Germany’s High Frequency Trading Act – Consequences for foreign trading participants

Günther Neurohr

Fimas GmbH – Financial Market Solutions

With a diploma in business administration from the University of Giessen in Germany and the University of Huelva in Spain, Günther Neurohr has been a consultant and business analyst at Fimas. He has participated in several projects and was involved in implementing requirements concerning the EMIR regulation for a big national bank. Currently Günther is involved in analyzing processes, risks and controls within a big international Custody Bank.

The German government has been working on a High Frequency Trading (HFT) Act since July 2012. The law came into force on 15th May 2013, with an implementation period of six to nine months.

As one of the first jurisdictions to introduce legislation designed to control high-speed trading, Germany’s rules are being closely watched by the wider financial industry. In many ways, the rules mirror proposals planned for inclusion in a revised version of the EU’s trading rulebook; the Markets in Financial Instruments Directive, MiFID II, which is set to come into force no earlier than 2015.

The legislation applies to almost all market participants in electronic trading of financial products and introduces requirements intended to mitigate the potential risks arising from algorithmic or high-frequency trading techniques, which are defined as “…system determination of order initiation, generating routing or execution without human intervention for individual trades or orders” (MiFID II Draft).

Among other measures, under the HFT Act, exchanges will be required to determine a minimum tick size and an order-to-trade ratio that is appropriate for each specific instrument and that will be measured per trading participant and product over one month. Additionally, exchanges will be obliged to charge separate fees for excessive usage of exchange systems.

The final version of the rules omitted a minimum holding period for trades, which is seen as a way to slow the pace of computerized trading, but it has controversially maintained a licensing requirement. This means all HFT firms that trade directly or indirectly on German markets will need to be authorized by German regulator BaFin. This liability is considered as the most worrying part of the German rules and market participants can start questioning whether it is worth continuing to trade in Germany, particularly as the rules could be overtaken by MiFID II.

However, the German lawmakers added an exemption for foreign trading participants, from countries within the European Economic Area (EEA), intending to provide cross-border services into Germany or to establish a branch in Germany: Participants who own a license in their domestic location have the possibility of applying for a European passport and transfer their license into Germany. In such cases, the supervisory authority of the institution‘s home country needs to notify BaFin according to Art.31 and Art.32 MiFID.

Firms are granted a period of six months (ending November 2014) for complying with the new law. This transitional provision is also intended for EEA-participants which already hold an authorization for dealing on own account and intend to use the European passport.

No exemptions will be available for any non-EU firms. The rules will therefore be toughest for foreign firms that trade in Germany and do not have regulatory approval in any EU state. The options facing these firms are to obtain an EU license and passport it into Germany within the transitional period, or set up a German legal entity for approval by BaFin by February 14, 2014.