Last week, I posted on how regulation has unintentionally led to increased high frequency trading across various asset classes. Today, we saw a different angle on the HFT debate, with the IntercontinentalExchange (ICE) highlighting the results of changes they implemented to encourage HFT as a source of liquidity, but discourage counterproductive high-volume quote generation.
Many other exchanges, like LSE and Deutsche Borse, have chosen to penalize market participants with increased fees if they have a high order-to-trade ratio, that is, if their algos generate lots of traffic but result in few actual trades. The claim is the high level of short-lived orders affects exchange performance for all participants.
About a year ago, ICE instituted a more nuanced approach for their high frequency messaging policy. They welcome any order volume, provided it is within a narrow boundary close to the best bid or ask. They claim this encourages HFT order volume that is useful as liquidity and penalizes algorithmic traders that are flooding the market with out of the money orders that rarely trade.
Naturally, ICE’s statement today highlights the positive impact these changes have had on HFT traffic – orders far from current market values were down 63% over the year, and most market participants modified their algos to avoid the penalties. To me, this is the more interesting aspect of the story. Whether it is the simplistic approach many of the exchanges are taking or this differentiated approach at ICE, the market works best when it corrects itself without waiting for slow-moving and heavy handed regulations to come down from law makers.