“It’s The Content, Stupid”


John McPartland, a senior policy advisor at the Chicago Federal Reserve, has just published an updated version of a paper titled “Recommendations for Equitable Allocation of Trades in High Frequency Trading Environments” .  Some folks are probably wondering why an advisor at the Chicago Fed is getting involved in the HFT debate.  Well, we have had the pleasure of meeting John McPartland and can tell you that he is a very astute market observer and he has some very creative ideas about fixing some of our market structure problems.  Prior to his Chicago Fed days, John had a long history of working in the financial markets including being a settlement banker, trader and deputy manager of the Chicago Mercantile Exchange (CME) Clearing House.

John has been a vocal proponent of batch auctions and in his new paper he adds nine recommendations that he thinks will bring fairness back to our markets.  John is particularly concerned about three predatory trading practices:  spoofing, layering and quote stuffing.  Being the cagey veteran, John knows that enforcing a ban on these practices in a microsecond, high frequency world is extremely difficult for regulators to do.  John states:

“The thesis of this paper is that, rather than attempting to ban these techniques (which could likely be difficult to enforce in practice), one could change the character and economics of the trading environment so as to disincentivize these and similar undesirable trading techniques. Rather than propose solutions that might preclude specific HFT strategies, we propose to simply change the economics of the trading environment by modifying the criteria of order allocation priority and by discouraging certain questionable industry practices to strike a more equitable balance between the high frequency trading community and the investment management community.” ​

In our opinion, this is a very smart approach that has a much better chance of success than any “holistic reviews”. John lists nine recommendations that he thinks will erode the unfair HFT advantage:

1- Create a new trade allocation formula ​based on pro-rata share of orders

2- Create a new, optional, term limit order type that would reward traders for the time that their orders are committed to be resting in the order book. ​

3-Completely dark orders or the hidden portion of resting orders that are not fully displayed (lit) in the order book should go to the very end of the queue (within limit price) with respect to trade allocation.

4- Multiple small orders from the same legal entity should first be aggregated as a single order and should carry the lowest allocation priority time stamp of all of the orders so aggregated. ​

5- Batch Auctions -trading venues should divide their trading sessions into discrete periods of one half second. ​

6- Visibility into the order book should be no more granular than aggregate size at each price point. Market participants should not be able to view the size of individual orders or any other identifiers of any orders of others. 

7- No market participant should be permitted to cancel an order before first obtaining an acknowledgement from the trading venue that the original order was received.

8 – Each automated trading system (each individual algorithm) that has the capacity to generate, modify, or cancel orders without human intervention should have a unique identifier. ​

9 – Seek public comment on precisely when trade information becomes generally available to the public at large.  ​

These are nine creative approaches to solving the fairness issue in our equity markets.  Our favorite suggestion is #6 and focuses on something that we have talked about for years – the content of the data feeds.  We have long suggested that there is too much information being disseminated in the data feeds that exchanges sell.  We have also suggested that most investors don’t realize how much information about their orders and their investment style is being leaked through these feeds.  John also recognizes that these data feeds are a source of unfairness and states:

“Market participants should only have access to information that they legitimately need to make an informed economic decision on market depth, price, and liquidity. Market participants that have the ability to query the order book should ideally only be able to see the aggregate size at each bid and offer price points.  No market participants should be able to see any other identifying data in the order book that would reveal the identity or origin of the other market participants that have entered orders. No market participant should be able to see or otherwise ascertain the time stamps or the individual lot sizes of orders entered other than their own. Such granular data is not information that any market participant legitimately needs to make an informed economic trading decision. It should be sufficient for trading venues to provide market participants with a graphic representation of where they stand in the order queue.”

John knows that he is going to get pushback on this recommendation from folks who say that he is trying turn back the clock on transparency.  He counters that by saying:

“Dissemination of granular data from the order book allows algorithmic traders to gain inappropriate insights into the trading patterns of both algorithmic traders and click traders. That said, we have no qualms about HFT firms using aggregated data from the order book: High frequency traders should continue to have the unfettered ability to attempt to reverse engineer aggregated data and reach any conclusions that they may care to reach.

After noting some academic research which shows that there is a tradeoff between market liquidity and transparency, John closes his case against the excessive granularity of data feeds with this statement:

“It should become obvious that displaying the both the order sizes and the time stamps of all other orders in the order book can only have a detrimental impact on market liquidity. The granularity of order book information currently being provided has now exceeded all bounds of propriety, confidentiality, and common sense.”

We agree with John and believe that the type of content that is being disseminated by the exchanges in the data feeds need to be reexamined by regulators.  While the industry debates the advantages and disadvantages of speed, we believe that the content of the data feeds has been overlooked.  To paraphrase a line from the Democratic strategist James Carville, “It’s the content, stupid”.