Wednesday, December 19, 2012

BaFin Authorized to Regulate High Frequency Trading under Draft German Legislation

Draft legislation would authorize the German Federal Financial Supervisory Authority (BaFin) to oversee high frequency trading with a special right to information that would enable better surveillance of firms engaged in algorithmic trading and the systems used for the trading. In particular, under the draft          High Frequency Trading Act, BaFin could require from the firms a description of their algorithmic trading strategies and the specifics of the trade parameters or trade limits. In addition, the legislation would authorize exchanges to ban the use of a specific algorithmic trading strategy if it violates exchange regulations or to remedy undesirable situations that could have an adverse impact on the orderly conduct of exchange trading. In order to aid in regulatory surveillance efforts, the draft would require electronic identification for orders generated algorithmically. The German federal government is committed to the Act, which is designed to curb the risks associated with algorithmic high frequency trading. The legislation must be considered by the Bundestag and the Bundesrat.

High frequency traders must be authorized by BaFin, including traders admitted to a trading venue as trading participants, as well as firms to which trading participants grant electronic access to the trading venue. However, pursuant to the EU passport under the Markets in Financial Instruments Directive (MiFID), securities firms domiciled in another EU state with state approval for trading on their own accounts would not need additional authorization in Germany.

Under the draft, asset management companies, investment services enterprises and investment stock companies engaged in algorithmic trading must structure their trading systems so that they do not disrupt the market. Specifically, firms engaged in algorithmic trading must ensure that their trading systems are resilient, have sufficient capacity and are subject to appropriate trading limits. Algorithmic trading is defined as trading in financial instruments for which a computer algorithm automatically determines the specific order parameters, such as a decision to initiate an order, its timing, price and quality.