Introduction

Description of different regulatory methods and the example of European competition law

Due to the very nature of algorithms that operate with numbers, the regulators must translate qualitative legal norms into quantified technical standards. A change of paradigm from a formalistic approach of the European financial regulation is necessary. The later approach primarily relies on a list of prohibited behaviors which content and conditions do not evolve simultaneously with and accurately describe the new techniques and behaviors of the regulated actors and therefore does not permit the authorities to regulate the actors efficiently.

Numerous approaches have been proposed to deal with this particular context and to take into account the new economic and legal theories. Among these we find, for example, the pragmatic and economic approach, which finds its source in the writings of American authors of the end of the 19th century and beginning of the 20th century. The principles-based approach, on the other hand, is a general move away from detailed prescriptive rules to rules or principles stated in general terms to set the standards by which regulated firms should operate. These approaches have proved to be fairly efficient in competition law. However, some undesired behaviors were still hard to prosecute at the end of the 20th century. For this reason, European competition law changed its paradigm and privileged an effects-based approach over the more formalistic principles-based approach, which had over the years included lessons from the pragmatic and economic schools.. This change, implemented and enforced by the European institutions, has answered many criticisms and proved its effectiveness.

Effects-based approach as a solution for the European regulation of algorithmic and high frequency trading

Given the success of the effects-based approach in competition law, we propose to analyze and suggest it as a way to regulate algorithmic and high frequency trading. The effects-based approach refers to the pragmatic method of regulating and interpreting the law, which is based on the analysis of the economic and structural effects of the regulated actors’ behaviors as well as the economic consequences of the law. This approach has a double objective. On the one hand, to determine, on the basis of the effects they produce, which behaviors should be sanctioned or tolerated. This is a realistic approach in which the content of the law is determined according to the behavior of the bad man, thus allowing for effective regulation and avoiding harmful effects. On the other hand, the effects-based approach makes it possible to regulate a market, organizations or an institution in a fair and objective manner on the basis of the experience gained. This is more of a utilitarian approach where law is seen as a means of acting on society, a tool capable of preserving its order, balance or progress. The effects-based approach has several characteristics: (i) the importance of the actors' behavior and the results that must be achieved by them, (ii) the study of a large number of data, both economic and structural, is necessary to guarantee the effectiveness of this method and to verify that the objective of the regulation has been achieved by the actors, (iii) the ability to change the content of the law through the use of many different legal instruments in order to ensure that it evolves with the actors’ practices, and (iv) the importance of co-regulation and accountability of the actors in order to ensure both the legitimacy of government intervention and effectiveness in defining behavior.

The observation of various aspects of European financial law illustrates, in our opinion, the integration of the effects-based approach in this area of law. This integration has been an opportunity to develop a solution to the difficulty of applying European financial regulation, especially in the area of algorithmic and high frequency trading. The lack of flexibility and adaptability of regulation inevitably leads to an excessive formalism that prevents the normal functioning of the market and the control of all actors. The adoption of the effects-based approach in European law has indeed allowed, both in competition law and in financial law, for the law to evolve concomitantly with the regulated object. It also makes it possible to integrate the teachings of various philosophical and economic currents that are now commonly accepted. The analysis of effects under the prism of principles and technical standards, themselves adopted on the basis of experience, dialogue and the study of market data, are in fact the main characteristics that allow, in our opinion, that a regulation be applied and sanctioned in an effective manner. These principles and technical standards, which evolve and are refined through collaboration between regulators and actors, are indispensable to the effects-based approach that allows financial law to be alive, just like the market it intends to regulate. Algorithmic turn in finance makes necessary a translation of law into numbers, the only language that algorithms understand. This translation is neither universally accepted nor accepted for good.

Why no paragraphs? This is unreadable as unbroken text.

What is the idea that you wish to convey? Regulations should be assessed according to their effects, it seems. Perhaps even that the beneficial effects should exceed the costs? It's difficult to see what's new about that.

The next draft should put in one or two short sentences the idea you are introducing to the reader. The next paragraphs should say how you came by it, perhaps without Peirce and Dewey, or if with them in some fashion that uses them as sources of ideas, not labels. Then, having developed the idea that's yours, you can show in a conclusion what the reader might do to take the idea further on her own. There would be an outline, some headings, paragraphs, careful organization.

Regulation of algorithmic and high frequency trading

-- By LucaEngstrom - 23 Mar 2022

In an era of legislative hyperinflation in all sectors of public and economic life, the question of the method adopted to regulate economic actors is essential. It must indeed occupy a central place in order to ensure that the regulation and its application are effective and achieve the objectives intended by the legislator, such as consumer’s protection or the development of competitiveness. The focus on the effectiveness of regulation is crucial in order to avoid regulatory failure and its consequences. We know today that the financial crisis of 2008 was largely due to the inadequate regulation that was in place at the time and its ineffective implementation and enforcement. The issue of regulation is all the more important in the current context, which is characterized by its global aspect in which markets evolve, companies innovate and information technologies are omnipresent. Financial law and competition law are particularly exposed to this permanent change both because of the evolution and redefinition of traditional markets and the use of algorithms by regulated actors. The development of social and economic sciences as well as the application of new theoretical trends in law also contribute to this change. Numerous approaches have been proposed to deal with this particular context and to take into account the new economic and legal theories. Among these we find, for example, the pragmatic and economic approach, which finds its source in the writings of three authors of the end of the 19th century and beginning of the 20th century: Charles Sanders Peirce, William James and John Dewey. The principles-based approach, on the other hand, is a general move away from detailed prescriptive rules to rules or principles stated in general terms to set the standards by which regulated firms should operate. In order to regulate algorithmic and high frequency trading, we propose to analyze another method: the effects-based approach. The effects-based approach refers to the pragmatic method of regulating and interpreting the law, which is based on the analysis of the economic and structural effects of the regulated actors’ behaviors as well as the economic consequences of the law. This approach has a double objective. On the one hand, to determine, on the basis of the effects they produce, which behaviors should be sanctioned or tolerated. This is a realistic approach in which the content of the law is determined according to the behavior of the bad man, thus allowing for effective regulation and avoiding harmful effects. On the other hand, the effects-based approach makes it possible to regulate a market, organizations or an institution in a fair and objective manner on the basis of the experience gained. This is more of a utilitarian approach where law is seen as a means of acting on society, a tool capable of preserving its order, balance or progress. The effects-based approach has several characteristics: (i) the importance of the actors' behavior and the results that must be achieved by them, (ii) the study of a large number of data, both economic and structural, is necessary to guarantee the effectiveness of this method and to verify that the objective of the regulation has been achieved by the actors, (iii) the ability to change the content of the law through the use of many different legal instruments in order to ensure that it evolves with the actors’ practives, and (iv) the importance of co-regulation and accountability of the actors in order to ensure both the legitimacy of government intervention and effectiveness in defining behavior. At the end of the 20th century, European competition law changed its paradigm and privileged an effects-based approach to a formalistic approach. This change, implemented and enforced by the European institutions, has answered many criticisms and proved its effectiveness. The observation of various aspects of European financial law illustrates, in our opinion, the integration of the effects-based approach in this area of law. This integration has been an opportunity to develop a solution to the difficulty of applying European financial regulation, especially in the area of algorithmic and high frequency trading. The lack of flexibility and adaptability of regulation inevitably leads to an excessive formalism that prevents the normal functioning of the market and the control of all actors. The adoption of the effects or economic approach in European law has indeed allowed, both in competition law and in financial law, for the law to evolve concomitantly with the regulated object. It also makes it possible to integrate the teachings of various philosophical and economic currents that are now commonly accepted. The analysis of effects under the prism of principles and technical standards, themselves adopted on the basis of experience, dialogue and the study of market data, are in fact the main characteristics that allow, in our opinion, that a regulation be applied and sanctioned in an effective manner. These principles and technical standards, which evolve and are refined through collaboration between regulators and actors, are indispensable to the effects-based approach that allows financial law to be alive, just like the market it intends to regulate.

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