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.