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Joe Barbieri has Bachelors' degrees in both Civil Engineering and Commerce from the University of Toronto. He has worked in the Financial Services field for over 13 years, with over 10 years on the institutional side of the business. He has covered positions from Fund Accounting to Investment... More
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  • What Does Tighter EU Trading Regulation Mean For You? 0 comments
    Jan 19, 2014 8:34 PM

    European lawmakers have decided to tighten regulation on High Frequency Trading and speculation on derivatives. (1)(2)(3) This agreement is updating the Markets in Financial Instruments "MiFid" laws across the European Union. The agreement is scheduled to come into effect in late 2016. (3) This type of regulation is being contemplated in the U.S. as well at the same time under the Dodd-Frank reform. (6)(7)

    High Frequency Trading uses computer programs to trade in-between the spread of the buyer and seller very rapidly, making very small increments of value over large quantities of trades. While this was originally thought to increase liquidity by reducing trading spreads, it can actually cause more volatility by "hogging" available trades and causing distortion in market prices if the bid ask spreads start to move quickly. Since these programs are faster than other methods of trading in the market, they tend to get orders filled first and put other market participants at a disadvantage. (4)(5)

    In terms of speculation in derivatives, this is being targeted to prevent the volatility that occurred in 2008 and to help stabilize food and resources prices. This regulation is a step in the right direction, but it is only the beginning. Regulators tend to be years behind the markets that they regulate. High Frequency Trading has been around for at least 5 years (4), and there is still time before the regulations start to take effect. Some other methodology may become popular by the time the rules kick in. These changes in regulation should be helpful in trying to take trading from opaque areas and allow it to be done on regulated exchanges. The strength of the third party guarantor is a key to building trust in trading, especially for the small investor. The issue with this is that new products can always be developed that are between counterparties and can be traded between each other. These arrangements would get around any exchange regulation. If a deal is between the two parties, nobody will know it exists until the deal is settled and some effect is visible in market prices. Reduced flexibility, tighter margins and higher costs are cited as effects of this new legislation. (1) This can be positive or negative depending on where you fit into the trading system. Compliance and monitoring areas will see large growth in budgets, where leveraged speculation will either decrease or change to accommodate the new rules. More transparency may mean higher trading volume and more business for everyone involved.

    What does this mean for you? These regulations address some key trading issues, but they are not complete in and of themselves. There will be some evolution and refinement of the rules as more issues come up. Trading will not change radically over the next few years, but longer term contracts will be gradually changed to accommodate the new rules. The real solution is to remove the motivation for trades that would create large speculation and volatility - in short, removing the greed factor in markets.

    Sources:

    1) http://www.bloomberg.com/news/2014-01-15/eu-lawmakers-seal-deal-on-financial-market-rules-overhaul.html

    2) http://dealbook.nytimes.com/2014/01/14/europe-reaches-agreement-on-trading-of-derivatives/?_r=1

    3) http://in.reuters.com/article/2014/01/14/eu-mifid-idINL6N0KO3T220140114

    4) http://en.wikipedia.org/wiki/High-frequency_trading

    5) http://www.businessdictionary.com/definition/high-frequency-trading.html

    6) http://www.theglobeandmail.com/report-on-business/regulators-stumble-on-automated-trades/article15940530/

    7) http://www.aima.org/en/regulation/markets-regulation/high-frequency-trading/

    Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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