FT Explainer: Keeping up with high-frequency traders

Market regulators charged with overseeing orderly trading are fighting a losing battle when it comes to keeping up with super fast technology.

What is the problem?

Modern trading can take place in barely comprehendible measurements of time. Banks and high-frequency traders often boast of executing orders on stocks and futures exchanges in milliseconds, or thousandths of a second.

The bar is constantly being raised and already some trade in microseconds (millionths of a second) and even nanoseconds — billionths of a second. To put this into perspective, the average time it takes a human finger to click a mouse is a leisurely 150,000 microseconds.

But problems arise because asset classes can correlate in volatile markets and do so at remarkable speeds.

“Constructing a coherent picture of these interactions can be extremely difficult, if not impossible, without accurate timestamps,” UBS told clients in a recent research note. “This is particularly true when markets are busy and prices are volatile over short periods. These are often the very events which warrant further study.”

Regulatory reports into notable market dislocations illustrate the difficulty of a regulator’s job. After the 2010 Flash Crash — when US stock indices dramatically plunged and recovered in a 36-minute period — a joint report by the Securities and Exchange Commission and Commodity Futures Trading Commission assessed trading in second intervals, even though it admitted many high-frequency traders consumed data in milliseconds.

So when a similar event happened in the bond markets on October 15 2014, investigators at the US Treasury went further. They slowed down the critical moments to a millisecond level, much like a slow-motion replay of a controversial sports incident.

Overlapping data from CME Group, a futures exchange, and BrokerTec, a cash markets venue run by interdealer broker ICAP, yielded a far better picture of the workings of modern day markets.

How have regulators responded?

In an attempt to stay on top of such speedy activity, the European Union is trying to synchronise the clocks on the computers that timestamp trades.

New regulations come into effect from January 2018 that require traders and venues to timestamp events accurately and to within a defined framework against a standard known as Coordinated Universal Time (UTC).

The thresholds depends on trading style. The market’s fastest traders may need to be within 100 microseconds’ accuracy, but slower market participants — such as asset managers — receive a full millisecond’s grace. Those who trade by telephone have to do it to the second.

Most computer systems are synchronised to UTC, which is critical as they would all diverge from each other over time if unaligned.

Is the industry ready?

Current timekeeping technologies for trading are not very consistent, which is a significant problem. Some trading venues say they can achieve accuracies in practice of being within 500 microseconds — some way off what EU regulators are hoping to achieve.

Still, it could have been worse. European regulators had initially proposed that trading venues synchronise their clocks to a nanosecond, or one billionth of second, until the UK’s National Physical Laboratory (NPL), a government body that sets measurements standards, pointed out it was impossible.

Financial services companies are having to test new technologies. The NPL is rolling out a precise time signal. In August it signed a deal with UBS and TMX Atrium, a Canadian trading technology company. UBS says its tests demonstrated that an accuracy of within 50 nanoseconds is achievable. NPL has also carried out a trial with Intercontinental Exchange, one of Europe’s largest futures markets.

NPL says its own clock is so accurate that at most it would be out by just one second over 158m years. The next generation of clocks promises accuracy to one second in 14bn years — very handy, assuming the earth lasts that long.

Will it be enough?

For now, timestamping is in an experimental phase in Europe, but other regulators are looking at the precedent it sets. The problem may be that despite setting a very high standard, the EU’s parameters might not even be accurate enough.

“The timestamp granularity isn’t sufficiently tight. Even one microsecond might not be enough,” says Dave Snowdon, founder and chief technology officer at Metamako, an Australian trading technology company. “The fastest traders are so quick they can respond to a trade and cancel the order in 200 nanoseconds. [Under European plans] that would have the same timestamp.”