High Frequency Trading

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Markets Committee

High-frequency trading in the foreign exchange market
Report submitted by a Study Group established by the Markets Committee This Study Group was chaired by Guy Debelle of the Reserve Bank of Australia September 2011

Copies of publications are available from: Bank for International Settlements Communications CH-4002 Basel, Switzerland E-mail: publications@bis.org Fax: +41 61 280 9100 and +41 61 280 8100 This publication is available on the BIS website (www.bis.org).

© Bank for International Settlements 2011. All rights reserved. Brief excerpts may be reproduced or translated provided the source is cited.

ISBN 92-9131-885-X (print) ISBN 92-9197-885-X (online)

Preface
In March 2011, the Markets Committee established a Study Group to conduct a fact-finding study on high-frequency trading (HFT) in the foreign exchange (FX) market, with a view to identifying areas that may warrant further investigation by the central banking community. This initiative followed from a number of previous discussions by the Committee about factors contributing to changes in the structure of the global FX market. The Study Group was chaired by Guy Debelle, Assistant Governor of the Reserve Bank of Australia. The Group drafted an interim report for review by the Committee in May 2011. The finalised report was presented to central bank Governors at the Global Economy Meeting in early September 2011, where it received endorsement for publication. The subject matter of this report is clearly part of the core expertise of the Markets Committee, which has a long-standing interest in the structure and functioning of the FX market. I hope this report will serve as a timely input to the ongoing discussion about the impact of technological changes, including the rise of algorithmic trading in general and HFT in particular, on the functioning and integrity of financial markets. The FX market focus of this report should also be a valuable complement to a discussion that has so far been based mostly on developments in equity markets. Hiroshi Nakaso Chairman, Markets Committee Assistant Governor, Bank of Japan

High-frequency trading in the foreign exchange market

iii

Contents

Preface .................................................................................................................................. iii Executive summary ............................................................................................................... 1 1. What is high-frequency trading in foreign exchange? .................................................... 3 1.1 1.2 1.3 1.4 HFT is a subset of automated trading .................................................................. 3 Strategies and business models .......................................................................... 5 Participants and trading venues in FX ................................................................. 6 Relationship with other market participants .......................................................... 7 1.4.1 FX prime brokerage relationships ............................................................... 7 1.4.2 Relationship with traditional liquidity providers ............................................ 8 1.5 2. 2.1 2.2 3. 3.1 3.2 4. 5. Estimated scale of activity.................................................................................. 10 Views of market participants .............................................................................. 12 Findings in the empirical literature ..................................................................... 13 FX market on the day of the “flash crash” .......................................................... 15 JPY move on 17 March 2011 ............................................................................. 17 Effect of HFT on price discovery and liquidity in FX .................................................... 12

Behaviour of HFT in FX in times of stress...
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