Having warned all the way since 2009 that HFTs not only accelerate but are ultimately responsible for flash crash events like the countless example seen in global capital markets, from US stocks in May 2010, to ETFs in August 2015, to the FX, most recently the sterling’s instaplunge last month, we were content to read that another prominent institution validated our concerns – which have been repeatedly ignored by the SEC which has been unfortunately captured by the HFT lobby – when the Bundesbank today released a report in which it warned that high-frequency trading firms “tend to aggravate financial-market swings and contribute to “flash crash” events.”
“In a calm market environment, HFT market participants contribute a significant amount of liquidity,” the Bundesbank said. “However, during highly volatile market phases, the research shows that HFT market makers in both Bund and DAX futures markets temporarily reduce liquidity. HFT actors are especially active in times of strong market fluctuations and can therefore contribute to trend-enhancing price developments.”
“Taken together, the different behaviors of active and passive high-frequency trading firms indicate a heightened risk of periods of short-term excessive volatility, which could encourage market upheavals as far as flash events,” the Bundesbank wrote.
In its study, the Bundesbank examined trading in some of the most liquid German stock and bond futures contracts, in which high-frequency firms accounted for about 44% of trades. The Bundesbank divided high-frequency firms into two broad types: those that trade actively on news, and those that act as market-makers, or intermediaries between buyers and sellers of assets.
As the WSJ explains, the German central bank found that the first type of traders were particularly active during periods of high market volatility, and therefore contributed to that volatility. The second group, by contrast, tended to withdraw from financial markets during periods of high market stress—just when they might be needed most to provide additional liquidity.
“Around the time of the publication of important news, the liquidity provided by HFT [firms] falls significantly,” the Bundesbank wrote
That finding roundly refutes the biggest defense by the HFT lobby, namely that high frequency traders provide liquidity: based on this latest report, not only do passive HFTs withdraw from market making at times of “market stress” or volatility spikes, exacerbating the lack of market depth, but active HFTs, those who traditionally try to frontrun orderflow, become even more active accentuating spikes in either direction as market orders enter.
Buba’s conclusion: “For one, the results demonstrate how important in implementation of incentive mechanisms is so that passive HFT market makers keep up liquidity provisions in periods of higher stress… “Future research from central banks, regulatory authorities and academic institutions could profit from easier access to similarly granular data.”
In the recent past, regulators have diverged with the conventional view propounded by supporters of HFT, according to which the only impact of algo traders is to boost liquidity, and increasingly believe that such firms could cause market distortions. European Union regulators have agreed on new rules due to enter into force next year, known as MiFID II, which introduce closer regulation and monitoring of algorithmic and high-frequency trading firms.
One additional rule under discussion is enforcing minimum resting times for orders, a step that has been fiercely opposed by some traders. Such a rule would help reduce the incentives for a technological “arms race” on stock markets, which has questionable social value, the Bundesbank said.
Alas, with the HFT lobby still all powerful, not to mention ever more affluent as a result of such market aberations as Virtu’s 5+ years with just one day in which it lost money, it is unlikely that the market structure will change or if any regulations seeking to limit the impact of HFT on market will be implemented in the near future.