Despite recent heightened criticism of high-frequency trading, “aggressive regulation” of HFT isn’t needed and there are several potential economic benefits of this trading strategy, according to a new analysis by the Mercatus Center, a market-oriented research group at George Mason University.
The study, An Analysis of Global HFT Regulation: Motivations, Market Failures and Alternative Outcomes, notes empirical evidence that shows that HFT reduces trading costs, provides better investment performance for long-term investors, and offers more flexibility and options for smaller retail investors. Conversely, the study argues that when countries limit HFT, they suffer diminished liquidity.
The study argues that there is “little evidence that a market failure exists requiring additional aggressive regulation of HFT, or that government intervention will achieve market integrity or ‘fairness’ goals better than existing market incentives.”
Many regulatory proposals also have “unclear definitions of HFT that fail to differentiate it from algorithmic trading and other technology-driven markets,” the study says. As a result, the authors of the report, Holly Bell and Harrison Searles, note that these proposals “could have unintended consequences for financial markets as a whole.”
What’s more, there are a number of existing regulations and cooperative nonregulatory solutions in place to ensure the integrity of financial markets where HFT is used, the authors say, including circuit breakers, HFT-neutralizing algorithms and erroneous order detection systems.
The authors warn that “aggressive HFT regulations in certain markets” could push financial activities and capital into growing and emerging HFT markets, such as those of Japan and Singapore. “Therefore, regulators should be careful to gather empirical evidence of a market failure before enacting new regulations targeting HFT.”
Indeed, in a recent interview with ThinkAdvisor, Securities and Exchange Commission Chairwoman Mary Jo White said that while a “high priority” for the Commission was to “view the range of equity market structure issues, which includes fragmentation and high-frequency trading issues,” even critics of high-frequency traders argue “that they’ve added liquidity and some price advantages” to the market.
There are concerns, however, “about the level playing field,” with the debate centering on “any unfairness [and] ultimately [whether] high-frequency traders or a subset of them add or detract from market quality,” White said.
The public discussion, she added, also tends “to lump all high-frequency traders into a single nomenclature, but the reality is that it’s much more complex than that — you have different high-frequency trading strategies and different issues.”
The bottom line, White said, is that high frequency trading is “an issue that we are intensively focused on, and if we think changes should be made, we’ll make them.”
Check out Beware High-Speed Trading’s Hidden Cost: Seawright on ThinkAdvisor.