BIS Examines High-Frequency Trading in FX Markets (Sept. 27, 2011)The Bank for International Settlements, an international body comprised of central banks, issued a report on high-frequency trading in the foreign exchange markets on Sept. 27. The report examines the effect of high-frequency trading on other market participants, its behavior in normal and stressed times, and the contrasts to the behavior of HFT in the equity markets. The report finds that HFT has changed the “ecology” of the FX markets ecology and suggests that other market participants are adapting to the presence of HFT.
“HFT has arguably helped to increase market efficiency by mobilizing the power of new technology in the marketplace and by creating incentives for other participants to upgrade their own technology as well,” the report states. “However, the competition posed by HFT firms through their ability to compress spreads and make profits at the expense of traditional market-makers has resulted in some market-makers pulling back or changing how and where they provide liquidity.”
The report identifies several issues pertaining to market functioning, systemic risks, and market integrity and competition that may warrant further investigation. In particular, the report examines two specific periods when FX markets were under stress: USD/EUR trading during the flash crash on May 6, 2010 and USD/JPY trading on March 17, 2011. The report finds that the liquidity provided by HFT firms “may evaporate rapidly in stressed circumstances.” On the other hand, the report finds that this is also true of the liquidity provided by “traditional” market-makers such as banks. The report also finds that systemic risk is more likely to be triggered by a rogue algorithmic trade than by pure HFT activity, but warns that HFT can “amplify and propagate” a shock caused by a rogue trade or some other market disturbance.
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