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2013 | OriginalPaper | Buchkapitel

1. High-Frequency Trading: Friend or Foe?

verfasst von : Moderator Jim Gatheral, Ari Burstein, Kevin Callahan, Charles-Albert Lehalle, Doreen Mogavero, Lawrence Ryan, L Smith Cameron

Erschienen in: The Quality of Our Financial Markets

Verlag: Springer New York

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JIM GATHERAL: Let me ask the obvious question: High-frequency trading: friend or foe?

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Nächstes Kapitel Mid-Day Address

In an interview with Traders Magazine, Burstein elaborated at length about the position of the ICI on high-frequency trading. He told the trade publication: “HFTs are not doing anything illegal. They are taking advantage of inefficiencies in the market structure. Institutions, for better or worse, try to hide their orders to prevent leakage of information. Everybody’s trying to sniff out everybody’s orders. We don’t have a problem with that. Our concern is transparency and the needs of regulators. We have issues where there is abuse or manipulative practices. Regulators are having difficulties detecting this because of a lack of transparency. That’s where we want to see some changes.” Ari Burstein Discusses, Traders Magazine, January 21, 2011, http://www.tradersmagazine.com/news/ici-burstein-hft-buyside-106950-1.html

Much attention has been devoted to these controversies in the media and in academic studies. First, NASDAQ market makers were accused in the late 1980s of abusing their privileges by not providing liquidity and two-sided continuous quotes at the time of the 1987 market crash. That led to the introduction of the Small Order Execution System (SOES). More significantly, these same market makers were also accused of colluding to keep bid ask spreads on stock prices artificially wide, a practice characterized by only quoting stocks in even one eight increments (0.2/8, 4/8, 6/8). Later, specialists on the New York Stock Exchanges were accused of “flipping” and “trading for eights” and “interpositioning” themselves unfairly on some orders to the disadvantage of institutional and retail customer orders. These scandals led to a series of market structure reforms.

See, Christie WG, Thompson RB (2006) Wall Street scandals: the curative effects of law and finance. Wash U Law Rev http://lawreview.wustl.edu/inprint/84-7/christiethompson.pdf

See, For Whom the Bell Tolls: The Demise of Exchange Trading Floors and the Growth of ECNs, Page 900. Jerry W. Markam, General Counsel and Director of Compliance, Iowa Grain Company and Daniel J Harty, Professor of Law, Florida International University School of Law at Miami, September 18, 2008. http://www.law.uiowa.edu/documents/jcl/Volume%2033/4/Markhamfinal.pdf

Regulation NMS, or National Market System, was enacted by the Securities and Exchange Commission in 2007 to foster competition among US exchanges and individual orders, and to promote fairness in price executions across all exchanges and platforms.

MiFID, the Markets in Financial Instruments Directive was enacted as European Union law on November 1, 2007 to foster competition and investor protection. It harmonizes the regulation of financial services among EU member nations.

As of writing, TABB Group and other analysts estimate HFT share volume hovering around 50 % of the marketplace. On some individual stocks the market share can rise as high as 70 %, they estimate.

The speaker is referring here to dark markets versus lit markets. Dark markets are, in a sense, functionally opposite to lit markets. In lit markets, prices and other trading data are publicly displayed prior to execution, which is not the case in the anonymity of dark markets.

Richard (Rick) Ketchum Chairman & CEO, FINRA, in testimony May 20, 2010, before the US Congressional Subcommittee on Securities, Insurance, and Investment Committee on Banking, Housing, and Urban Affairs picked up on this theme.

Ketchum, said in part: “A generation ago, the vast majority of activity occurred on the equity market that listed the security. Today, orders are routed to some 50 competing platforms. This complex environment creates opportunities for traders seeking unfair advantage to manipulate markets. How? By exploiting inconsistencies or gaps created when the responsibility of regulatory oversight is divided. Regulatory gaps and splintered oversight make it possible for trading abuses—such as market manipulation, marking the close and front-running customer orders—to be carried out furtively across multiple markets, with a reduced chance of detection.” See, http://www.finra.org/Newsroom/Speeches/Ketchum/P121509

This refers to the ability of market participants to gain advantages in speed of trade execution through advanced technology, specifically the “co-location” of their computer servers near stock exchanges. That lowers so-called latency, a critical factor in high-speed trade executions.

‘Bus’ speeds are a measure of speed in computer systems.

This refers to a switched fabric communications link employed in high-performance computing.

Liquidnet, founded in 2001 by Seth Merrin, is the electronic brokerage anonymously facilitating block trading among buy-side institutions. Instinet, launched in 1967 as Institutional Networks Corp., is regarded as an early pioneer in electronic trading for institutional investors in a similar anonymous manner.

Here’s how Funding Universe described it: “When LaBranche & Co. issued its prospectus, the public learned how lucrative specialist operations could be. In 1998 the firm – including its recent acquisitions – had a pretax profit margin of 45 percent, compared with, for example, 25 percent for the financial services firm of Goldman Sachs & Co. and 12 percent for Merrill Lynch & Co., the world’s largest brokerage. In 1998 LaBranche’s 36 managing directors received $60.2 million in compensation – an average of $1.7 million each. George M.L. (Michael) LaBranche IV and the other 35 managing directors collectively owned about 70 percent of the firm. LaBranche, president, chairman, and chief executive officer, was also a governor of the New York Stock Exchange.”

For example, see this study as evidence of the decline in implicit and explicit trading costs: Bid-Ask Spread: Measuring Trade Execution Costs in Financial Markets, Hendrik Bessembinde, University of Utah, and Kumar Venkatarama, Southern Methodist University, March 2009. http://kvenkataraman.cox.smu.edu/papers/BVEQF.pdf

Navigating Liquidity 4. Market microstructure: a paradigm shift https://www.cheuvreux.com/pdf/Navigating_Liquidity_september2009.pdf, Crédit Agricole Cheuvreux, April 2010.

P&G stock drops 37 % – not really, David Goldman, CNNMoney. May 6, 2010 http://money.cnn.com/2010/05/06/markets/procter_and_gamble_stock/index.htm

In its report on the Flash Crash, the CFTC and SEC report noted a skittish market environment prior to the Crash because of concern about European sovereign debt. However, the report cited a single sell order of 75,000 S&P E-mini contracts traded at the Chicago Mercantile Exchange as the catalyst for the Crash. Media reports identified the mutual fund Waddell & Reed as the source of that sell order, which was valued at approximately $4.1 billion.

See, Extra: How High Frequency Trading Grew. 60 Minutes, CBS News www.cbsnews.com/video/watch/?id=6945166n

This refers to the ability of market participants to gain advantages in the speed of trade executions through advanced technology, specifically the “co-location” of their computer servers near stock exchanges. That lowers so-called latency, a critical factor in high-speed trade executions.

See, Traders May Face Nordic-Style EU Fee for Cancelled Orders, Jim Brunsden, Bloomberg News http://www.bloomberg.com/news/2012-03-23/high-frequency-traders-may-face-eu-fees-on-excessive-orders.html

As of writing June 2012, the SEC had approved two proposals to address “extraordinary volatility” in individual stocks and the stock market generally. One is a “limit-up and limit down” proposal. The second updates existing market-wide circuit breakers. Under this proposal, the circuit breakers, when triggered, would halt trading in all exchange-listed securities throughout the US markets. The exchanges and FINRA planned to implement these changes by February 4, 2013. As background, See, SEC Announced Filing of Limit Up-Limit Down Proposal to Address Extraordinary Market Volatility, SEC Press Release, April 5, 2011. http://www.sec.gov/news/press/2011/2011-84.htm

Cameron Smith was general counsel at Island ECN from 1999 to 2002. He is referring here to the market structure that prevailed prior to the introduction of reforms such as the 1997 order handling rules. His argument is that NASDAQ market makers and NYSE specialists had an unfair access to stock pricing and execution services over retail investors. Subsequently, limit order protection rules, for example, helped to “level the playing field” for retail investors.

Since the Flash Crash, measures were adopted to introduce such a market-wide mechanism. See, Regulators Adopt Tools to Prevent Another Flash Crash, Ben Protess, New York Times, June1, 2012, http://dealbook.nytimes.com/2012/06/01/regulators-adopt-new-tools-to-prevent-another-flash-crash/

According to critics, high-frequency trading permits gamers to flush out large orders by electronically ‘pinging’ small market orders to buy and sell. In this way, these gamers may unearth a larger order when several small orders are filled.

In September 2010, the Financial Industry Regulatory Authority censured and fined Trillium Brokerage Services LLC $1 million and also fined and suspended 11 of its employees in relation to engaging an “illicit high-frequency trading strategy and related supervisory failures” to gain an advantage. Trillium was accused of entering “numerous” layered, market-moving orders that triggered selling or buying interest in certain stocks. By submitting these orders, according to FINRA, Trillium “created a false appearance of buy- or sell-side pressure.” In that way, FINRA said Trillium gained a superior price advantages that would not have been possible to them in “46,000 instances.”

Some analysts would regard the Trillium episode as a form of quote stuffing, the practice of submitting an excessive amount of larger orders to buy or sell stocks in fractions of a second and then canceling the orders almost immediately.

The Depository Trust & Clearing Corporation.

Middlemen in Limit-Order Markets, Boyan Jovanovic, New York University, Department of Economics and Albert J. Menkveld, VU University Amsterdam, Tinbergen Institute, October 24, 2011. http://www.amf-france.org/documents/general/9414_1.pdf

Titel: High-Frequency Trading: Friend or Foe?
verfasst von: Moderator Jim Gatheral
Ari Burstein
Kevin Callahan
Charles-Albert Lehalle
Doreen Mogavero
Lawrence Ryan
L Smith Cameron
Verlag: Springer New York
Buch: The Quality of Our Financial Markets
Print ISBN: 978-1-4614-5591-2

Electronic ISBN: 978-1-4614-5592-9

Copyright-Jahr: 2013
DOI: https://doi.org/10.1007/978-1-4614-5592-9_1

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