EU lawmaker calls for "flash crash" stress tests

By Huw Jones

LONDON, July 21 (BestGrowthStock) – The European Union should force
share trading venues to stress-test how they would handle a
runaway U.S.-style “flash crash” like the one that sent Wall
Street tumbling in May, an EU lawmaker said in a draft report on
Wednesday.

Regulators are still unclear as to the exact cause of a
chain reaction among trading platforms that sent the Dow Jones
Industrial Average tumbling 700 points in minutes in May.

The incident threw a regulatory spotlight on computer or
algorithmic trading, which can process up to 33,000 orders a
second, a practice favoured by high-frequency traders (HFT) in
particular.

The EU is reviewing its trading rules known as the Markets
in Financial Instruments Directive (MiFID) in light of the huge
growth in competition and ensuing fragmentation it has spurred,
the financial crisis and the flash crash.

The report, authored by British centre-right member of the
European Parliament, Kay Swinburne, is non-binding and has yet
to be approved by parliament.

It will play an influential role in how MiFID will be
amended by parliament and EU governments, who have joint say.

“The European Parliament insists that post the ‘flash
crash’, all trading platforms stress-test their technology and
surveillance systems to ensure they could successfully deal with
the activity associated with HFT and algorithmic trading in
extreme circumstances,” the draft report sent to the media said.

European trading venues should have robust “circuit
breakers” that operate simultaneously across all venues to
prevent a U.S.-style flash crash, the report added.

It also calls for regulation of high-frequency trading,
which now accounts for 30 to 50 percent of trading volumes, and
an examination of its costs and benefits.

MiFID’s reporting requirements should be applied to the
“explosive growth of HFT strategies” as a matter of urgency.

The high trading speeds are obtained by “co-locating”
servers close to those of the trading venues, and the report
calls for equal access to all to such servers.

Brokers should also be banned from “sponsoring” unfiltered
market access to other participants, the report said.

“In order to comply with the principle that all investors
should be treated equally, the practice of flash orders should
be explicitly ruled out,” the report added.

Many of the report’s key recommendations are in line with
proposals from the Committee of European Securities Regulators,
which advises the EU’s executive European Commission, the body
that will draft legislative amendments to MiFID early next year.

BUSINESS MODEL BATTLE

Exchanges are lobbying hard for changes to MiFID, arguing
that if new trading venues compete with bourses and nibble away
at their volumes then they should be regulated in the same way.

Banks, which have stakes in many of the new venues, are keen
to keep control over their order flow as they face regulatory
inroads in other activities such as off-exchange derivatives.

MiFID was introduced in November 2007 and spawned 136 new
platforms so that, for example, less than 60 percent of UK
blue-chip trading takes place on the London Stock Exchange
(LSE.L: ).

The average order size has shrunk to 9,923 euros in 2009
from 22,266 euros in 2006. Investors wanting to execute large
orders without the market moving against them have shifted to
anonymous “dark pools”, a sector which needs stricter
supervision, the report said.

The report also recommends:

— that new multilateral trading facilities be regulated
like exchanges if they handle similar volumes;

— new rules should be drawn up to regulate broker crossing
networks and a review of whether they must convert to an
exchange if they trade above a certain volume;

— examine if market makers should be banned from
interacting with dark pool orders in a crossing network.

— suggests a minimum order size for dark pool trades;

— make waivers from MiFID’s pre-trade transparency
requirements harder to obtain;

— the European Commission be called on to set up a working
group to establish a privately run system for one-stop
publishing of share prices from all trading venues;

— that delays of more than 1 minute in reporting an
electronic transaction should be considered unacceptable,
compared with 3 minutes at present;

— trading data costs must be lower than $500 a month
currently in the EU, compared with $50 in the United States.

Stock Market Money

(Editing by Hugh Lawson)

EU lawmaker calls for “flash crash” stress tests