The German High-Frequency Trading Act : Implications for Market Quality

With the introduction of the High Frequency Trading (HFT) Act in May 2013, Germany has become the first country that regulates securities trading firms based on their infrastructure and order book activity characteristics. In order to increase the transparency of HFT firms and to facilitate market integrity, all non-regulated proprietary trading firms that rely on low latency connections, high intraday trading message volumes and autonomous decision making systems are required to be authorized by German regulators and fulfill a variety of organizational obligations. This study analyzes the impact of this act by identifying whether a change in daily trading messages was observable and how this change impacted order book liquidity levels. We find that the German HFT Act has successfully reduced the amount of intraday trading messages leaving trade executions only marginally affected. However, a large fraction of those messages lost were providing high quality liquidity at competitive limits and thereby decreasing implicit transaction costs, which results in increased bid-ask spreads after the introduction. But as those messages were of negligible sizes, the overall liquidity supply to the order book, measured by the order book depth level, remains unaffected. Therefore, consequences originating from the absence of unregulated HFT could be considered marginal for securities markets quality