High Frequency Trading Review

    27 September 2011

    The Markets Committee today released a report entitled High-frequency trading in the foreign exchange market. The report was prepared by a Study Group chaired by Guy Debelle, Assistant Governor of the Reserve Bank of Australia.

    The report examines the facts about high-frequency trading (HFT) in foreign exchange (FX), including its definition, effect on other market participants, behaviour in normal and stressed times, and key differences compared with HFT in equities. It also identifies areas that may warrant further investigation.

    HFT could be seen as beneficial for the functioning of the FX market in normal times, but it has also changed the market’s ecology with implications for its resilience in times of stress. Anecdotal evidence suggests that HFT participants are not necessarily flightier in volatile markets than traditional FX participants, although the latter’s incentive and ability to provide liquidity have changed in the presence of HFT.

    The May 2010 “flash crash” in equities suggests that pure HFT (in contrast to algorithmic execution involving large unidirectional trades) is not by nature a trigger of systemic risk, but that it may have the potential to propagate shocks initiated elsewhere. However, the different nature, structure and size of the FX market may make a flash crash-type event less likely in FX than in equities.

    Many of the “predatory” or “unfair” practices attributed to HFT in FX are, in fact, not new. A key question is whether and how other market participants are adapting to the presence of HFT. Business incentives exist for different parties, including prime brokers and trading venue operators, to self-regulate and mitigate potential negative outcomes.

    Markets Committee Chairman Hiroshi Nakaso said that the report is a timely input to the ongoing discussion about the effects on financial markets of technological innovation (of which HFT is one example). The report’s focus on FX complements a discussion that has so far been based mainly on developments in equities.

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