French Market Authority Report on High-Frequency Trading — No Surprises
Since the SEC approved the IEX exchange application on 17 June 2016 (learn more in our blog post about the exchange), the issue of high-frequency trading (HFT) has largely receded from being front page news. The issue of HFT is (or was) particularly acute in the United States because of certain characteristics of the US market (read our blog post for more on this issue), with regulators in other jurisdictions finding that HFT has mostly had a neutral or positive impact on market quality (for example, in Australia). The French regulator Autorité des Marchés Financiers (AMF) can now be added to the latter list based on the findings in their latest report on HFT in France.
Findings Support HFTs Being in the Market
The following briefly summarizes the findings in the report:
- HFTs are, on average, present at the best price 91% of the time, and represent 70%–80% of the total amount present at the best bid–offer spread.
- HFT activity varies widely among stocks and seems to be mainly correlated with the presence of the stock on multiple indexes because there are more arbitrage opportunities (rather than the trading volume of the stock).
- HFTs have a variable impact on spreads depending on the context:
- Beginning of the day: HFTs contribute to tighter spreads.
- Announcements: HFTs drive wider spreads in anticipation of announcements as well as reducing liquidity. Although HFTs reduce their presence before announcements faster than other market participants, they return more quickly as well.
At one point, the AMF notes that market making activity is, almost exclusively, conducted by HFTs on liquid stocks, which are best able to offer effective inventory management. The relatively positive findings of the AMF report can be reconciled with the negative view of HFT by some market participants by understanding the difference between passive market making HFTs and predatory HFTs, which we discussed in a previous blog post on this issue.
Case Studies Further Support HFTs in the Market
The AMF conducted two case studies of HFT behaviour on particularly volatile trading days. These days were 3 December 2015, the day an updated monetary policy was expected from the European Central Bank (ECB), and 24 June 2016, the day after the United Kingdom voted to leave the European Union.
The 3 December case study showed findings that somewhat contradicted the “general case” of HFT behavior around announcements. In particular, the order book recovered slowly after each announcement, and some HFTs permanently withdrew orders when the market became “too volatile.” The 24 June analysis showed that HFTs sharply reduced their presence in the order book and non-HFTs supported market liquidity (although not fully replacing the withdrawn HFT liquidity) with large and fully executed orders.
We believe these findings can be placed into the typical HFT narrative that casts HFTs as providers of efficient market making under “normal” market conditions and even under quite volatile market conditions. The reason they can do that is because of their superior ability (relative to non-HFT participants) to update their quotes very quickly in response to new information. But there is a point at which volatility becomes too high for the algorithms, and even HFTs withdraw from the market.
We think this narrative does not provide a particularly strong criticism of HFTs in and of themselves, but rather it shows the importance of having a diverse ecosystem of market participants in order to increase the resilience of markets. We shared our thoughts on this particular issue in a post a few years ago on HFTs, price improvements, and adverse selection.
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