Earlier this week, one of the Technology Advisory Committee (TAC) working committees presented the US Commodities Futures Trading Commission (CFTC) a proposed four-point definition of high-frequency trading.
It’s important to remember that this definition is nothing more than a recommendation to the CFTC. As CFTC Commissioner Scott O’Malia stated publicly in the past, the working group’s definition will be the straw-man definition that will spur industry discussion and lead to an eventual regulatory definition.
According to the working group members, their goal was to keep the definition broad enough to capture any future practices within the existing definition and avoid narrow language that might lead to regulatory arbitrage.
Given the rise of high frequency trading has forced more firms to focus on market data and trade messaging latency as well as algorithmic execution like never before, how do you know whether your strategy would be considered high frequency trading under the proposed rule?
Here is definition as the working group presented it to the CFTC:
High frequency trading is a form of automated trading that employs:
(a) algorithms for decision making, order initiation, generation, routing, or execution, for each individual transaction without human direction;
(b) low-latency technology that is designed to minimize response time, including proximity and co-location services;
(c) high-speed connections to markets for order entry; and
(d) high message rates (orders, quotes or cancellations).
Most people in the industry would agree that all four points accurately describe high frequency trading, but it still leaves the regulators and the industry the challenge of turning a subjective concept into an objective definition. What qualifies as low latency technology, high-speed connections and high message rates?
Any fixed figure would be outdated almost immediately, which leaves regulators using fixed ratios to define high frequency trading. Yet the management, documentation and reporting of staying between those regulatory lines would be prohibitive to all but the largest firms with the deepest IT pockets.
The TAC has managed to grab the low-hanging fruit with its recommendation, now the hard work really begins.