ALGO-TRADING GIANLUIGI GUGLIOTTA

1. ALGO-TRADING GIANLUIGI GUGLIOTTA Poland, 9 March 2012

2. DEFINITIONS • No common agreeddefinition in economicliterature: use of sofisticatedtecnologyto: • Defineordersparameters (timing, price, quantities, …); • Interpret market signals • Exploit (guess) the functioning of algorithmsused by competitors • Quasi-market making • French FTT: Automated trading includes any trading system in which a computer algorithm determines automatically some parameters of the order (algorithms used to “optimize execution conditions” or to route orders towards platforms or used for order confirmation are expressly excluded from this definition) • ESMA Guilines: Trading algorithmmeans computer software operating on the basisof key parameters set byaninvestmentfirm or by a client ofaninvestmentfirmthatgeneratesorderstobesubmittedto trading platformsautomatically in responseto market information • MAR: algorithmic trading means trading of financial instruments using computer algorithms within the meaning [to be set forth by] MiFID2; • MiFID2: Algorithmic trading means trading in financial instruments where a computer algorithm automatically determines individual parameters of orders such as whether to initiate the order, the timing, price or quantity of the order or how to manage the order after its submission, with limited or no human intervention

3. BENEFITS • POTENTIAL RISKS • Narrowerspreads • Better price discovery • Increasedliquidity • Reduced short termvolatility • Betterexecutionoforders • Decreaseoftransactionsizes • Poorquality of liquidityprovided • Technologicalissues: • Overloading of trading system • Duplicative/erroneousorders • Overreacting to market events • Abusive behaviours • Disorderlymarkets

4. PROPOSAL FOR A REGULATION ON MARKET ABUSE • Strategieswhich are likely to consitute market abuse: • The sending of orders to a trading venue by means of algorithmic trading without an intention to trade but for the purpose of: • disrupting or delaying the functioning of the trading system of the trading venue; • making it more difficult for other persons to identify genuine orders on the trading system of the trading venue; or • creating a false or misleading impression about the supply of or demand for a financial instrument; • Quote stuffing: enteringlarge numbers of orders and/or cancellations/updates of orders so as to create uncertainty for other participants, slowing down their process and to camouflage their own strategy; • Layering and Spoofing: submitting multiple orders often away from the touch on one side of the order book with the intention of executing a trade on the other side of the order book (once that trade has taken place, the manipulative orders will be removed); • Momentum ignition: entry of orders or a series of orders intended to start or exacerbate a trend, and to encourage other participants to accelerate or extend the trend in order to create an opportunity to unwind/open a position at a favourable price.

5. MiFID2 / MiFIR INVESTMENT FIRMS TRADING VENUES • Technologicalstandards: • Resilienceand continuity • Trading thresholds/limits • Prevention of unlawfullconducts • Reportingrequirementsto CA: • Strategies and parameters • Details of keycontrols • Data stored on orders + TR • Market makingobligations: • Continuousoperation • Quotationof competitive prices • DEA surveillanceresponsibilities • Suitability • Respect of thresholds and rules • Risk management • Techologicalstandards: • Resilience and continuity • Thresholdslimits, trading halts and cancellation • Prevention of disorderly trading • Mere possibilityto • Limitorder to transaction ratio • Slow down order flow • Limit minimum ticksize • DEA surveillancersponsibilities • DEA limited to authorizedfirms • Suitability • Responsibility of memberfirms

6. MiFID2 EU COMMISSION RESPONSIBILITIES • Delegatedacts to armonise in furtherdetail • Organisationalrequirements on firmsperformingdifferentinvestmentservices of activities • Resiliencerequirements on trading venues • Trading halts • Ortedr to transaction ratio • Minimum ticksize • Controls on DEA • Co-location services and feestructure • Report on the impact of requirementsregardingautomated and HFT trading (2 yyafterenteringinto force of new provisions)

7. Borsa Italiana’sfee on desplayedorders (2-04-2012) • Scope:desplayed orders exceeding pre-defined order-to-trade ratios • 100:1 as to equitiestraded on the main market segment (MTA) • 40:1 as to equitiestraded on theiSMEs market (AIM) • Tax Rate: progressive: • From 1 to 5 times the ratio  0.01 euro • From >5 to =10 times the ratio  0.02 euro • As from >10  0.025 euro • Upper dailythreshold  1,000,00 euro per market segment (MTA / AIM) • Exemption: market making (specialist)

8. French FTT on HFT (1-08-2012) • Scope:orders cancelled or modified within 1 second (or shorter time limit to be specified by ministerial decree) by an HFT firms trading on own capital  and with operations in France where they exceed an order-to-trade ratio to be defined by ministerial decree; • Definition of automated trading: any trading system in which a computer algorithm determines automatically some parameters of the order (algorithms used to “optimize execution conditions” or used to route orders towards platforms or used for order confirmation are expressly excluded from this definition) • Tax Rate: 0,01% of the value of the cancelled or modified orders • Exemption: market making

9. PROPOSAL FOR AN FTT DIRECTIVE • Policy goals: … to create appropriate disincentives for transactionsthat do notenhance the efficiency of financialmarketstherebycomplementingregulatorymeasuresaimiedatavoiding future crises • Risk of delocalisation: • Coordinatedapproach … in line with the ambitions for G20 co-operation; • Broadlydefinedtax scope • State of residence (or establishment as for branches) of atleast on of the financialactorsinvolved in the transaction (independently from the place of trade of the financialinstrument) • Exemptions: • Primarymarkets (securities and currencies) • Central banks • Ring fencing of lending and borrowingactivities

10. ESMA GUIDELINES ON AUTOMATED TRADING (1-5-2012) To promote fair and orderly trading INVESTMENT FIRMS TRADING VENUES • Controls • Due diligence on non licencedfirms • IT compatibility • Pre and post trade controls • Trader access and knowledge • Preventativepolicing • Cancel, amend or correcttransactions • Excessivefloodingof the order book • Breachesofcapacitylimits • Capacity to constrain or halt trading • Obtaining information from members • Monitoring • Record keeping and cooperation • Block or cancelorders • That do notmeetspecificparameters • On instrumentsthattraderscannottrade • That compromise the firm’s risk management thresholds • Notconsistentwithapplicablerules • Procedurestooverrideautom. blocks • Informauthorities:on risks & incidents • Rekordkeeping • Training on order entry procedures • Controls: • Realtimemonitoringprocedures • Closescrutinybycompliance staff • Messagingtraffictoindividualplatforms • Manageoperationalrisk • IT compatibility

11. ESMA GUIDELINES ON AUTOMATED TRADING (1-5-2012) To prevent market abuse INVESTMENT FIRMS TRADING VENUES • Staffing (sufficient and knowledgeable) • Monitoringsystems on orders and transactions • Identification and reportingofsuspicioustransactions and orders • Periodicreviews and auditofprocedures and arrangements • Record keeping on alert management • Understanding, skill and authority ofcompliance staff • Training in market abusefortraders • Monitoringactivities • Identification and reportingofsuspicioustransactions and orders • Periodicreviews and auditofprocedures and arrangements • Record keeping on alert management