynes told the Reuters Summit on Monday.
Brian Gallagher, MD, head of European electronic trading at Morgan Stanley, went further and questioned the definition of high frequency traders.
"It's such a broad term. Rather than defining HFT as a particular strategy, we would say look at potentially abusive order types," Gallagher told the Reuters Summit.
(Editing by Jane Merriman)