Themis Trading Response To Goldman Sachs Market Structure Op-ed
In our years trading stocks for institutional clients, and commenting on market structure, we have found that the splash made by a politician discussing HFT is directly proportional to the likelihood that said politician can affect lawmaking and business practices. Senator Kaufman certainly made a splash, as did Congressman Markey. Even Congressman Garrett made a splash (ok – let’s be honest and call it a sprinkle – and a sprinkle aimed at garnishing campaign donations from firms entrenched in the status quo). But Holy Guacamole! – Attorney General Scheiderman brings up something called The Martin Act, and we are talking tsunami!
Yesterday, HFT Lobbyists, ex SEC Chairman (Levitt), exchange executives, “influential bloggers”, and even Quant Rock Stars (Cliff Asness) took to Twitter and mass media to criticize the AG, and claim he has no business sticking his nose into the underworld of stock market plumbing. Make no mistake – the Martin Act is nuclear and very, very scary to these folks.
Why, even Goldman Sachs took to the WSJ last night to opine on market structure. Their President and COO wrote an op-ed that you should read, titled The Responsible Way to Rein in Super-Fast Trading.
It is a fine letter, and Mr. Cohn concedes that the gains brought about by modern market structure have indeed been accompanied by increased instability and operational risk. He proposes four principles.
1) Mandated execution controls – pre-trade volume and price controls. There is a risk of some HFT firms taking shortcuts to achieve lower latency. This would likely not affect big players like Goldman too much, and if all HFT firms had to do this, then the big boys would not lose their speed advantage. This seems like it should be a no-brainer.
2) Message traffic fee. We’ve been calling for this rather than a transaction tax. It makes perfect sense that those that use the system more pay more. However, message fees have been tried before and were filled with loopholes and special exemptions.
3) Simultaneous distribution of public market data -“The public aggregator should release information to all market participants at the same time.” The devil is in the details with that statement. Short of mandating the use of one feed, or stopping trading venues from distributing/selling faster feeds, latency arbitrage will likely always be an issue. Think about it – there are over 60 different trading destinations with different technologies, and different speeds.
4) Clearing members should be able to set pre-check credit limits. Another no-brainer. Of course clearing agents should have credit limits on their clients. Can you imagine what the havoc and ripple effect the Knightmare would have caused if they had not been self-clearing? LTCM anyone?
While Mr. Cohn tosses market structure critics a few bones, his letter does not acknowledge numerous other issues like:
1) Payment for order flow
2) Dark pool disclosure issues (IOI, etc)
3) Routing conflicts
4) Order types
5) For-profit exchange status and SRO exemption
6) Lack of regulatory oversight systems (CAT)
We would have especially liked to see Mr. Cohn comment on those issues. They are at the very heart of the ills of our market. If Maker-Taker goes away, then so do so many latency and message traffic wars to get to the top of the queue in the lit markets. If payment for order flow goes away, then dark pools become much cleaner, and actually do what they are designed to do – trade blocks. As they stand now, the pools are merely internalization engines that sell the top spot in their routing tables to high frequency trading firms.
If the distortive incentives that are all cloaked under the big umbrella of “payment for order flow” are addressed, then truly a free market will decide the correct speed of players, the correct mix of lit and dark trading, as well as the validation of trading styles that the ecosystem known as The Market will support. We would have loved to see Mr. Cohn make that case, given the great degree of respect he is held within the industry.
Overall, Mr. Cohn’s op-ed reads like a piece that a regulator would write. He proposes a few easy fixes that everyone agrees with but doesn’t touch the more difficult issues.
Here’s the question: If all four of Goldman’s principles were enacted, do we still have our market structure problems that we currently have?