A number of positives are cited as resulting from HFT; in particular, the provision of greater liquidity and the narrowing of spreads and commissions. However, there are concerns that the types of trading strategy to which HFT gives rise run the risk of disadvantaging others in the markets, and that, if HFT algorithms fail, they have the potential to cause rapid and significant market distortion.

Market manipulation. Some of the trading strategies that were being used by high frequency traders are already seen as market abuse by the FSA (for example, "layering" or "spoofing" of orders, which create a false or misleading impression about the demand or supply for securities) (FSA’s Market Watch 33, August 2009, www.practicallaw.com/7-500-3132).

However, according to Nikunj Kiri, a partner at Herbert Smith LLP, deciding whether other common HFT strategies such as order anticipation (trading to capitalise on anticipated trading) constitute market abuse is a much greyer area: "There is a difficult line to draw between trading strategies which legitimately identify market trends from publicly available data and market manipulation. The data they are using is available to the market as a whole: high frequency traders are just using available technology to make use of it. There is a real question as to whether it is the role of a regulator to intervene to prevent participants taking advantage of technologies and data that are capable of being used by the rest of the market." (For more information on the methods used, see box “Technical strategies”.)

The reviews of HFT on both sides of the Atlantic are still underway. However, there are strong signs that high frequency traders are facing increased regulation in due course.

US. The SEC started to investigate HFT as part of its January 2010 consultation on equity market structures. There was subsequently a "flash crash" on US stock markets on 6 May 2010, in which the prices of thousands of US securities fell rapidly, only for that decline to be reversed within minutes. Although the report into this event found that HFT did not, in fact, trigger the crash, the SEC is piloting certain additional controls on trading, including the implementation of "circuit breakers" where there is extreme price volatility in a security. The SEC is also considering further regulatory strategies (Findings regarding the market events of May 6, 2010, www.sec.gov/news/studies/2010/marketevents-report.pdf).

UK. The FSA is not currently considering specific regulation in this area. It stated earlier this year, however, that it is conducting further thematic work and will be monitoring the output of EU reviews currently underway. The FSA has said that firms’ systems need to be sufficiently resilient to cope with the effects of HFT, and that market integrity standards need to be maintained and enforced: "Gaining an edge by applying better trading technology is legitimate; using technology to manipulate markets is not" (The FSA’s markets regulatory agenda, May 2010, www.fsa.gov.uk/pubs/other/markets.pdf).

However, there is a definite growth in supervision of HFT by the FSA, according to Kiri: "We're finding that, both on the sell-side and the buy-side, firms are being subjected to much more scrutiny by the FSA about the systems and controls in place to mitigate the risks arising from HFT. Buy-side firms seem to be being asked to make certain they have controls in place to ensure that their strategies and the data used by them have been adequately tested and are not manipulative in nature. Sell-side firms providing direct market access to market participants are being asked to ensure they have appropriate controls in place, both pre-trade and post-trade, to prevent or detect abusive trading and identify any abusive activity being conducted through that access."

Little detail is known about the study commissioned by the Treasury, but its focus looks likely to be on the potential technical developments and possible pitfalls of HFT.

Commission. At an EU level, the Commission has been examining the possible impact of HFT on markets as part of its post-implementation review of the Markets in Financial Instruments Directive (2004/39/EC) (MiFID).

The Committee of European Securities Regulators (CESR) had appeared to adopt a fairly low-key approach, stating in July 2010 that it considered further work was necessary to better understand HFT strategies and the risks that they pose, and that it considered further scoping work was necessary to develop specific guidelines on appropriate systems and controls for HFT, such as the use of volatility measures or circuit-breakers (CESR technical advice to the European Commission in the context of the MiFID review − equity markets, 29 July 2010, esma.europa.eu/popup2.php?id=7004).

However, rhetoric emanating from the Commission itself is of a stronger nature. In a speech on 12 October 2010, Michel Barnier, Commissioner for internal markets and services, stated that HFT required more supervision, and stated that the Commission would work with the SEC to develop "effective regulations" to deal with the risks arising from HFT. "This is rather different in tone from CESR's recommendations," says Kiri. "Whilst I do not expect the Commission to prohibit the use of direct data feeds or co-location, further detailed regulation of HFT as part of the revised MiFID now seems inevitable."

While the political will looks clear, Kiri emphasises that market opinion may be more divergent: "Many believe that these are appropriate and legitimate trading techniques, and are not improper per se. There is a school of thought that there is no need for more regulation. However, I cannot see the area being left untouched."