US senators push for curbs on flash traders

US senators stepped up their scrutiny of high-frequency trading at a congressional hearing on Tuesday, raising pressure on regulators to curb alleged conflicts of interests they say are jeopardising public confidence in America’s equity markets.

“Financial markets cannot survive on technology alone. They require a much older concept: trust. And trust is eroding,” said Carl Levin, a senior Democratic senator from Michigan and chairman of the Senate permanent subcommittee on investigations.

The hearing comes in the wake of Flash Boys, a book published this year by Michael Lewis, which charged that the US stock market was rigged by high-frequency traders, who use algorithms and well-placed computer servers to beat their competitors in fractions of a second. The Securities and Exchange Commission is also probing high-frequency trading and recently made recommendations to prevent disruptions to market stability after the “flash crash” that hit the US market four years ago.

Mr Levin was flanked in the hearing by John McCain, the Republican senator from Arizona, who also expressed concern about high-frequency trading, saying it had “fuelled suspicions that Wall Street may well have become the ultimate insiders’ game”.

The hearing targeted conflicts that the lawmakers say are embedded in the market structure, frequently benefiting a small group of traders with superfast technology at the expense of the rest of the market. One was the practice of retail stockbrokers receiving payments from wholesale brokers who place orders on the market. A second conflict was in the “maker-taker” arrangement, by which some exchanges offer rebates for orders. The senators said the practice could also offer financial incentives for brokers at odds with their clients

There was attention paid to the rules, contained in Regulation NMS of 2007, which were designed to make the market more competitive and open. Critics have charged that it makes the market overly complex and creates advantages for some players over others.

Financial markets cannot survive on technology alone. They require a much older concept: trust. And trust is eroding

The hearing on Tuesday featured testimony from fund managers, academics and traders including Brad Katsuyama, who was featured in Mr Lewis’ book and has emerged as a leading voice calling for changes to high-frequency trading.

Speaking to the lawmakers, Joseph Brennan, head of global equity index group at Vanguard, and Thomas Farley, president of the New York Stock Exchange, voiced support for a review of “Reg NMS.”

“As our markets have evolved under Reg NMS, it is time to explore ways to better balance the sometimes incompatible goals of encouraging competition among market centres and facilitating the interaction of orders,” Mr Brennan said.

The two also called for efforts to revisit the maker-taker model. Some believe the practice has encouraged traders to seek the most profitable rather than the most advantageous way to execute client orders.

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Mr Farley said NYSE is seeking support at the industry level for the elimination of maker-taker and the use of rebates. “Broad adoption of this policy would reduce the conflicts inherent in such pricing schema and further reduce complexity through fewer order types and fewer venues,” Mr Farley said.

Joe Ratterman, chief executive of BATS Global Markets, argued that rebates provide an incentive to encourage liquidity makers to post tight bid-offer spreads to the benefit of all investors and warned that restricting these incentives could be counter-productive.

“Whether it is banning the current maker-taker fee structure, limiting payment for order flow generally, or other attempts to alter the economics of trading, price controls are a blunt instrument likely to cause disruptions and consequences that are unforeseeable and potentially detrimental to all types of investors,” he said. “I am concerned that additional pricing restrictions could drive significantly more volume to dark venues or order types, make the compensation brokers receive for their liquidity far less transparent, and widen the displayed bid-ask spread in a manner that effectively taxes all investors.”

Additional reporting by Philip Stafford in London