According to some increasingly loud voices, the US equities market structure is a runaway train destined for an accident that will make the May 6th flash crash look like a fender bender. High frequency trading is getting unwanted attention ranging from bloggers and mainstream press to investment firms' newsletters. All are concerned that HFT is dangerous (might cause another flash crash) and unfair to retail investors.
A quarterly newsletter sent out by Baron Funds draws attention to Reg NMS and says shareholders have been harmed by its unintended consequences. In the newsletter Ronald Baron, CEO and CIO of Baron Funds, calls for HFT firms to adhere to "affirmative obligations" such as specialists have always had to do, and to eliminate co-location of servers at exchanges and other venues. He also wants HFT to be disallowed in the first and last 30 minutes of a trading day.
Last week Themis Trading went to the extreme and called for a ban on new market venues. “Most industry professionals generally agree that something in our current market structure caused May 6th and unless we get to the bottom of it, May 6th is more than likely to happen again,” said Themis co-founders Sal Arnuk and Joseph Saluzzi.
HFT supporters keep dragging out the increasingly impotent "adds liquidity" argument, even as revealing graphics from trade database development firm Nanex show that there are some not-quite-cricket practices such quote stuffing going on. (Quote stuffing is the practice of firing so many orders into the order book - in particular ticker symbols - that the market cannot possibly respond.) This is not liquidity, just the opposite.
The SEC's recommendation to form a consolidated audit trail to - at the very least - help do forensic investigations after a flash crash event is attracting a lot of wannabe technology vendors, but little other enthusiasm. Inside Market Data reported that the estimated $4 billion industry-wide costs required to build a consolidated audit trail ( with ongoing annual costs of around $2.1 billion) are too high and the 32-month implementation period far too long.
In the meantime, another new venue - this one for futures- is popping its head above the parapet. ELX says it is time for CME Group to let go of its virtual monopoly on US futures markets and the courts agreed, signalling the next explosion in new trading destinations. In Europe new MiFID rules may not help to bring that fragmented market time-bomb together, nor will they necessarily encourage liquidity. Worries about a flash crash there surface almost daily in the press.
Maybe it is time to say 'enough already! Stop the madness!' Themis thinks so: “In our US equity market place alone, we have in excess of 12 exchanges, as well as over 40 dark pools and ATS's. These market centers all operate by their own rules and have their own fee schedules. Given that the US equity market is more fragmented than ever, which is a direct and unintended consequence of Reg NMS, we question the wisdom of allowing even further fragmentation until our regulatory bodies have a firm understanding of precisely what went wrong on May 6th, as well as their having a firm understanding of all the newer nuances of our modern market structure, including the effects of various order types, co-location, and data feeds.”
In Europe the venues are also proliferating - exchanges include Bolsa de Madrid, Deutsche Börse Eurex, the London Stock Exchange, NYSE Euronext, and SIX Swiss Exchange. MTFs include BATS Europe, Chi-X, NASDAQ OMX Europe, NYSE Arca Europe, and Turquoise. Yikes. No one knows for sure what caused the flash crash, but fragmentation from new market structure is surely one of the culprits.
As blogger Steve Wunsch, of Wunsch Auction Associates, said in TABB Forum on August 10: "The flash crash is not difficult to explain, if one is willing to honestly look at it. But that wouldn’t suit the SEC, because the picture that emerges is one of the Commission having created an electronic Frankenstein that went berserk on May 6 with a suddenness and ferocity that only the SEC could have devised."
Reg NMS and MiFID and the resulting fragmentation of each marketplace are getting a bad rap, and it may be time for the SEC and European regulators to speed up their investigations. In the US, at least, the SEC continues to approve new equities trading destinations and more are entering the approval process regularly.
Inside Market Data asks how much an orderly market is worth: "Those who believe lightning never strikes the same place twice might say the benefits aren’t worth the cost. But lightning always strikes again somewhere, and—as the saying goes—those who don’t learn from the past are doomed to repeat it."
Until there is an audit trail, along with monitoring and surveillance technology, deployed to all destination venues and controlled by the regulators, HFT and algorithmic trading will remain the skunks at the garden party. I wonder if more draconian measures are not imminent.