China and Clinton Agree: Traders Should Pay for Canceled Orders

Chinese securities regulators are preparing some of the world’s strictest regulations on a trading practice at the heart of the global debate over high-speed computerized markets.

The draft rules are designed to prevent traders from flooding exchanges with orders they don’t fill by charging market participants fees for habitual cancellations. The proposal, which could come into force next year, echoes a plan by U.S. presidential hopeful Hillary Clinton to discourage high-speed trading strategies that she says could destabilize markets.

As regulators around the world grapple with the most effective ways to police computer-driven markets, they have focused on how to stop traders from using bogus orders to unfairly move prices in their favor. Critics contend that the tactic makes markets less fair and enables some traders to engage in a manipulative practice known as spoofing. Opponents of the proposed taxes on canceled orders say they would harm legitimate market makers and raise costs for the average investor.


The China Securities Regulatory Commission says the rules will make exchanges safer. The CSRC stepped up its focus on destabilizing trading practices after a $5 trillion stock-market crash over the summer saddled millions of individual investors with losses. While critics say tighter regulation is designed to deflect blame for the selloff, policy makers also see weeding out manipulation as part of a long-term effort to professionalize the nation’s markets and lure more international investors, according to Oliver Rui, a professor of finance and accounting at China Europe International Business School in Shanghai.

“The new rules are trying to make the market more stable and they seem to be in the right direction,” said Gerry Alfonso, a Shanghai-based sales trader at Shenwan Hongyuan Group Co., China’s fifth-largest brokerage by market value. “The regulator is trying to give investors more confidence and to avoid market manipulation. These are all good developments.”

China’s proposals on algorithmic trading, revealed around the same time in October as Clinton’s, state that “frequently placing and withdrawing orders where the ratio of trades concluded is abnormally low” would be prohibited, according to a translation by law firm Linklaters LLP. Traders who cancel more than 40 percent of their submitted orders in any given day would be charged a fee of 2 yuan (31 cents) per transaction.

Broader Package

The plan is part of a broader package of automated trading rules for Chinese markets, first released for public discussion on Oct 9. China ended its consultation on Nov. 8 and the finalized rules are likely to be released early next year, according to John Xu, a Shanghai-based counsel at Linklaters. The measures would then go into effect 30 days later.

Other measures suggested by the CSRC include forcing traders who use automated orders to provide a detailed description of their strategies to regulators and wait for a review before they’re allowed to execute trades. That proposal has raised concern among some international investors who don’t want to disclose their proprietary trading algorithms, according to Calvin Tai, the head of global clearing at Hong Kong’s stock exchange.

Clinton, the front-runner to win the Democratic nomination for president, called for a fee on canceled orders in October and explicitly linked the idea to curbing high-frequency traders. Her plan is designed to target “harmful” high-frequency trading that makes markets “less stable and less fair,” Clinton’s campaign said at the time. 

For every 27 orders placed on U.S. stock exchanges, about one is filled, according to data from the U.S. Securities and Exchange Commission. In other words, approximately 96 percent of all orders sent to U.S. equity markets are canceled.

China wouldn’t be unique in trying to limit canceled trades. Traders using Frankfurt-based Deutsche Boerse AG’s stock market are restricted from submitting an excessive amount of orders that don’t get executed. Borsa Italiana has a high-usage surcharge to prevent orders from getting too far out of whack with the number of actual trades.

HFT Tools

Reining in cancel rates might unfairly punish firms using legitimate computer formulas to constantly update the prices at which they offer to buy or sell securities, according Bill Harts, chief executive officer at Modern Markets Initiative, a U.S.-based trade group for high-frequency firms. Traders who use automated strategies say they often cancel orders because the speed at which markets now move makes many quotes irrelevant almost immediately.

“Cancellation messages are the tools of our trade,” Harts said by e-mail. “Like the shopkeeper who cuts his price in response to the competitor across the street, they are what enable us to continuously narrow spreads, saving investors’ money. Therefore, a tax on cancellations is a tax on competition, and it would ultimately be paid by investors receiving worse prices.”

Yet canceled orders are also central to spoofing, a type of bait-and-switch scheme in which perpetrators submit fake bids to entice other traders and then withdraw the orders once prices move in the desired direction. In the most high-profile case to date, the U.S. Justice Department and the Commodity Futures Trading Commission in April accused London trader Navinder Sarao of spoofing that contributed to the May 2010 flash crash, which briefly wiped almost $1 trillion from the value of U.S. equities.

“For legitimate electronic trading, the algo rules shouldn’t hurt,” said Peter Lewis, the Hong Kong-based founder of Peter Lewis Consulting (China) Ltd., and a former head of trading at HSBC Holdings Plc and Societe Generale SA. “However, they will certainly cut down on abusive market practices such as spoofing.”