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March 1, 2013 11:37 am
An influential MEP told me some months ago that of the 250 meetings he’d attended in the preceding six months, 80 per cent were about high-frequency trading. This is an astonishing number.
Who would have guessed that this one issue would have captured so much attention, given all the other urgent financial and economic issues facing European policy makers?
I am fairly sure that there really are not that many firms engaged in high-frequency trading in European markets. Certainly no more than two dozen engage in this type of trading on a large scale. So it appears that the majority of the people talking about HFT are not actually in that business. Which raises a simple question – do they really know what they are talking about?
In my experience, the answer unfortunately is no. The latest example came a few weeks ago when Stuart Gulliver, chief executive of HSBC, spoke before the UK parliamentary committee on banking standards. During the course of a discussion on HFT, Mr Gulliver claimed that he would be surprised if the boards of HFT firms fully understood what is going on in these activities, or fully understood the maths sitting behind it.
Mr Gulliver may know a great deal about banking, but this statement is grossly inaccurate. Unlike large financial institutions such as HSBC, HFT firms tend to be highly entrepreneurial and innovative partnerships managed by their owners. They do not rely on client, shareholder or taxpayer funds to run their operations. Since their own money is at stake, the owners and managers have the strongest possible incentive to keep a very close watch on how trading is conducted and minimise the risk of loss. In fact, more often than not, the senior managers are the originators of the very strategies that these firms deploy.
Mr Gulliver also expressed the view that algorithms function in what he called an ethics-free zone. Apparently he thinks that these trading systems run all by themselves. Wrong again. While many of the trading processes we use nowadays are automated, there are still people behind every transaction. People design these systems and strategies, programme the computers, supervise the trading and manage the risks.
These people are certainly not operating in an ethics-free zone. The exchange-traded markets where HFT takes place are heavily regulated and completely transparent. This may come as a surprise to our critics, but HFT firms want and need a strong regulatory climate for the simple reason that this ensures transparency and lowers barriers to entry, two key requirements in order to offer our services. The tools of trading may have changed, but the purpose that they serve remains the same – bridging the gap between buyers and sellers.
There is an odd misconception that HFT is a form of market manipulation. This claim is difficult to understand, especially given what we have learnt about the manipulation of manually determined interest rate benchmarks such as Libor. It should be obvious to any objective observer that it is much more difficult to engage in manipulation in a market where every transaction is publicly reported and digitally recorded. Perhaps if Libor had been electronically generated, it might have been harder to manipulate.
Moreover, the UK Foresight Committee concluded last year in its report on electronic trading that while HFT activity had surged in recent years, many concerns around its impact on market integrity were unfounded. The committee commissioned three separate empirical studies that found no link between HFT and market abuse. One of those studies found that the increase in HFT over the five-year period had actually reduced the likelihood of market manipulation.
The empirical data show that it has never been cheaper and more efficient for institutions and retail investors to transact on these markets. Institutions today pay up to 90 per cent less commission through automated trading than they paid 15 years ago transacting over the phone.
At the same time, statistical measures such as execution shortfall show that the market impact of institutional orders has steadily fallen over the past 10 years, according to ITG and Elkins McSherry. Vanguard, one of the world’s largest asset managers, has calculated that because of lower transaction costs over the last 15 years, the average pensioner will have 30 per cent more in their pension account. HFT has made markets more efficient and cheaper for end users.
Certainly there are risks that need to be addressed. Pretty much all participants use algorithms and algorithms can go wrong. Machines can malfunction. That is an unfortunate fact of life, and it worries us as much as our critics.
That is why the principal trading industry is working with policy makers and regulators across Europe to demonstrate how HFT works and how to make markets safer. For example, we recently gave demonstrations to groups of regulators to show how a live market-making algorithm functions in real-time and what risk controls can be used to stop a malfunctioning algorithm.
This discussion needs to be had, and the principal trading industry stands ready to contribute to it. Our hope is that those other parties with strong views on HFT are open to a discussion focused on solutions and based on facts, rather than on misconceptions held by people who do not really know what they are talking about.
Remco Lenterman is managing director, IMC Financial Markets, a high-frequency electronic market maker
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