Preserving capital markets efficiency in the high‐frequency trading era

Although HFT has become a main feature of financial markets internationally, its impact on equity markets’ functioning is still under discussion, since HFT can negatively affect market quality and stability. Regulatory measures recently adopted on both sides of the Atlantic to better control HFT-related risks chiefly focus on markets’ stability, orderly functioning, and integrity, but poorly consider how HFT interacts with the allocative function of price discovery. In order to fill this gap, this article focuses on how HFT-related informational inequalities among investors threaten equity markets’ (long-term) efficiency. Subscription to news wires and market data-feeds, along with co-location, grant HFTs early access to market-moving information that allows for latency arbitrage and trading ahead of other investors, which can discourage informed (slower) traders from undertaking costly fundamental analysis. Therefore, HFT challenges the theoretical framework underlying the Efficient Capital Markets Hypothesis, and can negatively affect price accuracy, real resource allocation and equity markets’ allocative efficiency. Against this backdrop, this article develops a conceptual framework for possible regulatory strategies aimed at limiting the negative effects of HFT on allocative market efficiency by reducing HFTs’ speed advantage or incentivizing fundamental informed traders to enter markets where they face costly pressures to compete with HFTs. Restricting the sale of trade data feeds or mandating speed bumps may discourage HFT and weaken its positive effects in terms of increased liquidity and better short-term price discovery, without definitely curbing HFT-related risks concerning price long-term accuracy, while replacing the current continuous trading regime with a batched auctions-based regime would ask for major regulatory changes. Introducing an EU-like continuous, event-driven, and timelier, disclosure regime could limit these possible drawbacks by providing informed traders with more frequent and cheaper access to relevant information.