The Future of Computer Trading in Financial Markets - An International Perspective (pdf, 2014)
Foreward by Professor Sir John Beddington CMG, FRS
Chief Scientific Adviser to HM Government and Head of the Government Office for Science (2014)
Well functioning financial markets are vital for everyone. They support businesses and growth across the world. They provide important services for investors, from large pension funds to the smallest investors. And they can even affect the long-term security of entire countries.
Financial markets are evolving ever faster through interacting forces such as globalisation, changes in geopolitics, competition, evolving regulation and demographic shifts. However, the development of new technology is arguably driving the fastest changes. Technological developments are undoubtedly fuelling many new products and services, and are contributing to the dynamism of financial markets. In particular, high frequency computer-based trading (HFT) has grown in recent years to represent about 30% of equity trading in the UK and possible over 60% in the USA.
HFT has many proponents. Its roll-out is contributing to fundamental shifts in market structures being seen across the world and, in turn, these are significantly affecting the fortunes of many market participants. But the relentless rise of HFT and algorithmic trading (AT) has also attracted considerable controversy and opposition. Some question the added value it brings to markets and, indeed, whether it constitutes a drag on market efficiency. Crucially, some also believe that it may be playing an increasing role in driving instabilities in particular markets. This is of concern to all financial markets, irrespective of their use of HFT, since increasing globalisation means that such instabilities could potentially spread through contagion. It has also been suggested that HFT may have significant negative implications relating to market abuse. For these reasons, it is unsurprising that HFT is now attracting the urgent attention of policy makers and regulators across the world.
This international Foresight Project was commissioned to address two critical challenges. First, the pace of technological change, coupled with the ever-increasing complexity of financial trading and markets, makes it difficult to fully understand the present effect of HFT/AT on financial markets, let alone to develop policies and regulatory interventions that are robust to developments over the next decade. Second, there is a relative paucity of evidence and analysis to inform new regulations, not least because of the time lag between rapid technological developments and research into their effects. This latter point is of particular concern, since good regulation clearly needs to be founded on good evidence and sound analysis.
Therefore, the key aim of this Project has been to assemble and analyse the available evidence concerning the effect of HFT on financial markets. Looking back through recent years and out to 2022, it has taken an independent scientific view. The intention has been to provide advice to policy makers. Over 150 leading academics from more than 20 countries have been involved in the work which has been informed by over 50 commissioned papers, which have been subject to independent peer review.
The key message is mixed. The Project has found that some of the commonly held negative perceptions surrounding HFT are not supported by the available evidence and, indeed, that HFT may have modestly improved the functioning of markets in some respects. However, it is believed that policy makers are justified in being concerned about the possible effects of HFT on instability in financial markets. Therefore, this Report provides clear advice on what regulatory measures might be most effective in addressing those concerns in the shorter term, while preserving any benefits that HFT/AT may bring. It also advises what further actions should be undertaken to inform policies in the longer term, particularly in view of outstanding uncertainties. In conclusion, it is my pleasure to make this Report and all of its supporting evidence and analysis freely available. It is my hope that it will provide valuable insights into this crucial issue.
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