Bloomberg News

High-Frequency Firms May Face Tougher EU Market-Abuse Rules

September 13, 2011

(Updates with estimated scale of market abuse in the EU in 13th paragraph.)

Sept. 13 (Bloomberg) -- The European Union is considering listing “specific examples of strategies using algorithmic trading and high-frequency trading” that should be banned and punished by regulators as market manipulation.

The measures to increase investor protection and reduce volatility are part of plans to clamp down on market abuse in the region, according to a draft of the proposals obtained by Bloomberg News.

“There are particular automated strategies that have been identified by regulators which, if carried out, are likely to constitute market abuse,” the European Commission document says. “Further identifying abusive strategies will ensure a consistent approach in monitoring and enforcement by competent authorities.”

High-frequency traders have come under increased regulatory scrutiny following the so-called flash crash in May of last year, during which the Dow Jones Industrial Average briefly lost almost 1,000 points.

The proposal “gives an indication as to where the commission expects European regulators’ collective attention to be focused post flash-crash,” Darren Fox, a financial-services lawyer at Simmons & Simmons LLP in London, said in an e-mail.

The Brussels-based commission targets so-called layering, in which traders place large orders they have no intention of allowing to go through, and quote stuffing, in which investors seek an advantage by delaying data feeds.

Tricking Computers

“Spoofing,” in which market participants try to trick other computers into making decisions that can be exploited for profit, would also be banned.

The EU move follows investigations by U.S. regulators into the practices of high-frequency traders.

The European measures should “be clear, decisive and consistent internationally,” Etay Katz, regulatory partner at law firm Allen & Overy LLP in London, said in an e-mail. The proposal “does not appear to meet any of these objectives in that there is no substantive impact analysis nor a differentiation between good and bad conduct.”

The plans have a “vague reliance on the intent of the order-placing activity which has always proven very difficult to fathom,” Katz said.

Michel Barnier, the EU’s financial services chief, has said the tougher market-abuse rules are needed because current sanctioning powers for regulators are too weak and are not appropriate to deal with innovative trading activities.

Market Manipulation

Traders made about 13.3 billion euros ($18.2 billion) from market manipulation and insider dealing on EU equity markets in 2010, according to a commission study prepared in tandem with the proposals.

That figure “likely underestimates the true extent of market abuse as it only encompasses equity markets,” the commission study says.

Under the proposals, regulators would get the power to set maximum fines for financial-services companies of at least 10 percent of their annual sales. Individual traders would face fines of at least 5 million euros for the worst infractions.

Traders found guilty of “intentionally” engaging in insider dealing and market manipulation should face criminal sanctions that are, “effective, proportionate and dissuasive,” according to the draft rules.

Under the EU plans, which would need approval from governments and members of the European Parliament, unsuccessful attempts to manipulate markets should also be punished.

Financial Turmoil

Jacques de Larosiere, the former head of the International Monetary Fund and the Bank of France, called on the EU to bolster its sanctions in a 2009 report on the roots of the financial turmoil that followed the collapse of Lehman Brothers Holdings Inc.

Some EU states already use criminal sanctions to uphold financial services laws. In the U.K., insider trading carries a maximum sentence of seven years in prison.

The rules, which would amend an existing EU law against market abuse from 2003, would also bolster measures against insider trading on commodities derivatives.

“Under the current market abuse framework investors in commodity derivatives may be less protected than investors in derivatives of financial markets,” the document says. To avoid this, insider information rules for commodity derivatives should also include “price sensitive” data on primary markets, the document says.

Punish Traders

Regulators should also be required to punish traders who make transactions on primary commodity markets to influence the value of related derivatives, and vice versa, the document says.

The use of derivatives to manipulate the price of foodstuffs and other raw materials is of “notable concern,” the commission’s impact study says, as it is currently not prohibited in the EU, and can lead to “distorted” prices that harm the real economy.

The commission is also seeking to improve protection of people who come forward to reveal market abuse at financial firms.

“Whistle blowing can be a useful source of primary information and may alert competent authorities to cases of suspected market abuse,” the EU draft says. There should be “the possibility of financial incentives for persons who provide competent authorities that leads to a monetary sanction.”

Chantal Hughes, a spokeswoman for the commission, declined to comment on the content of the draft proposals.

--Editors: Peter Chapman, Christopher Scinta

To contact the reporters on this story: Jim Brunsden in Brussels at

To contact the editor responsible for this story: Anthony Aarons at

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