Where Has All The Volume Gone?


Depends on which headline you read, SEC Chair White’s speech last week was either an indictment of HFT or an exoneration of HFT.   Here are some headlines from the media:

Fortune:  SEC: Everything about highfrequency trading is under review

Businessweek: No HighFrequency Crackdown in SEC Blueprint for Tighter Control

IBD: SEC To Curb High-Speed Trades

Bloomberg:  SEC Will Keep Thinking About High Frequency Trading

Once again though, lots of folks that are new to the market structure debate are missing the point. It’s not about HFT, it’s about the market structure that has allowed HFT to flourish for all these years. We believe the Mary Jo White speech is a turning point in the market structure debate.   The speech is a comprehensive, well-thought out road map for market structure issues for the next few years.

Chair White put everything on the table:  registration of prop traders, data feed regulation, the possibility that Reg NMS might have contributed to fragmentation, lack of transparency in dark pools, broker routing disclosure and conflicts of interests, order types and the wide tick program.  These issues hit at the heart of the market structure debate and they are issues that we have been calling for reform for a number of years now.

While we expect that the industry is already gathering  sand to throw in the wheels of change, we are encouraged by the speech.  Chair White also recommended the creation of a Market Structure Advisory Committee.  Heck, who knows, maybe we’ll even get an invite to participate on this committee.

And to prove they are serious, last week, the SEC launched two salvos at the industry:

1- Liquidnet was fined​ $2 million for “improperly using subscribers’ confidential trading information in marketing its services.”

2- Wedbush Securities was “accused of violating the agency’s market access rule that requires firms to have adequate risk controls in place before providing customers with access to the market.”

The Wedbush case is very troubling because it gets to the systemic risk issue that has long festered in our market.  The SEC realized that sponsored access was a problem back in 2010 and created the Market Access Rule (15c3-5) to address the markets concerns.  The rule which was implemented in July 2011 and sought to reign in many high frequency traders who were gaining unfettered access to the market through broker/dealer pipes.  While most brokers have complied with the rule, the SEC has accused Wedbush of essentially ignoring the new rule.  The SEC stated:

Wedbush allowed thousands of essentially anonymous foreign traders to send orders directly to U.S. trading venues to trade billions of shares every month. Wedbush enjoyed increased trading commissions and fees generated by its high- volume market access customers from its risky market access business.”

“Wedbush failed to adopt and implement risk management controls that were reasonably designed to ensure compliance with applicable regulatory requirements—such as those for preventing naked short sales, wash trades, manipulative layering and money laundering.”

“During the relevant period, Wedbush had about 50 sponsored access customers that generated average monthly trading volume of 30 billion shares. Several of Wedbush’s sponsored access customer firms had more than 1,000 authorized traders each, and one had more than 10,000 traders.

The Wedbush case clearly demonstrates that the SEC has more work to do on the risk control area of the market.  We think the suggestion by Chair White last week to register active proprietary traders and subject them to dealer rules is a step in the right direction.

One interesting note about the Wedbush case may solve the riddle of: Where has all the volume gone?  The case brought by the SEC has a relevant period of July 2011 to January 2013.  During this period average daily volume across all US stock exchanges was 6.9 billion per day.  Assuming that Wedbush stopped their unfettered access after the relevant period ended, then we would expect a significant dropoff in their volume (Wedbush was doing almost 1.5 billion shares per day during the relevant period)​.  We would also expect a significant drop off in overall market volume. Sure enough, volume across all US stock exchanges from February 2013 to present has averaged 6.2 billion shares.  This is a 700 million share per day drop since the relevant period of the Wedbush case.  Coincidence?  We don’t think so.