Quote Stuffing The Gateway – How Exchanges Are Profiting From Manipulative Acts
Driving from New Jersey to NYC could be brutal due to the logjam of vehicles at the Lincoln Tunnel. During the morning rush hour, just getting through the tunnel could take you over an hour. But if you travel during off peak hours, when there is no traffic, you could drive through the tunnel in just minutes. Wouldn’t it be nice to have your own private tunnel reserved just for your car? You would never have to worry again about being slowed down by traffic while all those other vehicles would be stuck in traffic at the Lincoln Tunnel.
While private vehicle tunnels are not likely to exist, private gateways do currently exist for stock exchange data traffic. These gateways allow paying customers to rent their own private tunnel to send and receive data from a stock exchange (as opposed to using a shared gateway). While exchanges claim these private gateways were built for “risk management” issues, the real reason a private gateway exist is to make sure a high frequency clients data is not slowed down due to excessive messaging traffic (it is important to note that private gateways are an additional service that is different from colocation).
One example of an exchange that offers a private gateway is DirectEdge (now owned by BATS). DirectEdge advertises their gateway (which is known as the EdgeRisk Gateway ) as follows:
“EdgeRisk Gateway is an optional, fee-based service available to market participants who want additional protection against the potential risks of shared infrastructure.
Such risks can include performance degradation or disruptions in service resulting from sharp increases in the order activity of other Exchange members.”
We looked further and found the June 2013 SEC filing that DirectEdge published for their EdgeRisk Gateway product and found some more interesting details on it:
– In order to assist Members’ and non-Members’ efforts to mitigate the impact of trading disruptions, the Exchange proposes to offer EdgeRisk Gateway as a new, optional fee-based service that provides Members and non-Members the option to obtain dedicated primary and backup access gateways in addition to, or in place of, a shared access gateway.
-It would reduce the impact of another firm’s message peaks or programming mistakes on the Subscriber’s trading experience.
– To the extent that the load on a Subscriber’s dedicated gateway is less than the load on a shared gateway, a Subscriber normally would expect reduced latencies in sending orders to the Exchange through its dedicated gateway. In this regard, the Service is similar to other types of services provided by self-regulatory organizations that offer higher levels of service for a higher fee.
– In providing access to a pair of access gateways, the Service is also designed to allow Subscribers to mitigate risks associated with potentially fraudulent and manipulative acts and practices that may adversely affect the Subscriber’s trading experience. If, for example, a firm attempted to manipulate the submission of order flow into shared access gateways by directly or indirectly causing a surge in message traffic to be sent to the Exchange, Subscribers would, to an extent, mitigate the risks associated with such a manipulative tactic, as they would be insulated from all such external order flow. ”
Manipulating the submission of order flow by causing a surge in message traffic? This sure sounds like Quote Stuffing to us. While our friends at Nanex have been highlighting this problem for years now, this is the first time that we have seen an exchange essentially publish an admission that quote stuffing exists. Up until this point, all we have heard from the exchanges is that quote stuffing does not exist. It strikes us as odd and conflicted that DirectEdge is now seeking to profit from manipulative activities such as quote stuffing (DirectEdge charges $5,000 per month or $60.000 per year for a pair of servers that get you your own private gateway).
To further prove our point that shared gateways are gamed and exchanges are now seeking to profit from this gaming, we would like to quote from an article written last year by a former high frequency trader titled “Barbarians at the Gateways”. The author describes how the gaming of gateways works:
“Gateways are often shared across customers, as a gateway for each and every exchange participant would likely require a massive data-center footprint. As such, gateways must be closely monitored for malicious manipulation. An example of gateway “gaming” is shown in figure 11. In figure 11a, client A is connected to two distinct gateways. In 11b, Client A induces extreme load on Gateway 1, causing Client B traffic to slow. In 11c, Gateway 1, not under load, slows all attempts for Client B to cancel resting markets. Client A has an advantage with the self-made fast path.”
While we have highlighted DirectEdge’s gateways in our note today, we want to be clear to make sure you understand that they are not the only exchange offering this type of product. For example, Nasdaq offers a similar product in their Nordic marketplaces known as “Dedicate Gateway Service” which they describe as:
“NASDAQ OMX Nordic offers all customers the opportunity to access the market by connecting via a production gateway dedicated uniquely to your firm and avoid the potential impact of other firms trading activity. Customers subscribing to this service will be granted exclusive use of a production gateway subject to the same service levels as any other production gateway. This service is primarily designed for firms engaged in high frequency trading where low latency is of outmost importance and is available for both co-located and extranet customers.”
Private gateways are yet another way exchanges are selling services which allow one client to have an advantage over another client. Exchanges, which are supposed to have SRO responsibilities, continue to cater to their high frequency trading clients and are now profiting from “excessive messaging” manipulative strategies. Rather than try and identify the quote stuffing culprit, exchanges have figured out a way to profit from this illegal activity. We are disappointed that regulators continue to allow exchanges to offer services like these which disadvantage the majority of their clients for the sake of the exchanges bottom line.