Global regulators published guidelines on Thursday to better monitor automated transactions while saying there was little hard evidence to justify reining in high-frequency trading.
Leaders of the world's G20 major economies last November called on the International Organisation of Securities Commissions (IOSCO) to mitigate risks from technological advances in trading technology.
The flash crash on Wall Street in May 2010 shocked small investors and rang regulatory alarm bells, helping to turn the political heat on high frequency trading (HFT) and the algorithms they use.
HFT accounted for 56 percent of U.S. and 36 percent of European equity volume last year, according to TABB Group.
IOSCO's recommendations stop short of the draconian measures some HFT firms fear, such as mandatory testing of algorithms, saying data is scarce.
There is no agreed definition of HFT but it typically involves algorithms that instruct ultra-fast computers to trade across assets, darting in and out of markets to exploit small price changes.
The available evidence fails to find a consistent and significant negative effect of HFT on liquidity, IOSCO said.
The limited empirical evidence available so far has not clearly identified negative effects of HFT on the efficiency of the price discovery process, the global watchdog said.
It added that it has not been presented with clear evidence of the systematic and widespread use of abusive practices by those engaging in HFT.
However, IOSCO, which groups regulators -- such as the U.S. Securities and Exchange Commission and Britain's Financial Services Authority -- from some 100 countries, said the submission of large numbers of orders and trades across multiple venues poses significant challenges to competent authorities.
Many trading strategies used by HFT participants are so sophisticated they raise an issue as to (whether) regulators have the necessary resources to conduct effective market surveillance, the IOSCO report said.
Regulators in the U.S. and EU are already pursuing many of the recommendations and the aim of IOSCO is to ensure a consistent global approach among its members.
The widespread use of algorithmic trading and HFT could be putting off traditional investors from entering some markets due to fears their slower systems put them at a disadvantage, IOSCO said.
A U.S. government report into the flash crash of May 2010, when Wall Street went briefly into a tailspin, did not directly blame HFT, but IOSCO said the event showed how algorithms can amplify interconnections between markets.
The report said direct electronic access, whereby brokers allow clients to use their systems to trade directly on markets, was an area where HFT may pose significant risks.
IOSCO's recommendations, which its members will begin implementing straight away, focus on closer monitoring of HFT rather than trying to curb it.
A rule from the SEC takes full effect next month, forcing broker dealers to block reckless orders piped by clients directly on to markets.
IOSCO also requires trading venues to be able to halt dealings quickly to avoid flash crashes, and to have controls on clients that allowed direct access to markets using its systems.
The EU is poised to take tougher steps to rein in HFT later on Thursday when its executive European Commission will propose a reform of the bloc's securities trading rules.
The MiFID II reform foresees direct regulation that will require HFT to provide continuous liquidity, rather than being able to dart in and out when they want to, a draft obtained by Reuters showed.
IOSCO is required to report back on implementation and further work on trading to the G20 by mid-2011.
(Reporting by Huw Jones)