By Luke Jeffs and William Hutchings
   Of FINANCIAL NEWS

U.K. market regulator the Financial Services Authority is examining the impact a new breed of high-frequency trading firm is having on the U.K. equity market.

The regulator has in the past month approached as many as 10 asset managers to discuss the effect of these high-frequency companies’ strategies on the U.K .market, to establish whether intervention is needed, according to three sources close to the watchdog.

The FSA plans to speak over the next few weeks to investment banks about the rise in Europe of these specialist trading firms.

High-frequency traders, typically hedge funds or proprietary trading boutiques, use sophisticated systems and algorithms to generate huge volumes of trades that exploit instantaneously tiny price discrepancies between markets.

The FSA probe emerged a week after U.S. Senator Charles Schumer, a Democrat From New York, wrote to the Securities and Exchange Commission demanding the U.S. regulator ban “flash-trading”, a practice he claimed gave high-frequency traders an advantage over “retail and institutional investors”.

Financial regulators have become increasingly concerned about the techniques used by these firms as their activities have expanded rapidly in the past two years. High-frequency traders will this year account for about three quarters of all U.S. equity flow compared with 30% in 2005, according to research by consultancy Tabb Group. Their share in Europe has not been quantified but traders and exchanges estimate they generate about a half of orders in European markets such as the U.K., France and the Netherlands.

The FSA has begun talks to collect information on the complex techniques used by firms to enable the regulator to decide whether further action is required.

A spokeswoman for the FSA declined to comment on the initiative but said: “The FSA is working with its counterpart regulators to monitor these developments, and to respond as appropriate. We recognize that equity markets are continuing to evolve rapidly, partly because of technological developments, and partly in response to legislative and regulatory changes such as Mifid the European Commission directive that took effect in November 2007].”

City of London traders last week voiced concerns that their trading strategies were increasingly being “picked off” by predatory algorithms, complex computer programs used by some high-frequency firms to analyze trading patterns, spot rivals’ plans and trade against them.

The traders agree the algorithms are not illegal but insist they are detrimental to the market because they fuel volatility and exaggerate share price movements.

But Peter Green, chief executive of high-frequency trading firm Kyte Group, said he would be “surprised if there were a strong regulatory reaction”. He said: “It is difficult to see the FSA making fundamental changes to the rules just because some firms have a technological advantage.”

Xavier Rolet, chief executive of the London Stock Exchange, risks angering his high-frequency clients when he cancels on September 1 a tariff popular with these firms.

Rolet said last week: “In recent years, a new breed of customers has emerged promising they would provide substantial liquidity if the exchanges bought order flow. “We’ve revamped our fee structure after it became obvious the previous tariff was imbalanced in favour of a small minority of high-velocity trading customers at the expense of our largest clients.”

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