Regulators set to clamp down on HFT market abuse in 2015 warns report

Traders expect regulators to focus on market abuse in 2015

Securities market regulators are beginning to clamp down on market abuse linked to complex high-frequency trading strategies – but there is much more to be done, according to a new report by financial consultancy Kinetic Partners.

In its annual Global Regulatory Outlook report, the company published a survey on what senior financial services executives thought regulators would prioritise in 2015. Market abuse emerged as the single largest issue, chosen by 52% of respondents in the US and 37% worldwide. The survey also found that technology was core to firms’ responses. More than one in five (22%) said that their technology investment would concentrate on market and transaction monitoring systems in 2015, putting it behind only regulatory reporting (27%) and AML/knowing your customer systems (23%).

“Regulators are really only beginning to tackle HFT market abuse,” said Simon Appleton, a director at Kinetic Partners in London. “The first enforcement action at the SEC was only in October 2014, but that trickle of cases is likely to increase fast. Regulators expect firms’ systems for preventing disorderly markets and identifying market abuse to keep up with changes in the marketplace.”

While issues such as bribery seem to be attracting less regulatory attention (with only five percent of survey respondents expecting regulators to prioritise it), others, such as HFT, have risen rapidly up the agenda. HFT was fourth in the list of concerns regulators were expected to focus on, as noted by 17% of respondents overall (and 18% of senior executives), putting it ahead of AML.

HFT has been a controversial topic for several years. Supporters argue that HFT provides valuable liquidity and is simply the natural evolution of trading, given current technological capabilities. Opponents argue that HFT firms often create thousands of orders, most of which are cancelled, which make it difficult to discern what is happening in the market. Some, such as independent Brussels-based public interest group Finance Watch, have argued that HFT is a danger to the market and may be concealing sophisticated market abuse strategies executed across multiple trading venues.

Although there is no direct connection between HFT and market abuse, some asset managers have characterised HFTs as predatory vultures that prey on institutional flows, while security companies such as NICE Actimize have stated  that market fragmentation combined with sophisticated HFT technology may provide opportunities that could be exploited by unscrupulous traders to implement abusive trading strategies across venues.

“Financial services professionals are right to expect regulators to continue to clamp down hard on market abuse, such as insider trading, market manipulation and financial fraud,” said. Appleton “These already account for many of the fines in key jurisdictions, and the past year has continued to see regulators impose large fines on firms.”

“More than ever, regulators are expecting not just compliance from firms but for them to play an active role in enforcement,” added Nick Matthews, managing director in the Duff & Phelps Dispute and Legal Management Consulting practice. “The best defence firms have against punitive measures is to identify abuse and report it before it comes to the regulator’s attention. Even banks with sophisticated market monitoring systems in place need to ensure their investment in technology not only meets regulators’ expectations, but also keeps pace with developments in the industry.”