Reining in Computerized Trading, Without More Regulation
September 20, 2012
Do automated systems undercut the confidence of both ordinary investors and market professionals -- and put financial systems at risk?
“U.S equity markets are in dire straits,” David Lauer, a consultant with advocacy group Better Markets Inc. and a former high speed trader, told the Senate Committee on Banking, Housing and Urban Affairs during its hearing Thursday on computerized trading. “We are truly in a crisis.”
Lauer and other participants in the hearing told panel members how rapid-speed trading can give an unfair advantage to technically sophisticated trading firms, enabling them to trade profitably at the expense of other investors.
“Any individual (without very sophisticated infrastructure) looking to trade the market with a relatively short time horizon … is completely out out-gunned,” said Larry Tabb, chief executive and namesake of the Tabb Group, a Wall Street consulting and research firm, in a prepared statement.
Last week, for instance, NYSE Euronext paid a $5 million penalty to the Securities and Exchange Commission over allegations that it gave market data to some of its clients faster than retail or long-term investors.
“Most rules and regulations seem to further enable those with short-term profit incentives, as evidenced by the proliferation of new order types suggested by the exchanges and approved y regulators,” noted Andrew Brooks, head of U.S. Equity Trading at T. Rowe Price Associates Inc
Tabb also cited technology-related fiascos such as the May 6, 2010 Flash Crash and the August 1 flood of erroneous orders that cost Knight Capital $440 million as events that have badly shaken confidence in the markets—among industry professionals, themselves.
“We sampled 260 market professionals, or vendors that serve market professionals, and the confidence is not good,’’ Tabb said. The percentage of professionals who had weak confidence in the stability of market was 15 percent after the Flash Crash of May 6, 2010. That reached “a whopping 34 percent two weeks after the Knight debacle.”
Even those testifying in defense of the current market conceded that high-speed trading has caused some problems. “Our markets are designed to execute all stocks, regardless of shape or size, using the same market mechanism,” said Chris Concannon, executive vice president, Virtu Financial. “As the list of public companies continues to grow, a more diverse number of public companies trade on our market while subject to the same market structure. A stock that trades once per day is traded in the same market structure as a stock that trades one million times per day. Our market is solely designed for Cisco, Microsoft and Bank of America and not for a stock that trades by appointment. I believe we should revisit our current market structure in order to create a better pricing mechanism for all stocks of different shapes and sizes.”
Andrew Brooks argued, “ We feel the time is appropriate to step back to examine market structure and how it impacts all investors. A good first step might be to experiment with a number of pilot programs to examine different structural and rule modifications.”
Lauer agreed. “I believe the SEC should consider some more creative, novel ideas for limited implementations or pilots to assess their efficacy and actual impact on the market.”