Financial Services Quarterly Report - Second Quarter 2013: The New German Rules on High Frequency Trading

by Dechert LLP

The German Federal Parliament adopted a bill on February 28, 2013, setting forth detailed rules and provisions dealing with so-called “high frequency trading” (the “HFT Rules”). Rather than being enacted on a stand-alone basis, the HFT Rules will be integrated into, and amend, existing statutes, such as the German Securities Trading Act (Wertpapierhandelsgesetz – “WpHG”), the German Banking Act (Kreditwesengesetz – “KWG”), and the German Stock Exchange Act (Börsengesetz – “BörsG”) and will supplement existing provisions regulating (i) trading with financial instruments (WpHG), (ii) the operation and functioning of stock exchanges and other trading venues (BörsG and WpHG), and (iii) the provision of services related to the trading in financial instruments (KWG and WpHG). The HFT Rules came into force on May 14, 2013.

Newly Introduced Obligations and Requirements

Licensing and Capital Requirements

Prior to the HFT Rules coming into force, an entity engaged in trading with financial instruments in Germany was required to obtain a license from the German Federal Financial Supervisory Authority (Bundesanstalt für Finanzdienstleistungsaufsicht – “BaFin”) only if it either (i) provided financial services (Finanzdienstleistungen) to third parties or (ii) conducted other types of banking business (Bankgeschäfte) as defined in the KWG. The effect of this was that trading with financial instruments on one’s own account did not trigger any licensing or registration obligations unless the activity was carried on for the purpose of acting as a market maker, which is considered to be the provision of a financial service.

The HFT Rules change this – dealing on one’s own account is now considered a financial service (and thus triggers licensing requirements, subject to the transitional period described below) if it is done using so-called “high frequency algorithmic trading techniques”, which are characterized by (i) the exploitation of infrastructures intended to minimize latency, (ii) a system automatically “deciding” whether orders are submitted, generated, transmitted or executed without the necessity of human intervention for individual trades or orders, and (iii) a high intraday number of orders, quotes or cancellations.

Once the transitional period expires, therefore, entities purchasing or selling financial instruments on their own account on a German stock exchange or multilateral trading facility by means of a high frequency algorithmic trading technique will be required to hold a license that covers “dealing on own account” within the meaning of Section A (3) of Annex I to the Directive 2004/39/EC on markets in financial instruments (“MiFID”) and will need to comply with stringent substantive requirements, such as (i) a minimum initial funds condition (which requires own funds of at least €730,000 if the entity applies for the license from BaFin, or the amount required under relevant home Member State law for an entity applying to another EEA regulator but making use of the passport regime), (ii) the requirement that the persons who effectively direct the entity’s business are of sufficiently good repute and sufficiently experienced so as to ensure the sound and prudent management, and (iii) the requirement that shareholders with qualifying holdings do not compromise the entity’s sound and prudent management.

It is worth noting that the licensing requirement is not limited to members of a German stock exchange (or multilateral trading facility). Entities that are granted direct electronic access to the stock exchange by a member of such stock exchange – for example, via order routing systems – will also be obliged to obtain a license if they employ high frequency algorithmic trading techniques. This applies in particular to customers of stock exchange members that are permitted by that member directly to enter orders into a stock exchange’s trade matching system for execution.

Because the requirement to obtain a special license is only triggered if the relevant entity trades on its own account, there is no need, for example, for an authorized provider of financial services or an authorized credit institution that makes use of high frequency algorithmic trading techniques merely for the purpose of providing financial services to third parties (e.g., brokerage services or portfolio management) to obtain an additional license covering “dealing on own account”.

The HFT Rules provide for a transitional period of six months for EEA entities, which ends on November 14, 2013, by which time entities must either have submitted an application to BaFin or have initiated the passporting process and must comply with the organizational requirements described below. BaFin has confirmed that it will not, during the transitional period, impose any sanctions or undertake any enforcement actions. Entities domiciled outside the EEA have an extended transitional period of nine months.

Organizational Requirements

The HFT Rules impose additional organizational requirements on the following types of undertakings if they engage in algorithmic trading (as defined below):

  • providers of securities services that are required to be licensed (Wertpapierdienstleistungsunternehmen – broadly, similar in concept to an “investment firm” as defined in Art. 4 para. 1 no. 1 of MiFID);
  • management companies of Undertakings for Collective Investment in Transferable Securities (“UCITS”) and of Alternative Investment Funds (“AIFs”).

The key organizational requirements are that systems must be in place to ensure that: (i) trading systems are resilient, have sufficient capacity and are subject to appropriate trading thresholds and limits, (ii) no erroneous orders are transmitted, (iii) the system does not create or contribute to the creation of a disorderly market, and (iv) the trading systems cannot be used for a purpose that would infringe on market abuse rules or provisions of stock exchange rules and regulations.

In addition, such firms are required to (i) have in place arrangements that enable them to effectively deal with unforeseen failures of the trading system, (ii) fully review and properly monitor their systems, and (iii) document every modification of the computer algorithms employed by them.

Obligations to Provide Information

In addition to the organizational requirements outlined above, the HFT Rules introduce a new reporting regime that requires certain information to be provided to competent authorities on a regular basis. This regime came into force on May 14 of this year.

Providers of securities services that are engaged in algorithmic trading (defined in the HFT Rules as trading in financial instruments using a computer algorithm that automatically – i.e., without the need for human intervention – determines certain specific parameters of each single order, such as the decision whether an order is placed, the timing of the order, and the price or quantity of the order) are required, upon request from the competent authorities, to provide information on the algorithmic trading strategies used, the systems utilized and details regarding specific parameters and thresholds employed by those systems. Competent authorities can also require information for the purpose of enabling them to determine whether the organizational requirements mentioned above are being complied with.

It is unclear whether a provider of securities services that is a member of a German stock exchange – or an entity that is being granted direct electronic access by such a member – can also be required by the competent authorities to provide the aforementioned information at any time without reason, or whether each request has to be justified.

By contrast, if the relevant provider of securities services is not a member of a German stock exchange, the HFT Rules explicitly state that competent authorities are only empowered to request information provided that they are able to demonstrate (which may need to be substantiated if challenged in court) that the requested information is necessary for ongoing compliance monitoring reasons.

It is therefore conceivable that members of a German stock exchange may be subject to a stricter regime as regards disclosure than the regime as it applies to non-members. In practice, however, it may be expected that both regimes will be applied by competent authorities without significant deviations.

Order-to-Trade Ratio

The HFT Rules provide for an obligation to uphold an appropriate ratio between (i) the orders entered, modified or cancelled, and (ii) the trades that are actually executed (the so-called “appropriate order-to-trade ratio”). This obligation also came into force on May 14 of this year.

These obligations only apply to members of a German stock exchange or members of a multilateral trading facility supervised by the BaFin. As long as an entity merely engages financial intermediaries (i.e., brokers) to trade with financial instruments on the aforementioned trading venues, it will not be subject to this obligation.

The HFT Rules generally deem an order-to-trade ratio to be appropriate if it can be deemed to be economically reasonable taking into account the overall trading volume of the relevant financial instrument, the specific market situation and the function of the trading participant concerned.

More detailed guidelines as to the appropriateness of the order-to-trade ratio may be issued with respect to multilateral trading facilities by the German Federal Ministry of Finance (Bundesfinanzministerium) in due course.

Moreover, the stock exchanges (and the operators of multilateral trading facilities) are required by law to stipulate more detailed provisions in their exchange (multilateral trading facility) rules and regulations. So far, there do not appear to have been any proposed amendments to existing exchange rules and regulations which are designed to implement this requirement.

A violation of the obligation to uphold an appropriate order-to-trade ratio could, among other things, result in the suspension or the withdrawal of the membership of the relevant stock exchange.

Algorithmic Trading and Market Manipulation

Section 20a of the WpHG prohibits certain trading practices that entail so-called “market manipulation” and makes it unlawful to initiate transactions or issue purchase or sell orders that have the potential to generate false or misleading signals affecting supply, demand, the stock exchange or market price of financial instruments, or that create an artificial price level. Further details on this ban on market manipulation are set forth in the Regulation to Further Define the Prohibition against Market Manipulation (Marktmanipulations-Konkretisierungsverordnung – “MaKonV”).

The HFT Rules will amend the MaKonV explicitly to state that certain trading practices executed using computer algorithms are to be viewed as market manipulation – for instance, purchase or sell orders may be deemed a false or misleading signal if they are generated by means of a computer algorithm that automatically places, modifies or cancels orders and:

  • causes, or may potentially cause, the disruption of, or delays in, the functioning of the trading system;
  • makes, or may potentially make, it difficult for third parties to identify genuine purchase or sell orders in the trading system; or
  • creates, or may potentially create, a false or misleading impression about the supply of, or the demand for, a financial instrument.

Other Requirements

In addition to the above, the HFT Rules require stock exchanges (and operators of multilateral trading facilities) to charge separate fees for excessive use of their trading systems, in particular as a result of entering, changing or cancelling a high number of orders.

Exchanges (and operators of multilateral trading facilities) are granted considerable leeway in structuring these separate fees, but they must be set at a level that effectively prevents excessive use of the trading systems and the resulting negative impact on system stability.

Apart from these extra fees, the HFT Rules do not impose additional monetary charges (for example, taxes) that are directly attributable to high frequency trading.

Summary and Outlook

Germany is not the only country embarking on the difficult task of regulating high frequency trading.  At the European Union level, for example, the European Commission will likely revise MiFID to introduce themes contained in the HFT Rules. The German HFT Rules, however, go beyond these likely revisions in material aspects by significantly modifying the current German regulatory regime governing the trading with financial instruments and the operation and functioning of stock exchanges and other trading venues (i.e., multilateral trading facilities). The ramifications go beyond those entities directly involved in the trading of financial instruments (e.g., operators and members of stock exchanges and providers of securities services) and also affect persons who indirectly participate in the trading of financial instruments, such as entities that are being granted direct electronic access to trading venues and that deal merely on their own account.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

© Dechert LLP | Attorney Advertising

Written by:

Dechert LLP

Dechert LLP on:

Readers' Choice 2017
Reporters on Deadline

"My best business intelligence, in one easy email…"

Your first step to building a free, personalized, morning email brief covering pertinent authors and topics on JD Supra:
Sign up using*

Already signed up? Log in here

*By using the service, you signify your acceptance of JD Supra's Privacy Policy.
Custom Email Digest
Privacy Policy (Updated: October 8, 2015):

JD Supra provides users with access to its legal industry publishing services (the "Service") through its website (the "Website") as well as through other sources. Our policies with regard to data collection and use of personal information of users of the Service, regardless of the manner in which users access the Service, and visitors to the Website are set forth in this statement ("Policy"). By using the Service, you signify your acceptance of this Policy.

Information Collection and Use by JD Supra

JD Supra collects users' names, companies, titles, e-mail address and industry. JD Supra also tracks the pages that users visit, logs IP addresses and aggregates non-personally identifiable user data and browser type. This data is gathered using cookies and other technologies.

The information and data collected is used to authenticate users and to send notifications relating to the Service, including email alerts to which users have subscribed; to manage the Service and Website, to improve the Service and to customize the user's experience. This information is also provided to the authors of the content to give them insight into their readership and help them to improve their content, so that it is most useful for our users.

JD Supra does not sell, rent or otherwise provide your details to third parties, other than to the authors of the content on JD Supra.

If you prefer not to enable cookies, you may change your browser settings to disable cookies; however, please note that rejecting cookies while visiting the Website may result in certain parts of the Website not operating correctly or as efficiently as if cookies were allowed.

Email Choice/Opt-out

Users who opt in to receive emails may choose to no longer receive e-mail updates and newsletters by selecting the "opt-out of future email" option in the email they receive from JD Supra or in their JD Supra account management screen.


JD Supra takes reasonable precautions to insure that user information is kept private. We restrict access to user information to those individuals who reasonably need access to perform their job functions, such as our third party email service, customer service personnel and technical staff. However, please note that no method of transmitting or storing data is completely secure and we cannot guarantee the security of user information. Unauthorized entry or use, hardware or software failure, and other factors may compromise the security of user information at any time.

If you have reason to believe that your interaction with us is no longer secure, you must immediately notify us of the problem by contacting us at In the unlikely event that we believe that the security of your user information in our possession or control may have been compromised, we may seek to notify you of that development and, if so, will endeavor to do so as promptly as practicable under the circumstances.

Sharing and Disclosure of Information JD Supra Collects

Except as otherwise described in this privacy statement, JD Supra will not disclose personal information to any third party unless we believe that disclosure is necessary to: (1) comply with applicable laws; (2) respond to governmental inquiries or requests; (3) comply with valid legal process; (4) protect the rights, privacy, safety or property of JD Supra, users of the Service, Website visitors or the public; (5) permit us to pursue available remedies or limit the damages that we may sustain; and (6) enforce our Terms & Conditions of Use.

In the event there is a change in the corporate structure of JD Supra such as, but not limited to, merger, consolidation, sale, liquidation or transfer of substantial assets, JD Supra may, in its sole discretion, transfer, sell or assign information collected on and through the Service to one or more affiliated or unaffiliated third parties.

Links to Other Websites

This Website and the Service may contain links to other websites. The operator of such other websites may collect information about you, including through cookies or other technologies. If you are using the Service through the Website and link to another site, you will leave the Website and this Policy will not apply to your use of and activity on those other sites. We encourage you to read the legal notices posted on those sites, including their privacy policies. We shall have no responsibility or liability for your visitation to, and the data collection and use practices of, such other sites. This Policy applies solely to the information collected in connection with your use of this Website and does not apply to any practices conducted offline or in connection with any other websites.

Changes in Our Privacy Policy

We reserve the right to change this Policy at any time. Please refer to the date at the top of this page to determine when this Policy was last revised. Any changes to our privacy policy will become effective upon posting of the revised policy on the Website. By continuing to use the Service or Website following such changes, you will be deemed to have agreed to such changes. If you do not agree with the terms of this Policy, as it may be amended from time to time, in whole or part, please do not continue using the Service or the Website.

Contacting JD Supra

If you have any questions about this privacy statement, the practices of this site, your dealings with this Web site, or if you would like to change any of the information you have provided to us, please contact us at:

- hide
*With LinkedIn, you don't need to create a separate login to manage your free JD Supra account, and we can make suggestions based on your needs and interests. We will not post anything on LinkedIn in your name. Or, sign up using your email address.