Germany's new High-Frequency Trading Act - Baker & McKenzie

Germany’s new High-Frequency Trading Act
Stock Corporation & Capital Markets, Germany
Newsletter
March 2013
Germany’s new High-Frequency Trading
Act
For further information, please
contact:
Frankfurt
Manuel Lorenz
Tel.: +49 (0) 69 29 908 253
E-Mail:
Manuel.Lorenz@bakermckenzie.com
The German legislator is concerned about the speed and complexity of highfrequency
trading (“HFT”) in securities as well as the inherent risks in such activity,
such as the overload of trading systems by larger numbers of orders, the
overreaction of trading algorithms to market events which leads to increased
volatility and abusive practices. To combat these risks the HFT Act was adopted by
the German Bundestag on February 28, 2013. It modifies the Stock Exchange Act,
the Banking Act and the Securities Trading Act. The HFT Act pre-empts proposed
legislation at the EU level as part of the current revision of MiFID (Markets in
Financial Instruments Directive) ,“MiFID II” and the Market Abuse Directive (MAR)
and closely follows the current state of the draft EU legislation. The HFT Act has
passed the second parliamentary chamber (Bundesrat) on March 22, 2013 and is
expected to enter into force soon.
This Client Alert provides an overview on the key elements of the proposed HFT
Act.
Key elements of the proposed legislation
1. Licensing requirement
Berlin
Friedrichstrasse 88 / Unter den Linden
10117 Berlin
Tel.: +49 (0) 30 2 20 02 81 0
Fax: +49 (0) 30 2 20 02 81 199
Duesseldorf
Neuer Zollhof 2
40221 Duesseldorf
Tel.: +49 (0) 211 3 11 16 0
Fax: +49 (0) 211 3 11 16 199
Frankfurt / Main
Bethmannstrasse 50-54
60311 Frankfurt/Main
Tel.: +49 (0) 69 2 99 08 0
Fax: +49 (0) 69 2 99 08 108
Munich
Theatinerstrasse 23
80333 Munich
Tel.: +49 (0) 89 5 52 38 0
Fax: +49 (0) 89 5 52 38 199
www.bakermckenzie.com
HFT is defined in the HFT-Act, as follows:
“Sale or purchase of financial instruments for own account as direct or
indirect participant in a domestic organized market or multilateral trading
facility by means of a high-frequency algorithmic trading technique which is
characterized by (i) the usage of infrastructures to minimize latency times,
(ii) the decision of the system regarding the commencement, creation,
transmission or execution of an order without human intervention for single
transactions or orders and (iii) a high intraday messaging volume in the
form of orders, quotes or cancellations.”
This definition is deliberately very close to the definition of HFT in the most recent
compromise proposal of the EU Council of MiFID II.
Under the HFT-Act, High-Frequency Trading will become a licensable investment
service even if not rendered as a service to others. As a consequence any HF
trader who executes trades on German securities markets needs to apply for a
BaFin license or needs to passport an existing license granted by another member
state of the EEA. Even “indirect” trading is covered by the licensing requirement,
i.e. the HF-trader himself must not be a trading member of the relevant securities

Germany’s new High-Frequency Trading Act
market – it will be sufficient that some trading member trades on the HF trader’s
behalf. This creates significant hurdles for non-German firms, as no license can be
granted to applicants who do not have their administrative headquarter in Germany
unless they open at least a branch office. It will be little consolation that the license
requirement for foreign HF traders applies with a grace period of nine months from
the date the act enters into force, taking into account that such parties need to
establish a branch office in Germany.
Any company licensed as a HF-trader will need a minimum capital of € 730,000
and will be subject to MiFID obligations for investment firms.
2. Stock Exchange Rules and MTF Rules
The stock exchange and securities trading rules are not limited to HF traders but
cover all forms of algorithmic trading, including HFT.
Algorithmic trading is defined in sec. 33 para 1a sentence 1 Securities Trading Act,
as amended, as
“trading with financial instruments such that a computer algorithm
determines automatically the individual order parameters without being
merely a system for the transmission of orders to one or several trading
venues or to confirm orders. Order parameters within the meaning of the
preceding sentence are decisions whether the order is given, the timing,
price and quantity of an order or how the order will be executed with limited
or no human interference.”
Under the HFT-Act, German stock exchanges will be granted an information right
vis-à-vis algorithmic traders regarding their trading, the systems used for trading, a
description of their algorithmic trading strategies and details as to trading
parameters and trading limits for the system. Moreover they may stop the use of an
algorithmic trading strategy if this is necessary to stop breaches of law or mischiefs
that impede an orderly trading. This can also be used by stock exchanges to take
“defective” and manipulative trading programs off the market.
Stock exchanges and MTF operators will also be obliged to include an obligation
for trading members to earmark orders from algorithmic trading and the algorithm
used for the respective trade in their rules. In addition they must use a fee model
that charges for excessive use of their systems (that is already done by the
Frankfurt Stock Exchange) Besides that they must also have “circuit breakers” to
ensure orderly trading in case of increased volatility.
In the future, market participants must keep an adequate ratio between orders and
transactions. The proportion is deemed adequate if based on liquidity and the
concrete market situation or the function of the relevant market participant, it is
“economically plausible”. However, stock exchanges shall make more detailed
rules to define an adequate “order/transaction ratio”.
Stock exchanges, MTF operators and systematic order internalizers are also
required to determine a minimum tick size to avoid negative impact on market
integrity and market liquidity.
2

Germany’s new High-Frequency Trading Act
3. Securities Trading Rules
The German regulator BaFin is given similar information rights as the stock
exchanges.
Any investment firm licensed in Germany using algorithmic trading must observe
additional obligations, namely they must ensure that
trading systems are robust and have sufficient capacities, adequate
thresholds for trading and maximum trading limits;
the transfer of erroneous orders as well as the functioning of a system in a
way that disrupts the market (or contributes to market disruption) is
avoided;
the trading systems cannot be used to breach European and national law
provisions on market abuse or the trading regulations at the market venues
connected to the systems
Given that HF traders are subject to a license requirement in Germany, it is clear
that not only German securities firms are covered by such requirements, but also
non-German HF traders. On the other hand, non-German algorithmic traders (who
are not HF traders) will not be subject to such additional obligations.
The definition of market manipulation was enhanced to also include transmission of
orders via algorithmic trading that are not for the purpose of trading but to
disrupt or delay the functioning of the trading system or are suitable to do
so;
hinder the determination of “real” purchase or sell orders in the trading
system or are suitable to do so;
or create an incorrect impression of the offer or demand regarding a
financial instrument or are suitable to do so.
This prohibition also covers trading not only instruments traded on regulated
markets but also instruments traded solely on exchange regulated markets, i.e. the
so called open market (Freiverkehr) segments. While the Freiverkehr is not only a
stock exchange segment, but also an MTF, instruments traded only on other MTFs
which are not operated by stock exchanges are not currently covered by the
prohibition.
The market manipulation rules have only a clarifiying nature. Such techniques
should for the most part be covered already by existing rules. The key difficulty for
regulators is to discover such manipulations.
Conclusion
Again, the German legislator has tried to pre-empt coming EU-legislation. As usual,
since the final rules will be different from the current draft rules, Germany will most
likely have to amend its rules once MiFID II is implemented. Nonetheless,
Germany will be the “guinea pig” in Europe to test the efficiency of the proposed
rules.
It remains to be seen whether non-German HF traders will shun German stock
exchanges and MTFs and move elsewhere, thus depriving German stock
exchange and MTF operators of valuable transaction fee income. On the other
3

Germany’s new High-Frequency Trading Act
hand, if MiFID II is adopted, all of Europe will have a license requirement for HF
traders and firms who have obtained a license in Germany may have a competitive
“first mover” advantage.
Also, time will tell whether the definition of HF trading is sufficiently clear to
distinguish HF trading from “normal” algorithmic trading.
At least, the legislative proposal introduced by the Social Democrat Party to require
a minimum waiting period of 500 milliseconds before an order can be withdrawn
was not adopted in light of the currently uncertain situation at the European level
regarding a similar rule in MiFID II as there is dispute whether such a rule could not
have adverse effects on bid/ask spreads.
This client newsletter is prepared for information purposes only. The information contained therein should not be relied
on as legal advice and should, therefore, not be regarded as a substitute for detailed legal advice in the individual
case. The advice of a qualified lawyer should always be sought in such cases. In the publishing of this Newsletter, we
do not accept any liability in individual cases.
Baker & McKenzie - Partnerschaft von Rechtsanwälten, Wirtschaftsprüfern, Steuerberatern und Solicitors is a
professional partnership under German law with its registered offices in Frankfurt/Main, registered with the Local Court
of Frankfurt/Main at PR No. 1602. It is associated with Baker & McKenzie International, a Verein organized under the
laws of Switzerland. Members of Baker & McKenzie International are Baker & McKenzie law firms around the world. In
common with terminology used in professional service organizations, reference to a "partner" means a professional
who is a partner, or equivalent, in such a law firm. Similarly, reference to an "office" means an office of any such law
firm.
4