Automation
More and more orders originate from computer algorithms rather than
from human traders. As in many other areas of daily life, this automation
brings great benefits and is nothing anyone should worry about per se. In the
last few years, though, the share of automated orders and, equally important,
cancellations has increased so much that in some market segments, algorithm
trading has become the determining factor. Now, a number of risks have
come to the fore and people have started mulling over regulating algorithm
trading or, as it is often labeled, high-frequency trading.217
FÜR KLAUS J. HOPT ZUM 70. GEBURTSTAG AM 24. AUGUST, supra note 1, at 1909-32 (Ger.);
Gerard Hertig, Mifid and the Return of Concentration Rules, in id., at 1989-2000 (Ger.).; Nis Jul
Clausen & Karsten Engsig Sørensen, Reforming the Regulation of Trading Venues in the EU under the Proposed MiFID II – Levelling the Playing Field and Overcoming Market Fragmentation?, 9
EUR. COMP. FIN. L. REV. 275-306 (2012); Guido Ferrarini & Niamh Moloney, Reshaping
Order Execution in the EU and the Role of Interest Groups: From MiFID I to MiFID II,
13 EUR.
BUS. ORG. L. Rev.557-97 (2012).
216 See, most notably, Proposal for a Regulation of the European Parliament and of the Council on OTC
Derivatives, Central Counterparties and Trade Repositories, COM (2010) 484 final (Sept. 15,
2010); Proposal for a Directive of the European Parliament and of the Council on Markets in Financial
Instruments Repealing Directive 2004/39/EC of the European Parliament and of the Council, COM
(2011) 656 final, at art. 61, 72, 83, (Oct. 20, 2011); Proposal for a Regulation of the European
Parliament and of the Council on markets in financial instruments and amending Regulation [EMIR]
On OTC Derivatives, Central Counterparties and Trade Repositories, COM (2011) 652 final, at art.
7-10, 24-27, (Oct. 20, 2011); Further Definition of “Swap,” “Security-Based Swap,” and
“Security-Based Swap Agreement”; Mixed Swaps; Security-Based Swap Agreement
Recordkeeping Exchange Act, Release No. 33-9204 and 34-64372, 76 Fed. Reg. ¶¶ 29818-
29900, corr. 32880 (Apr. 29, 2011). See also, e.g., Press Release, European Association of
Corporate Treasurers, Leading European Companies Unite Against Proposed Derivatives
Regulation, (Jan. 6, 2010), available at http://www.eact.eu/main.php?page=press; Dan
Awrey, The Dynamics of OTC Derivatives Regulation: Bridging the Public-Private Divide, 11 EUR.
BUS. ORG. L. REV. 155-93 (2010); Stefan Jobst, Börslicher und außerbörslicher Derivatehandel
mittels zentraler Gegenpartei, 21 ZEITSCHRIFT FÜR BANKRECHT UND BANKWIRTSCHAFT 384-
400 (2010) (Ger.); Joanne P. Braithwaite, The Inherent Limits of ‘Legal Devices’: Lessons for the
Public Sector’s Central Counterparty Prescription for the OTC Derivatives Markets, 12 EUR. BUS.
ORG. L. REV. 87-119 (2011); Franz-Christoph Zeitler, Vergessene Ursachen der Banken- und
Finanzkrise, 66 ZEITSCHRIFT FÜR WIRTSCHAFTS- UND BANKRECHT 673, 676-77 (2012)
(Ger.); Lambert Köhling & Dominik Adler, Der neue europäische Regulierungsrahmen für OTC
Derivate, 66 ZEITSCHRIFT FÜR WIRTSCHAFTS- UND BANKRECHT 2125-33, 2173-80 (2012)
(Ger.).
217 See, most notably, Concept Release on Equity Market Structure, Exchange Act Release
No. 34-61358, 75 Fed. Reg. ¶¶ 3594, 3606-12 (Jan. 14, 2010); Large Trader Reporting,
7:513 (2013)
Stock Exchange Law 557
The public became aware of this new phenomenon with the infamous
“flash crash” in the United States, when stock prices of many companies
plunged for a short time with a violence unseen before (May 2010).218 It is
likely that we will never fully understand what happened on this day, but it
seems from the many reports that algorithm trading had a critical impact on
the development, at least in the sense that the programs contributed to the
sharp decline by placing more and more sell orders that the market could not
absorb. Another famous case is the failed initial public offering (IPO) of
BATS Global Markets, ironically an operator of exchanges and other trading
facilities (“BATS” originally stood for “Better Alternative Trading System”):
on its first day of trading, BATS shares fell within seconds from roughly fifteen dollars to almost zero cents, prompting both the termination of trading
and the withdrawal of the IPO (March 2012).
219
More generally, there are at least two regulatory concerns that require further investigation: First, many exchange operators let algorithm traders place
and cancel orders at a rate that allows them to make money to the detriment
Exchange Act Release No. 34-64976, 76 Fed. Reg. ¶¶ 46969-47007 (July 27, 2011); Proposal for a Regulation of the European Parliament and of the Council on markets in financial instruments and amending Regulation [EMIR] On OTC Derivatives, Central Counterparties and Trade Repositories, COM (2011) 652 final, at arts. 17, 51, (Oct. 20, 2011); High-frequency Trading in the
Foreign Exchange Market, BANK FOR INTERNATIONAL SETTLEMENTS, MARKET COMMITTEE,
Sept. 2011, http://www.bis.org/publ/mktc05.pdf. See also, e.g., Merkt, supra note 1, at
2207, 2242-44; Terrence Hendershott, Charles M. Jones &Albert J. Menkveld, Does Algorithmic Trading Improve Liquidity?, 66 J. Fin. 1-33 (2011); Peter Gomber, et al., High-Frequency
Trading (Working Paper, 2011) (on file with the Virginia Law and Business Review); NIKOLAUS HAUTSCH, ECONOMETRICS OF FINANCIAL HIGH-FREQUENCY DATA (2012); The
fast and the furious: High-frequency trading seems scary, but what does the evidence show?, ECONOMIST,
Feb. 25, 2012.
218 Among the many statements, see, most notably, Testimony Concerning the Severe Market
Disruption Before the Subcommittee on Capital Markets, Insurance and Government Sponsored Enterprises of the H., 112th Cong. (2011) (testimony of Mary L. Schapiro, Chairman, Securities
and Exchange Commission), available at
http://www.sec.gov/news/testimony/2010/ts051110mls.pdf; Examining the Causes and
Lessons of the May 6th Market Plunge, Before the Subcommittee on Securities, Insurance, and Investment of the S. Committee on Banking, Housing, and Urban Affairs, 111th Cong. (2010) (testimony
of Mary L. Schapiro, Chairman, Securities and Exchange Commission), available at
http://www.sec.gov/news/testimony/2010/ts052010mls.pdf; STAFF OF CFTC AND SEC
TO THE JOINT ADVISORY COMMITTEE ON EMERGING REGULATORY ISSUES, 110th Cong.,
Rep. on Findings Regarding the Market Events of May 6, 2010, available at
http://www.sec.gov/news/studies/2010/marketevents-report.pdf.
219 See, e.g., Press Release, BATS Global Markets: BATS Global Markets Withdraws Initial
Public Offering (Mar. 23, 2012) (on file with the Virginia Law and Business Review);
Press Release, BATS Global Markets: A Message From BATS CEO Joe Ratterman (Mar.
25, 2012) (on file with the Virginia Law and Business Review).
558 Virginia Law & Business Review 7:513 (2013)
of other traders (similar to “classical” front-running). Those practices could
get in conflict with basic principles of many securities laws, such as equal
treatment of traders or investors, respectively. Second, algorithm trading is
often trend following, meaning that computers buy stocks that soar and sell
or short sell stocks that fall. If such strategies dominate the market, they become self-fulfilling and stock prices will move away from their “fair” price.
Again, this contradicts one of the core pillars of securities laws and, in particular, of stock exchange laws: to reduce volatility and increase reliability by
bringing together supply and demand at prices that reflect the overall market
interest.