Could too much regulation without consideration for what technology has to offer kill the market? While I believe that regulation without regard for the technology infrastructure has very real potential for a negative outcome, I believe high-frequency trading (HFT) is in fact good for smaller investors and the market as a whole. Let me explain.
When a large mutual fund buys or sells a million shares, high-frequency traders buy or short-sell quickly. So youll see a smaller and shorter-lived blip – HFT tends to reduce volatility in centralized market-places.
Further, all investors (including smaller investors), face a spread between bid and ask prices. The more volatile a stock is, the wider the spread is. HFTs tend to narrow the spread. If there are regulations that limit the message rate, market-makers – who require a large volume of messages – would widen their spreads. Wed then see increased transaction costs and increased volatility in the market, for all participants, large and small.
We already have SEC and ESMA regulations in place which make pre-trade risk-checks, which prevent fat-finger trades, mandatory. This is welcomed by all market participants. There are systems available which have built-in pre-trade risk checks, along with other risk checks mandated by MiFID as well as other upcoming regulations in Europe.
Technology providers spend weeks and months optimizing their systems, both hardware and software, to squeeze every nanosecond out of the latency, and then a new set of regulations come in wanting to prevent fast access to matching engines. Too much regulation can stifle innovation. American and European zeal for regulation may deter the number of non-domestic counterparties. The long-term effect of this is less liquidity in the markets, and potentially a shift in volume to developing markets, which will be costly for everyone trading, whatever their location or size of their trades.
Fintech firms by-and-large welcome regulation which increases transparency in the markets. This is a good thing, of course. An example of this is making trade-reporting for dark pools or MTFs mandatory. MiFID for example, encourages and sometimes mandates pre-trade and post-trade transparency. I am sure that technology firms will continue to work with the financial regulators to offer unbiased advice in coming up with regulations that work in tandem with innovation and facilitate efficient market conditions for all participants.
Instead of restrictive regulation that stifles innovation, lets get all market participants to benefit from advanced technology which keeps latency to a minimum by encouraging wider use of such technologies in co-location and proximity hosting centres. Then everyone can benefit from high-speed and low-latency technology and tighter spreads.
Sanjay Shah is CTO of Nanospeed.
