May 2014: Regulators’ Arbitrary Line in the Sand

How fast is too fast? That’s a question a lot of people have been pondering for some time, and thanks to the release of Michael Lewis’ Flash Boys, it seems that just about everyone has an opinion on high-speed trading (HFT). I am finding Flash Boys particularly stimulating, even though I am distinctly uncomfortable with Lewis’ disparaging description of RBC’s acquisition of Carlin Financial and his overt character assassination of Jeremy Frommer, the firm’s founder and CEO. I’m not defending Frommer—I don’t know him, nor do I want to—but I also don’t think it’s particularly ethical or savory to be so blatantly boorish. I think it’s safe to say that Lewis and Brad Katsuyama, his primary source for the book, have been crossed off RBC’s and Frommer’s Christmas-card list for the foreseeable future.

This issue is not peculiar to the capital markets, however. In track and field, for example, the International Amateur Athletics Federation—an anachronism if ever there was one, given that all international athletes these days are professionals—has adopted the 0.100-second rule for starts up to and including the 400 meters, meaning that athletes reacting to the starting gun within that timeframe are deemed to have false-started due to their “physiologically impossible” reaction times. A similar, seemingly arbitrary rule cannot be applied to the capital markets, however, where machines are responsible for reacting to market stimuli in moments so fleetingly swift that they make humans appear sloth-like.

In his column, Max Bowie argues that while HFT practices are still, amazingly, misunderstood in certain circles, drawing a line in the sand and effectively penalizing those firms that have deployed the technology and services that provide them with an edge over their rivals, risks standing in the way of progress. Max reasons that an advantage only becomes an unfair one when technologies or services are withheld from certain market participants.

In the current HFT debate, this is clearly not the case. Some might argue, however, that the underlying costs associated with the practice are prohibitive to some firms, although the same rationale could be applied to the industry’s most in-demand portfolio managers and traders in terms of their remuneration packages. Perhaps the regulators will introduce a draft system similar to the one currently used in the NFL, where weaker teams, determined by their previous season’s performance, get first pick of the new crop of talent. This would certainly render the capital markets playing field more equitable. And from there, it’s just a hop, skip and a jump to socialism.