June 28, 2012 / 2:50 PM / 8 years ago

Germany moves to regulate high-frequency trading

BERLIN (Reuters) - Germany’s ruling coalition has agreed key points for regulating ultra-fast trading on stock exchanges such as giving regulator Bafin the right to oversee so-called high-frequency traders, coalition sources told Reuters on Thursday.

The regulation will likely make it illegal to manipulate markets using strategies such as constantly requesting pricing information without intending to trade, the sources said.

“We are on the right path - the finance ministry has made convincing suggestions,” Klaus-Peter Flosbach, a finance expert for Chancellor Angela Merkel’s conservatives, told Reuters.

High-frequency trading (HFT) involves plugging algorithms into computers to generate numerous, lightning-speed automatic trades that are designed to make money from arbitrage on razor-thin price differences and movements.

HFT traders hold investments for short periods only, which has led to criticism that they cause volatility by flooding the market with orders before cancelling them in fractions of seconds.

Experts blame HFT traders for the “flash crash” of May 2010 when the S&P 500 plunged nearly 10 percent in a few seconds before quickly recovering.

The government wants to make it easier for Bafin to stop trading when there are such unusual price changes. A draft paper from the finance ministry had suggested introducing a minimum holding period of 0.5 second but coalition sources said this was no longer on the cards.

That will be welcome news to so-called “algo traders”, whose business model depends on using algorithms to exploit market volatility.

CLAMPDOWN

Under German law, algo traders do not need separate authorization to conduct HFT and there are no rules governing system breakdowns but the government now wants to close this gap in the regulatory framework.

The finance ministry draft paper said algo traders would need separate authorization to engage in HFT and added that they would also have to keep comprehensive documents for Bafin.

“High-frequency trading has increased the speed and complexity of trade and it conceals a multitude of risks,” the finance ministry said.

“Rules need to be created to strengthen the integrity and stability of the financial markets and to limit the risks. We must tackle that now,” the ministry added.

Frankfurt stock exchange operator Deutsche Boerse said it was in favor of the plans but added that all exchange operators in Europe should be subject to the same rules.

“In principle we welcome supplementary regulatory measures, which help make high-frequency trading more tangible - via increased supervision of trade and greater demands on risk management, for example,” a spokesman said.

Since March the exchange has been charging customers who put in significantly more orders than trades a fee.

The coalition’s finance experts and the finance ministry agreed to make it illegal to constantly test market levels to influence prices. Fines will also be imposed for excessive use of trading systems and there will be minimum limits for the smallest price changes, the paper said.

The draft law is expected to go to cabinet in the second half of the year.

HFT is responsible for some 70 percent of the daily turnover of shares in the United States according to some estimates, while in Germany it accounts for around 40 percent.

The European Union’s member states are discussing the rules governing HFT as part of a reform of securities trading rules known as MiFID.

Writing by Michelle Martin; Editing by Elaine Hardcastle

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