At a recent roundtable with reporters, SEC Chairman Mary Schapiro suggested that regulators may consider different remedies to fortify the U.S. market structure especially in terms of firms that participate in high-frequency trading. One remedy would be a fee for cancelled orders made by HFT shops (that make up nine-tenths of all orders) while others suggest that traders maintain competitive buy and sell orders in the market throughout most of the trading day, according to the Wall Street Journal.
Advanced Trading examines the move to slow down HFT in our March 2012 cover story. We interviewed industry observers to ask how to best manage high frequency trading without hampering capitalism. One of our sources was Jamie Selway, managing director of broker-dealer ITG.
Advanced Trading: Once firms are accustomed to trading at higher rates of speed, is it possible to slow down traders?
Jamie Selway, ITG: Anything's possible. You can certainly slow down the entire marketplace and have the effect of slowing down the high frequency guys and firms like us. It is possible to do something that can slow down, and throw some sand in the gears.
We would caution that there are some things you can do at the margin. It's not binary where all HFT is bad or all HFT is good. There is probably some analysis that there is some good and some bad.
Regulators should take surgical kinds of actions on some trading behaviors. They should take that type of approach instead of something broad and blunt in terms of policy making which would impact everybody.
Advanced Trading: Does the current political environment support a move to slow down HFT or will this take a while?
Selway: At this point I think the HFT stuff is [being discussed] fairly incremental politically. There was a time between Senators Kauffman and Schumer when there was a hue and cry around it. I think this debate is going on in the States less so and more so in Europe. I don't think the upcoming election has much to do with it.
The point is we don’t know a pile about HFT particularly the regulators and they're not as tooled up as they need to be. I don't know if the SEC has decided a policy direction to take but I think we all agree they should know more. Whether that means the construction of a Consolidated Audit Trail [to monitor the market in real time] we'll see. The commissioner of the SEC formed a sub-committee, a technology advisory committee to explore these options. That's being debated right now but nothing has been decided. I think politicians have moved on and allow expert regulators to take a look.
Advanced Trading: How do you respond to the charges that HFT creates shallow liquidity, too many canceled orders and volatility?
Selway: We always respond to critics of HFT by saying that we agree with a lot of what they say. The statements you made are for the most part true. Is HFT providing liquidity? Is it faster, smaller, less deep? Absolutely true.
The question is 'will you automate and create anonymous limited order to markets and compress spreads that you can trade off them to the other market makers and specialists of old to the liquidity providers of today?' Is that a better or worse thing?
The first thing you say is that on average, the spreads are tighter and seems like it could keep costs down. But that could be a statement you condition on average when you look at things that happen in detail and things aren’t always better.
The first thing to say about HFT is that it's different and the second is that it usually from the perspective of tighter, faster, better automated trades but the third thing is there could be tail risk. Just from the fact that we don’t know everything we need to know.
In terms of cancellation fees, in the past our CEO kind of encouraged exchanges to look at some sort of fee-based regime for cancels.
What we said was there are good cancels and bad cancels and good cancels are ones when someone is changing a bid or offer to make it more competitive, or changing a bid or offer around to engage in price discovery.
There are bad cancels where you're far off the quote and you're needlessly consuming system resources and changing prices that just don’t matter.
But at the end of the day, system resources are scarce and it costs a lot of money to operate. If people are making the assumption that message traffic is free and people are using it without some sense of discipline, that's a potential problem.
Advanced Trading: You mentioned regulators and politicians are ignorant ...
Selway:I would say that their knowledge is incomplete.
Advanced Trading: Is this causing HFT to be scape-goated?
Selway: Yes, there's a mixture of that. I am fond of saying I am not a huge regulations guy but I am a fan of regulations at an appropriate level that boosts confidence. I for one would prefer to be regulated by the SEC and not by ZeroHedge. So we have a team of experts and multiple agencies that are expert in regulations and know the markets and have the resources.
It would be nice if someone made an allegation about HFT that a regulator would respond to it, whether it's quote stuffing or some of the manipulation scares that get thrown around. It'd be nice of the regulators would respond to that. If they said, "Well, we looked at that and we see a problem - or we don't see a problem." Some combination of taking actions or not - but doing what is appropriate and that would allow confidence - that is where we'd like to be.
Whether it’s scape-goating or not, the guys who are in charge regulatorily aren't saying much.
Advanced Trading: Do you have any final thoughts on slowing down HFT?
Selway:Think the way people will make peace with a changed environment is with more information and more experience. We all need - whether we are buy side, sells side or regulator - to become more informed about the way these firms operate.
Some of the HFTs could help themselves by being more forthcoming and some have been. You look at some firms that have written letters and attend conferences. They perform sweeps and investigations and they find things, some of which are good and some that are bad. They are on the beat so they can separate the wheat from the chaff.
HFT is a lot like any other trading behavior. There are good apples and bad apples. The majority is good and trying to provide liquidity and earn what modest amounts they can earn for their business. Then again, there are folks who are not doing everything they should be doing. That's why we have regulators.