Italian Borsa Move May Breed Brave New World of Algos

The following is an excerpt from Dr. John Bates’ recent commentary on Huffington Post, which discusses Italian Borsa’s recent decision regarding high frequency trading. 

The Italian stock exchange Borsa Italiana's decision to clamp down on "excessive" HFT orders is likely to be a shot heard around the world. The Borsa is considering charging HFT firms for sending too many orders, particularly ones that do not result in trades, according to the FT.

Order-to-trade ratios have long been a concern of exchanges, ECNs and other trading venues as quote volumes go through the roof. If the number of orders being sent greatly outweighs the number of trades concluded, this can cause problems. All unnecessary orders (i.e. cancellations) create a load on exchanges; and they can provide a smokescreen to hide potentially abusive behavior (so called "quote stuffing").

I am willing to bet that the Borsa's move will be followed elsewhere. Most exchanges and alternative venues express concern that they will not be able to cope with the amount of orders coming down the pipe if they continue to grow. The SEC is considering charging HFT firms for cancelled trades, according to The Wall Street Journal. And interconnectivity between exchanges is increasing, so in order to trade smoothly between exchanges and effect arbitrage it is important that all destinations follow similar rules and procedures.

But many exchanges and ECNs, particularly in the U.S., have policies to encourage HFT rather than discourage. (Some venues even offer a tidy sum to attract large trades and liquidity providers by offering volume rebates.) The Borsa solution is the opposite of this -- it will discourage HFTs from experimentation.

I wonder if this is a brave new world for algorithms, where they have to pay a penalty for high frequency strategies. If so, they will have to change. The Borsa's solution, especially if it is embraced by other trading destinations, may spawn a new generation of intelligent "sensing" algos.

Read the full post from Dr. Bates here.