Will High-Frequency Trading Survive?

Chidem Kurdas

Computer-driven fast trading has become a piñata for governments everywhere. Proposed policies could make many algorithm-based strategies infeasible. This vilification does not make immediate sense. Is public interest better served by non-computer-driven slow trading?

The critics do raise certain questions.

There are complaints that fast trading makes markets more volatile. But there is no evidence that this is the case. High-frequency trading increases liquidity, which is the best defense against market disruption, and levels the playing field so that small firms can enter, says Thomas LaSala,  CME managing director and chief regulatory officer.

Rather than blame technology and speed, regulators should promote these types of strategies, he said, at a conference of the mutual fund association, the Investment Company Institute.

Some institutional investors worry that their order information goes to unknown parties in private “dark pools” where high-frequency trading takes place and the information may be used by these parties to trade ahead and profit at the expense of the institutions. The latter demand to know who gets their order information.

In part because of this issue, regulators want to learn about the computer codes that underlie high-frequency trading. Speakers at the ICI conference said that in the past regulators would ask the trader about a suspicious trade but now the “trader” might be a computer. So the idea is ask the creator of a computer code to explain the intent of that application.

Many trading shops do not want to reveal their proprietary code to regulators (or anyone else) for fear that it will fall into the wrong hands. Another problem is that it may be very hard to explain what a particular computer code does to a regulator who is not a quantitative trader.

Market makers engage in high-frequency trading for their customers. Exchange operators  argue that high-frequency traders in general should have an obligation to be market makers. The chief operating officer of NYSE Euronext, Lawrence Leibowitz, speaking at the ICI conference, said they favor more market making obligations for people who benefit from market making. But not all algorithmic traders can be market makers.

The greater threat, however, is the financial transaction tax proposed by Europeans (except the UK). By adding to the expense of each transaction this would reduce the net return from any trading but in particular from strategies that involve a lot of transactions . A similar levy may be imposed in the US as well.

ICI general counsel Karrie McMillan says the financial transaction tax is described as targeting Wall Street but will directly affect millions of American investors who are saving for their retirement. “This tax will hit Main Street,” she said.

If Europe and the US institute transaction taxes, Asian financial centers may be the beneficiaries. Someone at the conference said he does not want to move to Singapore.  That jurisdiction doesn’t look attractive but people including hedge fund investors who favor high-frequency strategies are thinking of other Asian locations.


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