Last week the European Commission clarified what constitutes algorithmic trading, high frequency trading and direct electronic access under the Markets in Financial Instruments Directive II. The EC made clear it takes a broad view of what constitutes algorithmic trading to include “arrangements where the system makes decisions, other than only determining the trading venue or venues on which the order should be submitted at any stage of the trading process, including at the stage of initiating, generating, routing or executing orders.” The EC stated that algorithmic trading referenced both the “automatic generation of orders” and “the optimisation of order-execution by automated means” (e.g., smart order routers). The EC also set a seemingly low threshold for algorithmic trading to constitute high frequency trading when it involves high intraday message rates. According to the EC, HFT will include submission on average of at least two messages per second in connection with any single financial instrument on any trading venue, or of at least four messages per second in connection with all financial instruments on any trading venue. Finally, the EC made clear that in determining whether a client of a trading venue member engages in direct electronic access, smart order routers embedded in a provider’s infrastructure (as opposed to the client’s) should be excluded. Under MiFID II, investment firms utilizing algorithmic trading or providing direct electronic access will have certain organizational and other requirements to help avoid market disruptions and violations of law. High frequency trading firms may have additional obligations, including potential registration and capital requirements. MiFID II is now scheduled to go into effect on January 3, 2018. (Click here for additional information on this matter in the article, “European Commission Adopts Second MiFID II Delegated Act” in the April 29, 2016 edition of Corporate & Financial Weekly Digest by Katten Muchin Rosenman LLP.)

My View: Under proposed Commodity Futures Trading Commission Regulation Automated Trading, any registrant, including persons that might be required to be registered as floor traders, that engages in algorithmic trading would have to implement a host of pre-trade risk controls and other measures, and comply with numerous requirements related to the development, testing, monitoring and recordkeeping of its algorithmic trading system. As under MiFID II, algorithmic trading is proposed to be broadly defined to include both order initiation and smart order routing. Specifically, algorithmic trading under proposed Regulation AT would include the trading of any future, option or swap subject to a designated contract market’s rules where an order, modification or order cancellation is electronically submitted and one or more computer algorithms or systems decides whether to initiate, modify or cancel the order, or otherwise makes “determinations” with respect to the order, including but not limited to:

  • the product to be traded;
  • the DCM where the order will be placed;
  • the order type;
  • the order’s timing;
  • whether to place the order;
  • the sequencing of the order (compared to other orders);
  • the order price;
  • the order quantity;
  • the partition of the order into smaller components for submission;
  • the number of orders to be placed; or
  • the management of orders after submission.

Because of the wide breadth of what might constitute algorithmic trading, it is important that, in any final rule, the CFTC adopt a more principles-based approach in imposing any requirements on registrants. Although all persons engaging in algorithmic trading, whether registered or not, should maintain appropriate controls and processes, one identical set of requirements for all such persons and all algorithmic trading systems – without regard to whether it is an order initiation system or a smart order routing system — is inappropriate. Moreover, it is not necessary and would be unjustifiably expensive for all persons along an order chain to maintain redundant pre-trade risk and other controls. (Click here for details on proposed Regulation AT in the article, “CFTC’s Proposed New Algorithmic Trading Rules Augur Potential Increased Obligations and Costs, and a New Registration Requirement” in the November 29, 2015 edition of Between Bridges.)