High frequency trading (HFT) is a type of electronic trading that is often characterised by holding positions very briefly in order to profit from short term opportunities.
Article 4(1)(40) of MiFID II defines High Frequency Algorithmic Trading Technique (HFT) as "an algorithmic trading technique characterised by:
(a) infrastructure intended to minimise network and other types of latencies, including at least one of the following facilities for algorithmic order entry: co-location, proximity hosting or high-speed direct electronic access;
(b) system-determination of order initiation, generation, routing or execution without human intervention for individual trades or orders; and
(c) high message intraday rates which constitute orders, quotes or cancellations."
High Frequency Algorithmic Trading Technique is typically not a strategy in itself but the use of very sophisticated technology to implement traditional trading strategies.
High message intraday rates
Criteria to define the high message intraday rates represent absolute quantitative thresholds differentiated in relation to single instruments and multiple instruments.
The relevant details are stipulated in Article 19 of the Commission Delegated Regulation (EU) 2017/565 of 25 April 2016 supplementing Directive 2014/65/EU of the European Parliament and of the Council as regards organisational requirements and operating conditions for investment firms and defined terms for the purposes of that Directive.
Pursuant to these provisions a high message intraday rate consists of the submission on average of any of the following:
(a) at least 2 messages per second with respect to any single financial instrument traded on a trading venue;
(b) at least 4 messages per second with respect to all financial instruments traded on a trading venue.
The purpose of this formula is to provide legal certainty by allowing firms and competent authorities to assess the individual trading activity of firms.
It is noteworthy, for the purposes of the above calculations are only included:
- messages concerning financial instruments for which there is a liquid market,
- messages introduced for the purpose of dealing on own account (messages introduced through other trading techniques than those relying on dealing on own account must be included in the calculation only where "the firm's execution technique is structured in such a way as to avoid that the execution takes place on own account"). Consequently, messages introduced for the purposes of receiving and transmitting orders or executing orders of behalf of clients are not included in these calculations.
In relation to DEA (Direct Electronic Access) providers, messages submitted by their DEA clients are excluded from the calculations.
Trading venues are required to make available to the firms concerned, on request, estimates of the average of messages per second on a monthly basis two weeks after the end of each calendar month taking into account all messages submitted during the preceding 12 months.
On 1 February 2019 ESMA made some comments (answer to the Question 30, Questions and Answers on MiFID II and MiFIR transparency topics, ESMA70-872942901-35) as to the issue, how the tests to identify high frequency trading techniques, described in Article 19 of Commission Delegated Regulation (EU) 2017/565, should be undertaken.
According to the ESMA, as regards the indicators in Articles 19(1)(a) & (b) firms should assess each instrument based on the relevant trading hours of that instrument for Article 19(1)(a), and sum those calculated indicators for all relevant instruments traded on a trading venue together for Article 19(1)(b).
Regarding the applicability established in Article 19(2) firms should apply these calculations to liquid instruments according to the relevant ESMA publications at the time of calculation.
Regulatory framework
High Frequency Trading is a subset of algorithmic trading, persons engaging in HFT techniques must abide by the general rules which apply to algorithmic traders, as well as specific rules for HFT.
High frequency traders will have to comply with more comprehensive data recording requirements and might face higher fees at trading venues that reflect the additional burden on system capacity.
Furthermore, MiFID II stipulates that any person that applies a high frequency algorithmic trading technique is required to be authorised as an investment firm.
An investment firm that engages in a high-frequency algorithmic trading technique must store in an approved form accurate and timesequenced records of all its placed orders, including cancellations of orders, executed orders and quotations on trading venues and make them available to the competent authority upon request (Article 17(2) MiFID II).
Detailed legal requirements for HFT firms are stipulated in the Commission Delegated Regulation (EU) 2017/589 of 19 July 2016 supplementing Directive 2014/65/EU of the European Parliament and of the Council with regard to regulatory technical standards specifying the organisational requirements of investment firms engaged in algorithmic trading.
There is also an extensive set of regulatory clarifications: Questions and Answers on MiFID II and MiFIR market structures topics, ESMA70-872942901-38, Direct Electronic Access (DEA) and algorithmic trading.
Dealing on own account exemption under Article 2(1)(d) of MiFID II does not apply to persons using a high frequency algorithmic trading technique.
Equally, the ancillary activity ("commodity derivatives trader") exemption - Article 2(1)(j) of MiFID II.
"What is a high-frequency algorithmic trading technique?
It is a type of algorithmic trading technique.
Algorithmic trading means trading in financial instruments where a computer algorithm automatically determines individual parameters of orders such as:
● whether to initiate the order;
● the timing, price or quantity of the order; or
● how to manage the order after its submission;
with limited or no human intervention.
Algorithmic trading does not include any system that is only used for:
● routing orders to one or more trading venues;
● processing of orders involving no determination of any trading parameters;
● confirmation of orders; or
● the post-trade processing of executed transactions.
Article 4.1(40) defines a high-frequency algorithmic trading technique as an algorithmic trading technique characterised by:
● infrastructure intended to minimise network and other types of latencies, including at least one of the following facilities for algorithmic order entry:
● co-location;
● proximity hosting; or
● high-speed direct electronic access;
● system-determination of order initiation, generation, routing or execution without human intervention for individual trades or orders; and
● high message intraday rates which constitute orders, quotes or cancellations."
Financial Conduct Authority, Markets in Financial Instruments Directive II Implementation – Consultation Paper I (CP15/43), December 2015, CP15/43, p. 206-207
Commission Delegated Regulation (EU) 2017/565 of 25.4.2016 supplementing Directive 2014/65/EU of the European Parliament and of the Council as regards organisational requirements and operating conditions for investment firms and defined terms for the purposes of that Directive
Article 19
High frequency algorithmic trading technique
(Article 4(1)(40) of Directive 2014/65/EU)
1. A high message intraday rate in accordance with Article 4(1)(40) of Directive 2014/65/EU shall consist of the submission on average of any of the following:
(a) at least 2 messages per second with respect to any single financial instrument traded on a trading venue;
(b) at least 4 messages per second with respect to all financial instruments traded on a trading venue.
2. For the purposes of paragraph 1, messages concerning financial instruments for which there is a liquid market in accordance with Article 2(1)(17) of Regulation (EU) No 600/2014 shall be included in the calculation. Messages introduced for the purpose of trading that fulfil the criteria in Article 17(4) of Directive No 2014/65/EU shall be included in the calculation.
3. For the purposes of paragraph 1, messages introduced for the purpose of dealing on own account shall be included in the calculation. Messages introduced through other trading techniques than those relying on dealing on own account shall be included in the calculation where the firm's execution technique is structured in such a way as to avoid that the execution takes place on own account.
4. For the purposes of paragraph 1, for the calculation of high message intraday rate in relation to DEA providers, messages submitted by their DEA clients shall be excluded from the calculations.
5. For the purposes of paragraph 1, trading venues shall make available to the firms concerned, on request, estimates of the average of messages per second on a monthly basis two weeks after the end of each calendar month taking into account all messages submitted during the preceding 12 months.
Recitals 23 and 24
(23) High frequency algorithmic trading technique in accordance with Article 4(1)(40) of Directive 2014/65/EU, which is a subset of algorithmic trading, should be further specified through the establishment of criteria to define high message intraday rates which constitutes orders quotes or modifications or cancellations thereof. Using absolute quantitative thresholds on the basis of messaging rates provides legal certainty by allowing firms and competent authorities to assess the individual trading activity of firms. The level and scope of these thresholds should be sufficiently broad to cover trading which constitute high frequency trading technique, including those in relation to single instruments and multiple instruments.
(24) Since the use of high frequency algorithmic trading technique is predominantly common in liquid instruments, only instruments for which there is a liquid market should be included in the calculation of high intraday message rate. Also, given that high frequency algorithmic trading technique is a subset of algorithmic trading, messages introduced for the purpose of trading that fulfil the criteria in Article 17(4) of Directive 2014/65/EU should be included in the calculation of intraday message rates. In order not to capture trading activity other than high frequency algorithmic trading techniques, having regard to the characteristics of such trading as set out in recital 61 of Directive 2014/65/EU, in particular that such trading is typically done by traders using their own capital to implement more traditional trading strategies such as market making or arbitrage through the use of sophisticated technology, only messages introduced for the purposes of dealing on own account, and not those introduced for the purposes of receiving and transmitting orders or executing orders of behalf of clients, should be included in the calculation of high intraday message rates. However, messages introduced through other techniques than those relying on trading on own account should be included in the calculation of high intraday message rate where, viewed as a whole and taking into account all circumstances, the execution of the technique is structured in such a way as to avoid the execution taking place on own account, such as through the transmission of orders between entities within the same group. In order to take into account, when determining what constitutes high message intra-day rates, the identity of the client ultimately behind the activity, messages which were originated by clients of DEA providers should be excluded from the calculation of high intraday message rate in relation to such providers.
Option 1 - Specifying infrastructure and an absolute threshold of messages per instrument
This approach would further specify the requirements a firm would have to meet in order to be considered using high frequency trading. The first element would be to meet the requirements of Article 4(1) 40 MiFID II in terms of infrastructure intended to minimise network and other types of latencies. The second element would be the specification of mechanisms for the identification of 'high message intraday rates". A participant/member in a trading venue would be deemed to have a "high message intraday rate" when the average number of messages sent per trading day with regard to any liquid instrument traded on a venue is above an absolute threshold of 2 messages per second. If both requirements are fulfilled a firm would be considered to engage in high frequency trading.
Option 2 - Specifying infrastructure and an absolute threshold of messages per instrument and across instruments per trading venue
In addition to the first element of option 1, a participant or member of a trading venue submitting on average at least 4 messages per second with respect to all instruments across a venue or 2 messages per second traded with respect to any single instrument traded on a venue would be deemed to have a "high message intraday rate".
Option 3 - Specifying infrastructure and a relative threshold of messages per instrument
This option would include the first element of option 1 and would seek to impose a relative threshold to measure the number of intra-day messages. A member or participant of a trading venue would be deemed to have a "high message intraday rate" if the median daily lifetime of its modified or cancelled orders in all instruments on a venue stays under a threshold set by the Commission. ESMA recommends setting this threshold between the 40th and the 20th percentiles of the daily lifetime of modified or cancelled orders from all members or participants on a trading venue.
Views at ESMA were split on the relative advantages and disadvantages of the options consulted on by ESMA. ESMA's Technical Advice therefore covers options 1, 2 and 3 above based on the proprietary order flow of investment firms (ESMA's technical advice to the European Commission on MiFID II/MiFIR, ESMA/2014/1569, 19 December 2014, p. 339). Option 2 was brought forward by ESMA late in its process of formulating the technical advice as a compromise solution and was not consulted upon in the general open consultation during the summer of 2014.
Commission Staff Working Document Impact Assessment Accompanying the document Commission Delegated Regulation supplementing Regulation (EU) No 600/2014 of the European Parliament and of the Council with regard to definitions, transparency, portfolio compression and supervisory measures on product intervention and positions {C(2016) 2860 final} {SWD(2016) 156 final}, 18.5.2016, SWD(2016) 157 final, p. 42
Regulatory chronicle
20 November 2020
1 February 2019
Questions and Answers on MiFID II and MiFIR market structures topics, ESMA70-872942901-38 updated
ESMA explains how the tests to identify high frequency trading techniques, described in Article 19 of Commission Delegated Regulation (EU) 2017/565, should be undertaken.
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Documentation |
MiFID II Article 4(1)(40)
Commission Delegated Regulation (EU) 2017/565 of 25 April 2016 supplementing Directive 2014/65/EU of the European Parliament and of the Council as regards organisational requirements and operating conditions for investment firms and defined terms for the purposes of that Directive, Article 19, Recitals 23 and 24
Questions and Answers on MiFID II and MiFIR market structures topics, ESMA70-872942901-38
Order duplication and liquidity measurement in EU equity markets, ESMA Economic Report No. 1, 2016
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