High frequency trading: should technological developments be considered a potential threat to financial markets and be subject to specific regulation?

Abstract

Regulators and policy makers are concerned that high frequency trading strategies may hamper the integrity of markets. Some participants in the debate about high frequency trading (HFT) consider that such trading provides liquidity to markets, reduces bid/offer spreads and corrects anomalies. Others believe that the liquidity produced is artificial, that such trading facilitates market manipulation, and that it may lead to “flash cracks.” (A flash crack (or flash crash) is a rapid and sudden drop and recovery in securities or financial instruments prices. The most famous is the one which occurred on may, the 6th, 2010 on the US stock market (the Dow Jones plummeted about 1000 points and recovered a few minutes later).) The purpose of this article is to shed some light on the various factors explaining the development of high frequency trading (including the end of the concentration rule, competition and technological innovation) as well as on the pros and cons of regulatory measures which are being considered, in particular in the revision of the Market In Financial Instruments Directive (MIFID 2) and the Market Abuse Directive (MAD2).