The Financial Times reported on April 28th, 2013 that high frequency traders are, for the first time, facing speed limits on a major trading platform – in the foreign exchange markets. EBS, one of the two dominant trading platforms in the FX space, is proposing scrapping altogether time-price priority (“first in first out” ), and instead batching incoming orders every few milliseconds and randomly selecting among them for execution. Said EBS CEO Gil Mandelzis,
“It is a technology arms race to the bottom, and a huge tax on the industry, since people are having to make significant investments in speed, without connection to their trading strategy. Speed has little to do with why many participants come to our markets…. they come to our markets to exchange risk, they do not come to race.”
Another FX trading platform, ParFX, just launched recently, and they also institute random pauses on incoming orders, in the name of fairness for all market participants.
Former SEC chief economist, Larry Harris, has been advocating for a speed limit in the equity markets for years – to no avail. From the FT article linked to above:
“Wherever you see high-frequency trading, requiring a delay is a sensible thing to do,” Professor Harris said. “We are talking about delays of one-thirteenth of the time it takes to bat your eye. It hardly slows down the market at all, but it ensures that a smaller trader has a better chance of getting first in line.”
You may recognize Professor Harris as one of the authors of Equity Trading in the 21st Century. We referenced that paper in our April 2010 SEC Market Structure Comment letter, written over three years ago – hard to believe, and quoted from it:
“Make-or-Take pricing has significantly distorted trading.”
We believe it has distorted true supply and demand, as dominant reasoning for buying and selling stocks is more tied to being first in line to catch a rebate, as opposed to the direction of the stock price. In addition this pricing model has created the very race condition that EBS’s Mandelzis talks about in the FT article:
“The ‘first in first out’ model sounds fair and plausible, but in modern markets it implies “winner takes all.”
Why has their not been any regulatory action or redress in the equity markets? Perhaps cozy relationships among regulators, lawmakers, and the industry and their lobbyists are a partial reason. The industry expects regulatory inaction, and has adapted to a world where regulators “looking into issues” has become code word for “investors are on their own.”
Speed arms races, and microstructure arbitrage (theft), are a tax to investors. The exaggerated benefits brought to the marketplace by their practioners haven’t even come close to outweighing the costs and risks that they have imposed onto investors.
Hopefully the US equity markets are watching this development in the FX space closely.