The regulatory challenge of high-frequency markets

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The Regulatory Challenge of High-Frequency Markets

Oliver Linton; Maureen O’Hara; J. P. Zigrand University of Cambridge; Cornell University; London School of Economics and Political Science High-frequency trading (HFT) has become the norm in equities, futures and options markets, and is quickly becoming commonplace in foreign exchange and commodity markets. The influence of HFT goes far beyond simply “speeding up” markets, but instead changes everything from liquidity provision to order strategies to market stability. For regulators, HFT poses daunting challenges as to how best to oversee markets in which computers generate, route and execute orders. An added complexity is that HFT also ties markets together at lightning speed, meaning that regulatory frameworks cannot simply apply to particular markets or even to specific asset classes. From “flash crashes” to new methods of manipulation, regulators now face a host of problems. In this chapter, we address the challenges of regulation in a highfrequency world. We discuss in detail regulatory issues created by HFT and how these differ from the problems facing regulators in the past. We provide some specific examples of the problems raised by HFT, and then turn to a discussion of the proposed solutions. Our premise in this chapter is that, just as markets have changed in fundamental ways, so, too, must their regulation and supervision. Two issues are particularly important. First, the speed of markets necessitates that regulation must move to an ex ante rather than ex post basis. There is simply not enough time to intervene effectively in markets after something has happened, so regulatory actions in the event of faltering markets must be pre-specified and applied 125

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