How does high-frequency trading use algorithms

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New notification requirement for operating algorithmic trading and offering direct electronic market access (DEA)

For investment services companies, new reporting obligations have been in effect since January 3rd, 2018 due to the implementation of the Financial Markets Directive (Markets in Financial Instruments Directive II - MiFID II) by the Second Financial Market Amendment Act. Investment services companies are affected by these notification obligations if they engage in algorithmic trading within the meaning of section 80 (2) sentence 1 of the WpHG (version from January 3, 2018) or if they conduct direct trading in accordance with section 2 (30) of the WpHG (version from January 3, 2018) Offer electronic access (Direct Electronic Access - DEA) to a trading venue. On the one hand, the notifications must be submitted to the authority responsible for supervising the investment services company concerned. On the other hand, the notifications must also be sent to the authorities that are responsible for overseeing the trading venues concerned.

Therefore, investment services companies are required to notify BaFin in the following cases:

The investment services companies are supervised by BaFin and offer a DEA for a trading venue or operate algorithmic trading. In this case, the obligation to notify results from Sections 77 (2) sentence 1 and 80 (2) sentence 5 of the WpHG (version from January 3, 2018).

The investment services companies are members or participants in a multilateral trading system (MTF) or an organized trading system (OTF) that is supervised by BaFin and offer a DEA for this MTF or OTF or operate algorithmic trading there. In these cases, the obligation to notify BaFin may also affect companies that are not under the supervision of BaFin. For these companies, the obligation to notify may result from the regulations of other EU member states that transpose Article 17 (2), subparagraph 1 and Article 17, paragraph 5, subparagraph 3 of MiFID II into national law.

Furthermore, in accordance with Section 3 (3) sentence 1 of the WpHG, the reporting obligations may also affect companies that are not considered to be investment services companies in accordance with Section 3 (1) No. 4, 8 or 15 of the WpHG. Therefore, the notification requirements can also apply to insurance companies and other companies if they are a member or participant of an organized market or MTF. Finally, the notification requirements in accordance with Section 28 Paragraph 1 Sentence 3 KAGB can also be applied to capital management companies.

BaFin has created a sample form with which the investment service companies concerned can comply with their reporting obligation vis-à-vis BaFin. The form must be sent by email to the following email addresses:

Advertisement about the operation of algorithmic trading: algo Anzeige @ bafin.de

Advertisement about the offering of a DEA for a trading venue: dea Anzeige @ bafin.de

BaFin is not responsible for the supervision of the stock exchanges located in Germany. The stock exchanges are supervised by the stock exchange supervisory authorities of the federal states. Therefore, investment services companies that operate algorithmic trading as trading participants on a German stock exchange or offer a DEA on a German stock exchange must submit the notification to the stock exchange supervisory authority responsible for the respective stock exchange. The obligation to notify the stock exchange supervisory authorities may also affect companies for which the obligation to notify arises from the regulations of other EU member states that implement Article 17 (2) subparagraph 1 and Article 17 (5) subparagraph 3 of MiFID II into national law.

The stock exchanges located in Germany will probably inform their respective trading participants about the notification procedure to the stock exchange supervisory authorities by means of a corresponding circular.

Further information on the notification procedure to the stock exchange supervisory authorities can be found using the links below. Questions about the notification procedure with these authorities can be sent to the email addresses listed.

Baden-Württemberg stock exchange supervisory authority: Baden-Württemberg Ministry of Economics, Labor and Housing

Stock exchange supervision Bavaria: Bavarian State Ministry for Economic Affairs, Regional Development and Energy (Email: algo Anzeige @ stmwi.bayern.de and dea Anzeige @ stmwi.bayern.de)

Stock exchange supervisory authority Berlin: Senate Department for Economics, Energy and Public Enterprises

Stock exchange supervisory authority Hamburg: Authority for economy, transport and innovation

Stock exchange supervisory authority Hessen: Hessian Ministry for Economic Affairs, Energy, Transport and Housing (https://service.hessen.de/html/9496.htm)

Stock exchange supervisory authority of Lower Saxony: Lower Saxony Ministry of Economics, Labor, Transport and Digitization

Stock exchange supervisory authority North Rhine-Westphalia: Ministry of Finance of the State of North Rhine-Westphalia (Email: V-BoersenaufsichtNRW @ fm.nrw.de)

Stock exchange supervisory authority Saxony: Saxon State Ministry for Economics, Labor and Transport

Further obligations for algorithmic trading

In order to counteract the risks associated with algorithmic trading and the risks associated with high-frequency trading, the national legislature had already passed the law on the avoidance of dangers and misuse in high-frequency trading (high-frequency trading law) in 2013. This law contained rules for high frequency and algorithmic trading. High frequency trading is part of algorithmic trading. It is characterized by a high number of order entries, changes or deletions within microseconds. High-frequency traders seek close proximity to the server of the trading venue in order to gain speed advantages through the short path of the signals.

The regulations of the High Frequency Trading Act are largely based on the drafts of the European regulations for the revision of the Financial Market Directive (MiFID II). MiFID II has now been implemented in national law. The regulations of the High Frequency Trading Act were adapted to the European requirements as far as this was necessary.

Even after the implementation of MiFID II, the following obligations continue to apply.

The operation of high-frequency trading is subject to authorization in accordance with Section 1 (1a) sentence 2 no. 4 d) KWG. Investment services companies that engage in algorithmic trading must maintain system and risk controls (section 80 (2) and (3) of the WpHG). Trading participants must identify orders generated by algorithms (Section 16 Paragraph 2 No. 3 BörsG). Furthermore, they must guarantee an appropriate order-to-trade ratio (Section 26a of the Stock Exchange Act). In the event of excessive use of the exchange systems, trading venues must levy separate fees or charges (Section 17 Paragraph 4 BörsG) and set an appropriate size for the smallest possible price changes (so-called tick sizes) (Section 26b BörsG). In order to prevent dangers emanating from algorithmic trading systems, trading venues must also put in place suitable precautions in accordance with Section 26d BörsG. These can be volatility interrupters, for example.

After the implementation of MiFID II in national law, the following additions and changes were made.

In section 80 (3) sentence 2 of the WpHG, a specific documentation requirement was introduced for investment services companies that operate high-frequency trading. In addition, investment services companies that operate algorithmic trading and pursue a market-making strategy must now provide liquidity at trading venues in accordance with Section 80 (4) and (5) WpHG. Finally, the characteristics for high-frequency trading mentioned in Section 1 (1a) sentence 2 no. 4 d) of the KWG have been adapted to the European requirements. This applies in particular to the criterion of the high volume of messages within the day.

The aforementioned regulations are supplemented by the Delegated Regulation (EU) 2017/584, the Delegated Regulation (EU) 2017/589 and ESMA Q&A.

Against this background, the BaFinFAQ on the High Frequency Trading Act has since been revised.

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Format article Publication: from 02.11.2012 00:00 o'clock New rules for high frequency trading

The importance of electronic commerce has increased significantly in recent years. The reasons for this are the rapid development of information technology and the growing competition between financial centers.

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