James Rundle: HFT Inquiries Bring a Knife to a Gunfight

Every other week, it seems, mainstream media carry stories about high-frequency trading (HFT). More often than not these are worded as though computers executing trades in the markets is a new phenomenon, and reports carry a subtle criticism: The practice is dangerous and there should be some sort of action around it. The Flash Crash of May 2010 is regularly cited as the primary contretemps illustrating these arguments, but the regulatory discussion of late has turned to what are perceived in some quarters as unfair advantages enjoyed by those practicing HFT.

These include, but are not limited to, exclusive fiber-optic links between New Jersey and Chicago, early looks at data, the ability to front-run pension funds, the inability of retail investors to compete in what should be a free market, and a link to price volatility. Some of these have merit, but invariably the criticisms and conspiracy theories are based on flawed logic and employ a selective appropriation of market reality.

This is why the announcement by New York’s attorney general Eric Schneiderman seems odd at first glance. He says the state will be investigating co-location, a practice that certain HFT firms use in order to minimize latency between exchanges’ matching engines and their own order systems.

Plot Holes
As I mentioned, there are areas of HFT that do need serious, empirical research and a brighter light shone on them. The relationship between HFT and market volatility, for instance, is one such area where it is right and proper for a well-resourced and informed regulator to take a serious look. Maker-taker rebate schemes need a serious rethink for investor and client protection reasons. The ability to accurately monitor trading activity in a high-frequency environment, too, is one where I feel regulators are not adequately equipped, based on the many conversations I’ve had with both sides on this topic. But co-location? It’s a bit like focusing on the wheels of a bicycle when the gears are playing up.

The resources these HFT firms command give them an unfair advantage, the argument goes. Not everyone can afford to locate in Mahwah, New Jersey, and the so-called “risk free” attribute this gives hyper-fast orders makes it a playing field that’s not so much level as bifurcated.

There has to be a sense of pragmatism from those who cite competitive reasons for why HFT should be eliminated.

I find this hard to accept. Take away co-location for that reason, and you might as well start putting caps on the responsiveness of algorithmic trading engines, on how quickly the internal switches between market data and order management systems can parse packets, or even create exclusion zones around datacenters.

Fool’s Errand
Trying to stop technology is a fool’s errand. Yes, there are complaints that advanced technology disadvantages the average investor, but it’s so well established within equities and futures markets now that high-speed trading is de rigeur. Brokers and banks offer the same services to clients—partly because they have to, thanks to best-execution rules and the need to stay competitive—so it’s not just the big, bad buy side doing it. In other words, you wouldn’t bring a Hummer to a Formula One race, so why would you insist on using outmoded technology in markets that have evolved beyond that?

I’m not defending HFT, and I’m certainly not endorsing controversial practices such as the early release of data to those who can pay for it. That seems to be on the wane with a number of recent high-profile announcements from data providers saying they will discontinue that service, and nobody can realistically argue that it doesn’t give certain participants a stacked deck.

But there has to be a sense of pragmatism from those who cite competitive reasons for why HFT should be eliminated. If the conversation differentiates properly between what is unfair, and what is simply a natural evolution of electronic markets, the end results will be a lot more to everyone’s liking.