Norway’s $750 billion sovereign wealth fund is preparing to weigh in on high frequency trading (HFT), a practice that has been credited with improving price discovery and reducing trading costs. While the fund acknowledges that HFT is a diverse set of strategies, it’s worried that the regulatory discussion is being dominated by groups that benefit from the practice instead of the large institutional investors that make up much of the market, reports Nathaniel Popper for The New York Times.
NBIM’s concerns for high frequency trading
Norges Bank Investment Management (NBIM) first signaled its concern about HFT in a discussion note that came out last month. Instead of taking a definitive stand, the note signaled that NBIM was mostly concerned about issues that specifically affect large, long-term investors like itself (NBIM owns about 1 percent of all U.S. stocks and 7 percent of all European stocks) including predatory HFT strategies, transient liquidity caused by HFT’s high rate of order cancellations, and the impact of low-latency arbitrage strategies.
“The U.S. market has gone through a lot of changes and has become quite complicated — and this complexity of the market creates a lot of challenges for a large investor like us,” said NBIM’s top trader Oyvind Schanke. “We don’t see any evidence that it is cheaper for us to trade.”
Trading costs for large traders
Even if fees are lower and spreads are narrower (the most obvious ways to calculate trading costs), HFT creates implicit costs for large traders that are harder to quantify. When a fund wants to buy a large number of stocks, for example, it’s difficult to do so without alerting other actors in the market, who could then make a small profit by getting out ahead of the larger firm. Strategies to hide large purchase orders increase the complexity and cost of execution as well as the timing risk.
And this doesn’t include abusive strategies that NBIM says are both possible and difficult to monitor. Since HFT strategies already account for so much traffic, (with a quote-to-trade ratio of 10 – 15 compared to a normal range of 1.5 – 3), it’s possible to intentionally slow down an exchange by overloading it with false orders, creating latency arbitrage opportunities. These predatory strategies may be illegal, but that doesn’t mean they are easy to catch or prevent.
NBIM is careful not to vilify HFT, but it seems clear that the group wants regulators to take a more active role to make sure that trading rules benefit a large cross-section of traders.
“The regulations that were put in place have created a market that is too complex,” said Schanke. “It would be beneficial to reduce the complexity in it.”