International Regulators Push For Controls On High Frequency Traders
Wednesday, October 26, 2011

The Technical Committee of the International Organization of Securities Commissions (IOSCO) has published its final report on regulatory issues raised by the impact of recent technological changes on financial market integrity and efficiency.

IOSCO, whose membership regulates more than 95% of the world's securities markets in 115 jurisdictions, is recognized as the leading international policy forum for securities regulators, is particularly concerned, in the report, to produce recommendations aimed at mitigating the risks from the latest technological developments in the financial system, including high frequency and algorithmic trading.

Its recommendations, which were developed in response to the G20 Leaders request in November 2010, are designed to help regulators to identify the practical impact that technological developments have had and the regulatory issues to which they may give rise; promote a consistent approach amongst global regulators to the latest technological developments; and mitigate the risk that technological change may pose to the integrity and efficiency of financial markets.

Masamichi Kono, Chairman of IOSCO’s Technical Committee, said: “Markets are evolving rapidly and it is important for regulators not only to monitor developments in technology and market structure, but also to continue to assess the impact of these changes on market integrity and efficiency and to address any risks identified.”

IOSCO’s general recommendations set out high level guidance to address issues in two specific areas: trading venue operators and trading participants.

Firstly, it recommends that regulators should require that trading venue operators provide fair, transparent and non-discriminatory access to their markets and to associated products and services; and that they should seek to ensure that trading venues have in place suitable trading control mechanisms (such as trading halts, volatility interruptions, and limit-up-limit-down controls) to deal with volatile market conditions.

Trading systems, IOSCO suggests, should be robust and flexible such that they are capable of dealing with, and adjusting to, evolving market conditions. In the case of trading systems, this should include the ability to adjust to changes (including sudden increases) in message traffic.

In addition, all order flow of trading participants, irrespective of whether they are direct venue members or otherwise, must be subject to appropriate controls, including automated pre-trade controls. These controls should be subject to the regulatory requirements of a suitable market authority or authorities. Regulators should also identify any risks arising from currently unregulated direct members/participants of trading venues and, where any are identified, take concrete steps to address them.

Regulators should continue to assess the impact on market integrity and efficiency of technological developments and market structure changes, including algorithmic and high frequency trading. Based on this, regulators should seek to ensure that suitable measures are taken to mitigate any related risks to market integrity and efficiency, including any risks to price formation or to the resiliency and stability of markets, to which such developments give rise.

Finally, market authorities should monitor for novel forms or variations of market abuse that may arise as a result of technological developments and take action as necessary. They should also review their arrangements (including cross-border information sharing arrangements) and capabilities for the continuous monitoring of trading (including transactions, orders entered or orders cancelled) to help ensure that they remain effective.

“The G20 Finance Ministers and Governors have asked for further work by IOSCO by mid-2012 on the subject,” Kono continued. “IOSCO will focus upon such issues as the development of recommendations for market surveillance and an analysis of the evolving new market structure in its next stage of work.”

IOSCO will therefore assess the new challenges that technological changes pose for regulators in their market surveillance, which include: the fragmentation of markets; the dispersal of trading information; the increased speed of trading; and the ability to gather and process the increased volume of trading data.

It will also consider the feasibility of regulators having additional tools to deal with the challenges arising from market surveillance, some of which may include additional audit trail or surveillance data consisting of all orders and trades by market participants in a given instrument; a single reporting point for all orders and for all transactions, by jurisdiction or geographical zone and across asset classes; and unique legal entity identifiers.

IOSCO will build on its work on supervisory cooperation to consider how best to enhance operational contacts and cooperation between regulators in order to more flexibly share information and views for day-to-day market supervision.

“In addition to the above report,” Kono added, “a broad range of work has already been completed by IOSCO in relation to market integrity and efficiency, particularly through the development of recommendations and principles in the areas of short selling, structured finance products, direct electronic access, OTC derivatives and dark liquidity. The implementation of these principles, alongside today’s recommendations, would be key in achieving the G20’s objectives.”