Japan Regulator Fires Warning Shot at HFT With Broker Questions

(Bloomberg) — Japans financial watchdog has started examining high-frequency trading, algorithms anddark pools, asking brokers for information about the practices.

The Securities and Exchange Surveillance Commission sent a questionnaire to brokerage firms this week, posing queries about the services they provide to HFT clients, including preferential treatment and products and differences in fees between HFT and non-HFT customers. The document, obtained by Bloomberg News, also seeks to establish whether high-speed clients have access todark poolsand under what conditions. Brokers have to reply by Feb. 12.

Japan doesnt have a real regulatory regime fordark pools, said Andrew Upward, head of market structure for Weeden & Co. in Greenwich, Connecticut. Japanese regulators are probably looking at the situation and saying, How can we make sure we have the tools to regulate the activity in these venues?

The regulator mentioned algorithmic trading in its annual administration report for the first time last year. The SESC has been criticized for doing little to police speed traders, which made up more than half of trading as recently as September.

HFT accounted for 53 percent of trades on the Tokyo Stock Exchange on Sept. 7, according to Deutsche Bank AG. Thats up from about 10 percent at the start of 2010, when the exchange switched to a faster trading system.

In the document, the SESC defines HFT firms as clients who place trading servers at or close to the exchange, who have fast direct electronic access to the market, use machines to place orders and who place orders rapidly.

The SESC is also asking brokers to provide sample order and trading data, and querying whether brokers check the integrity of orders before sending them. Brokers ability to trigger a kill switch for client trading in the case of an emergency is also under examination.

Japans move comes after the European Union sought to make electronic traders more accountable, while Australias watchdog said in October it would investigate futures trading after conducting a second, detailed review of HFT in its markets.

The operator of Canadas largest stock exchange last year adopted a speed bump to slow trading on one of its venues, while the U.S. in March proposed requiring HFT traders to register with regulators. China said late last year it planned to increase its oversight of algorithmic traders, including proposals for more disclosure and limits on remote control of trading machines from abroad.