US regulators are concerned that systems used by exchanges are not sophisticated enough to detect illegal practices in high speed trading.
Sources cited by the Wall Street Journal said that the Commodity Futures Trading Commission (CFTC) is investigating a number of unnamed trading firms for acting as both the buyer and seller of trades during high speed computer-driven transactions, known as 'wash trades'. Such trades, banned by US regulators, can be used to manipulate prices and can lead to market distortions, potentially resulting in large fines potential for companies found to be involved.
The CFTC investigation will also look at exchanges which are involved in processing the high frequency trades. Two exchanges involved in discussions are the CME Group, through which a large proportion of wash trades are thought to go through, and the IntercontinentalExchange.
It is said that regulators are concerned that the systems used by the exchanges are not sophisticated enough to detect wash trades conducted at high speeds.
A CME spokesperson has said it is in the process of updating its current systems, with the implementation of new technology later this year helping to prevent wash trades "at the trading-engine level".
One of the problems facing regulators is said to be proving that suspect trades are conducted intentionally, with the fast pace of high frequency trading meaning that buy and sell orders can be crossed accidentally. However the CFTC is said to be looking at data which shows that hundreds of thousands of potential wash trades occur on future exchanges each day, with such a high volume raising suspicion of illegal trading.
It is also said that it is difficult for examiners to detect whether trades originate from separate parts of a company, which would be allowed, or from the same trading strategy, creating further difficulties in monitoring high frequency trading.
According to the WSJ, CFTC Commissioner Bart Chilton will today call for a review of exchanges involved in algorithmic trading in order to gain a greater understanding of the impact of banned trading such as wash trades.
In the past high frequency trading has also received criticism from authorities in the UK. Benefits, such as increased liquidity, are being questioned by financial organisations involved in the Kay review. Critics also cited problems with high freqency trading problems such as the 'flash crash' in US markets in 2010.