Global Policy Forum

Financial Crisis 2: Rise of the Machines

This report by the Robin Hood Tax campaign warns of the rapid increases in “high frequency trading” (HFT) and promotes a tax-based remedy. HFTs are computer-driven trades that use algorithms to buy and sell large amounts of financial products that meet specific criteria, and do so at lightning speeds. Apart from the already worrisome volatility and price-increases that HFTs create, different algorithms can collide and create a “flash crash” that has the potential to ignite a financial crisis. The application of a small tax could not only reduce the incentive to partake in this form of trading, but also raise funds for sustainable development and the reduction of poverty. 

August 22, 2011

An explosion of high speed, high frequency trading carried out by computers is causing an increasing number of ‘flash crashes’ and undermining markets’ role in efficiently allocating resources, according to a report published today.

Financial Crisis 2: The Rise of the Machines warns that a “technological arms race” has left regulators floundering, unable to step in to prevent problems because of the speed at which transactions are occurring. Unheard of six years ago, experts estimate that high frequency trading conducted by computers according to complex algorithms may now account for more than three-quarters (77 per cent) of all equity deals in the UK.

The report, by the Robin Hood Tax campaign, says Western governments should follow the lead of Hong Kong and impose a Financial Transaction Tax to limit high frequency trading.

Richard Gower, Robin Hood Tax campaign spokesman, said: “This is casino capitalism cyborg-style. In pursuit of a quick buck, humans are ceding control of financial markets to machines and are unable to intervene fast enough if things go wrong.

“A Financial Transaction Tax would ‘throw sand in the wheels’ of markets and could raise billions to tackle poverty in the UK and in poor countries which were hit hard by the financial crisis.”

Andrew Haldane, the Bank of England’s Executive Director for Financial Stability has said that “Grit in the wheels like grit on the roads could help forestall the next crash.” Martin Wheatley, chief executive designate of the Financial Conduct Authority (FCA), one of the successor bodies to the Financial Services Authority, also supports a Financial Transaction Tax as a way of curbing high frequency trading.

The UK already has a 0.5 per cent stamp duty on share transactions which raises about £4 billion-a-year. But high frequency traders can avoid this by trading in derivatives known as “contracts-for-difference”. Extending the stamp duty to “contracts for difference” would be likely to raise upwards of £3bn.

An IMF working paper published earlier this year suggested extending the stamp duty to cover contracts-for-difference. Charles Li, Chief Exectutive of Hong Kong’s stock exchange says its FTT, “effectively limits high frequency trading, just like a highway with many toll booths discourages speeding.”

The most dramatic flash crash occurred on 6 May 2010, when the Dow Jones fell by 9 per cent, with more than half of the fall occurring in just seven minutes. Shares in Accenture plunged from $40 per share to just $0.01. The Dow Jones fall was more than twice that on the day that Lehman Brothers collapsed.

The search for a quick profit has seen high frequency trading spread to bond, currency and commodity markets. On 3 February 2010 traders Infinitum switched on a new oil markets HFT algorithm for just five seconds. In that time they lost more than $1 million and rocked the global oil price which spiked before losing 5 per cent of its value.”

Gower said: “High frequency trading has the potential to cause havoc in markets for commodities which are central to our economies and the lives and well-being of hundreds of millions of people.

“Markets should work in the interests of society – not the other way around. A Robin Hood Tax would be a big step towards a world in which finance behaves responsibly and pays its fair share.”

To read the report, please click here.


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