Financial Services and Technology Forum 6 March 2013 TOPIC: High Frequency Trading Panellists:     

Maria Teresa Fabregas Fernandez, Head of Unit for Securities Markets, DG MARKT, European Commission Olle Schmidt, MEP (ALDE, Sweden), Member of the ECON Committee, shadow rapporteur on MiFID Juan Pablo Urrutia, Director, General Counsel in EMEA, Investment Technology Group Ari Burstein, Senior Counsel, Securities Regulation – Capital Markets, ICI and ICI Global Remco Lenterman, Chairman, FIA European Principal Traders Association (FIA EPTA)

Moderator: Pierre Francotte, Chair of the Financial Services and Technology Forum and Senior Adviser, Kreab Gavin Anderson

Report on panel discussion PANELLISTS’ STATEMENTS Maria Teresa Fabregas Fernandez, European Commission The revision of the Markets in Financial Instruments Directive (MiFID) initiated in 2011 is necessary in order to improve transparency and stability on the markets, making sure they serve the real economy, and to improve investors’ confidence. In particular, the Commission introduced new requirements for firms and venues using High Frequency Trading (HFT). First, on firms, we strengthened provisions on authorization and supervision, and inserted effective risk controls. Firms should also be actively involved for example by putting in place proper monitoring regimes and annual reporting systems, and by flagging algorithms used to the relevant competent authorities. More than anything, it is essential to ensure that high frequency traders act in a responsible way and provide much needed liquidity to the markets. Second, the revision also provides for new requirements aimed at trading venues. These include the implementation of circuit breakers, and of effective procedures to ensure resilience of systems and orderly trading. Venues should be able to monitor orders and abusive behaviours through limiting ratios for unexecuted orders and systems to limit tick sizes. All these new measures shall be effectively monitored and supervised by competent

authorities. In parallel, the revised Market Abuse Regulation (MAR) will allow authorities to detect and sanction any possible market abuse performed with HFT strategies. The European Parliament has adopted its position on MiFID II last October. It is now awaiting the Council to reach a General Approach for starting trialogues discussions. Ari Burstein, ICI and ICI Global (represents the « buy-side ») The Investment Company Institute is the national association of U.S. investment companies, including mutual funds, closed-end funds, exchange-traded funds (ETFs) and unit investment trusts (UITs), representing the interest of millions of shareholders. Technology in general, not only HFT, changes the way the buy-side trades: for example through increased fragmentation in the market place and different types of trading venues available. But contrary to public opinion, the issue if not black and white. HFT strategies have some positive aspects such as the provision of and tighten spreads. But there are also a number of concerns for the buy-side and its members. First of all the increased number of cancelled orders on markets includes a number that are sent with no intention ever of being executed. Even though this is not a new phenomenon, technological progress has facilitated these practices, which should be effectively addressed in legislation. Another new concern relates to the increasing number of orders’ types (especially in the US), which add complexity and are increasing volumes but not liquidity! On this, more robust approval processes could help address the issue. The buy-side strongly encourages legislative developments, and is willing to support regulators in this exercise. The best situation would certainly be that the sell-side itself makes efforts to fix the problem, but unfortunately this is unrealistic as there are not enough incentives for that. Juan Pablo Urrutia, ITG In the context of current revision of financial regulations (especially MiFID and MAR), the European Securities and Markets Authority (ESMA) has already published guidelines on algorithmic and electronic trading. One of these obligations is to have monitoring in real time. The revision of MiFID goes much further and raises three concerns for us and the buy-side: 1. The requirement to impose market making obligations on market participants. The issue, on which the EP and Council seem to have different views, will be on whom the obligation falls; whom is considered to be a “market maker”. 2. The requirement to disclose algorithms. While the Commission leaves the option to member states, the EP requires detailed disclosure in its final text. This raises questions and possible concerns at three levels: a) whether it is a simple notification or if it requires approval by regulators; b) what is defined/ encompassed in the concept of algorithm to be notified; and c) the disclosure level of detail and potential leakage of commercially sensitive information.

3. The required minimum resting period, which the EP wants to be fixed at 500 milliseconds. Instead of fulfilling the well-intended objectives, this requirement could instead put buy-side firms at risk if they are obliged to hold positions for a certain time. Remco Lenterman, FIA EPTA In order for a financial (HFT) firm to be competitive today, it needs the best technology. This is a direct result of fragmentation, which itself is the result of a political decision to foster competition in markets. And the more competitive a firm becomes, the more orders it places and inevitably the more unexecuted orders also. Fragmentation and lower tick sizes has thus increased the number of unexecuted orders, which are thus not as it is widely alleged a direct consequence of HFT. The phenomenon of HFT has been existing long before. Olle Schmidt, MEP (ALDE, Sweden) Commissioner Barnier has put more than 25 new financial regulations or revisions on the table. It may be questioned whether this is not too much. But all these reforms have on unique and overarching objective that is to bring trust and confidence back to the markets, which is a pre-condition for growth. For example, the requirement suggested by the EP to install a 500 milliseconds resting time may seem arbitrary but is a concrete and understandable figure for ordinary people (a half second). It will be interesting to closely follow the outcomes and impacts of the new HFT legislation introduced in Germany by the Bundestag, although the whole markets may change significantly when the new Financial Transaction Tax (FTT) is in place. At EU level, the MiFID proposal will likely be discussed this autumn among the three institutions. HFT is one of the important issues.

ROUND OF QUESTIONS BY MODERATOR The moderator asked about the view of the panellists on the potential unintended consequences of HFT regulation on market activities. Remco Lenterman started by highlighting that legislators should be careful when categorizing a trading practice as abusive without clear evidence. Technological developments and evolutions on markets are not easy to keep pace with at legislative level so that should be done cautiously. In particular, he insisted that HFT did not cause the flash crash and should not be considered responsible for it. To this, Ari Burstein replied that the purpose of regulation is not to put the blame of anyone in particular, and that concerning the flash crash measures had been taken to deal with inefficient market structures in the US. However, the high increase of cancelled orders and the negative impact on liquidity caused by fragmentation and HFT practices to some extent have to be addressed. The revision of MAR is not directed at any firm or company in particular, but as a safeguard against those which are creating noise and deteriorating investors’ confidence. Remco acknowledged that

regulation has clearly not kept in pace with markets’ evolution and new algorithms, and that some supervision could be necessary. The moderator then asked the opinion of the panellists on the proposed requirement for disclosure of algorithms and whether this rule intended to increase investors’ protection could in the end have opposite results. Maria Teresa Fabregas Fernandez started by insisting on the fact that the requirement in the Commission proposal was only that algo strategies are presented to competent authorities, and not at all that they be analyzed and authorized by them. The EP and Council have no intention either to shift responsibility of algo traders to authorities. The objective of this requirement is to discipline these traders and ensure that algorithms are compliant with legislations. Without such a rule, the competent authorities would be unable to keep track on new algorithms and react in time in case of suspicious practices. On the issue of potential leakages highlighted by Juan Pablo Urrutia, Ms Fabregas Fernandez highlighted that to date authorities do already receive a lot of confidential information and no issue has ever arisen. Mr Urrutia followed-up on what was said agreeing that it would not be adequate to shift responsibility on the approval of algorithms but that other legal requirements should maybe be considered in order to ensure more responsibility. Indeed, he believes that it might be difficult for competent authorities to have genuine supervision and insights by simply receiving this information. QUESTIONS FROM THE AUDIENCE Geert Vanderbeke (ABN Amro Clearing) asked whether the initial “big idea” for financial reforms, i.e. to raise more capital on markets and increase (foreign) investors’ interests, was still driving negotiations; and whether misleading media representation was at the origin of a widespread perception of complexity. Maria Teresa Fabregas Fernandez answered that the key motivation for every single initiative and reform is to restore investors’ (EU and non-EU) confidence in markets and increase financing to the real economy. She also insisted that reforms at EU level do not take place in a vacuum. The EU is integrated into global financial markets. Concerns around HFT exist in countries all over the world, as are legislative reforms to address them. The International Organization for Securities Commission (IOSCO) is dealing with the issue and establishing guidelines at global level. Remco Lenterman then reacted by highlighting the different perspectives leading reforms in the EU and US on a number of issues such as resting time, order cancellation, and quoting obligation. Finally, Olle Schmidt said that the blame should not be put on the media. When the financial world collapsed in 2007 none even the experts could explain what had happened. Reforms undertaken at EU level are intended to address this complexity; they are not the cause of it. David Reed (Kreab Gavin Anderson) asked about how policymakers should strike the right balance between principles that become hardwired in level 1 legislation and hence difficult to change – and implementing legislation (level 2) which is a better place for more detailed requirements should any be needed, and which can more easily be reviewed and amended

in light of the pace of technological advancements. He cited the Parliament’s proposal for a minimum resting period as an example where it appeared strange to put such a level of technical detail into a level 1 Directive. Remco Lenterman agreed and added that by imposing ever stricter requirements (order cancellation charges, minimum resting time, continuous quoting obligations etc), legislations will make electronic firms a very unattractive business. This, consequently, will make it more advantageous to trade over-the-counter (OTC trading) as this trading method has much more freedom under currently revised texts. Ms Fabregas Fernandez replied that the objective of the Commission is on the contrary to bring all trades on regulated venues. Ari Burstein recognized that this is a delicate task for the Commission. These are market problems that should ideally be tackled by market based solutions but in the absence of those it is the role of policy makers and legislators to come up with the best possible solutions.