The Need For A Universal Cancellation Fee Policy

Recently, some exchanges have enacted cancellation fee policies (and some exchanges have already retracted their policies) to try to prevent the quote stuffing activities of some high frequency trading firms.  But try as they may, the high frequency trading firms continue to outfox the exchanges and continue to circumvent the cancellation fee policies.

One of the smaller stock exchanges, the Chicago Stock Exchange, recently filed a proposal  to once again amend their cancellation fee policy.  They have been trying to get a good cancellation fee policy since January 2010 and those dastardly HFT’s continue to figure out a way to avoid the policy.  In their filing, the Chicago Stock Exchange, talked about their difficulty policing the HFT’s:

“However, soon after the imposition of the original order cancellation fee (in January 2010), the Exchange had observed that the number of unexecuted and displayed orders had actually increased for certain Participants. It was apparent to the Exchange that in order to avoid application of the cancellation fee, certain Participants were submitting Quotable orders to the CHX’s Matching System, but for an extremely short duration, rendering such activity negligible.” 

“In August 2010, the Exchange amended its order cancellation fee…Nevertheless, after the modified order cancellation fee went into effect, the Exchange observed that certain Participants had found a number of methods for avoiding the application of the modified order cancellation fee.”

“In September 2011, the Exchange revamped its order cancellation fee methodology…the Exchange sought to eliminate the practice of quoting in thinly-traded stocks to reduce cancellation fee liability. Furthermore, by imposing the cancellation fee on a daily basis, the Exchange sought to eliminate end-of-the-month fee avoidance trading activity.”

We often notice an excessive amount of quotes in very thinly traded names.  One possible reason for these excessive quotes is that an HFT is trying to slow down a particular channel of stocks.  But based on the CHX document, another reason there are so many quotes in thinly traded names is because HFT’s are trying to build up their quote credits to avoid cancellation fees.  Since these stocks that they are quoting very rarely trade, the chance of the HFT getting stuck with a trade that they don’t want is extremely small.

While the Chicago Stock Exchange has made an effort to reign in the quote stuffers, other exchanges still have cancellation fee policies that are easily gamed.  Wouldn’t it make sense for the SEC to develop a universal cancellation policy similar to the latest Chicago Stock Exchange policy (which is way too detailed and complicated to explain in this note) and require that all exchanges follow this policy?  We have heard that some large HFT’s support a cancellation fee policy.  Well then, they shouldn’t have a problem if the SEC developed a universal cancellation fee policy