Taming HFT in the Multi-Dealer FX Market

Abstract

It is argued that liquidity risk caused by high-frequency trading in the institutional FX market is a more important factor than volatility risk. For mitigating the former, it is suggested that multi-dealer FX platforms introduce the market maker status (MMS). Those traders that have MMS would be required to maintain orders on both sides of the market with the bid/offer spread that does not exceed say 50% of the historical average. Those traders that do not have MMS would be prohibited from having orders on both sides of the market simultaneously. Also, the traders without MMS that have had transaction on one side of the market would be permitted to submit an order on the opposite side of the market only after a noticeable delay. These constraints are intended to increase adverse selection risk for traders that employ market making strategies but do not have MMS.

Keywords: high-frequency trading, FX, multi-dealer platforms, market making

JEL Classification: D4, F31