The proposal from the UK’s Department for Business, Innovation and Skills Select Committee – considered in light of the Kay Review – has added fire to debate over the controversial trading practice that is increasingly being scrutinised by regulators around the globe, notably the US, and Germany, which recently introduced tough HFT rules.
Critics say HFT facilitates reckless trading algorithms, resulting in market crashes like the “flash crash” of May 2010. Then, on April 23, a hoax tweet about a terrorist attack on the US president caused brief panic in the market, which some argue was unnecessarily exacerbated when strategic sequential trading kicked in.
Defenders claim it increases liquidity and improves efficiency. HFT certainly increases liquidity, but the quality of the liquidity is a different matter.
The practice floods the markets with liquidity in good times but it can very quickly disappear in bad times, when it is really needed in a crash. One could therefore argue that HFT does not provide beneficial liquidity.
The report says the tax would be aimed at discouraging very short-term trading behaviour rather than bolstering the UK exchequer. Yet the report fails to conclude what exactly is wrong with the practice.
It cites conflicting pieces of academic and governmental research that only strengthens the HFT defence argument that there is no definitive proof of it being harmful.
If the government believes HFT imposes a systemic risk to the financial system and that it needs to be curtailed, then merely taxing the profits is not be enough. Taxing the trades would be a more effective way of squeezing the practice out of existence.
And yet, if it agrees that HFT increases liquidity, and the benefits to the markets outweigh the bad, then there is no justification for punitive taxation.
There are certainly doubts over whether a tax would even discourage short-term trading behaviour, at least among longonly managers.
Giving evidence to the committee, Dominic Rossi, Fidelity Worldwide’s chief investment officer (CIO), pointed out that stamp duty had not deterred such behaviour. Aberdeen Asset Management’s CIO Anne Richards said the most obvious way would be to prevent people buying and selling within a certain time period.
The committee has not suggested the government consider such alternative forms of taxation.
The UK government will now decide if it should take the committee’s advice to consider the “viability, benefits and risks” of imposing such a tax.
But surely before considering the form and scale of a tax, it should first decide whether or not it supports the practice, and make a decision that is intellectually consistent with that view.