Alternative equity trading venue operator Keith Ross thinks the aggressive HFT reform policies outlined by Securities and Exchange Commission Chairwoman Mary Jo White yesterday have the potential to change industry business models but it “is not onerous” and the high frequency trading (HFT) firms “will adapt and continue to do well.” This comes as Eric Hunsader, perhaps among the more vocal critics of the SEC and HFT, is positive on White’s speech with a caveat.


Former GETCO CEO and alternative trading venue operator says SEC proposed changes would improve market stability

In an interview Ross, the former CEO of HFT firm GETCO who now holds the that same post with an alternative equity trading venue PDQ Enterprises, says that even some of the more controversial topics White outlined could end up benefiting market participants by offering a more secure trading environment. He said registration of HFT firms, for instance, would be nothing more than an inconvenience but wouldn’t necessarily impede honest market makers and HFT firms from conducting their business.

On perhaps two of the most controversial topics White touched on was payment for order flow and faster market access for HFT traders than that of the average investor, Ross was positive while Eric Hunsader, whose software company monitors HFT’s bad behavior, is cautiously optimistic.

SEC critic is cautiously optimistic

“What White said was great,” said Eric Hunsader, perhaps among the most vocal critics of the SEC and HFT. But along came a caveat.  “So long as they execute.  They need to do what they say they will do.”

Hunsader, president of Nanex, a software firm that tracks market behavior to the millisecond, has also spoken in front of the Chicago Federal Reserve on issues he believes weaken market structure.  In White’s speech he is concerned regarding the amount of time it might take to implement reforms, speculating on a two year time frame.

Some reforms need immediate action, he argues.

One of the sensitive topics White touched on was the duel feed issue that allows HFT firms a quicker pipe to execute trades.  “The direct feed issue needs to be done tomorrow.  Look at the language used in the fine levied on the NYSE for a template,” Hunsader said, referring to an issue where providing certain traders faster speed than average traders was addressed.  For his part, Ross agreed and said that HFT firms will just need to adjust.

Eliminate speed advantage, change business model to profitability from bid-ask spread

Trading venue operator Ross thinks the equalization of speed advantage and changes to the payment for order flow – highly controversial HFT advantages considered illegal in some circles – will bring about dramatic changes to the industry, but HFT will adapt.  In particular, Ross says HFT firms might need to rely on a wider bid-ask spread, the small differential between the buy and sell price, rather than use speed to get ahead of customer orders.  As previously reported in ValueWalk, Market researcher Larry Tabb has also suggested that a widening of the bid-ask spread and actually increasing transaction costs could benefit stability and stickiness in equity markets.

Most dangerous HFT issue remains little discussed until yesterday’s speech

White also took aim at perhaps the most dangerous, but little discussed, aspect of HFT: flash crashes.  In looking at “Anti-Disruptive trading that could be a result of manipulation – a major behind the scenes concern or regulators and financial reformers – could be the most important. Flash crashes are not officially monitored. Hunsader’s software does this, which is what motivates him to speak so forcefully regarding this danger.  This is a cautious area for regulators but speaks to their core mission: market stability and investor protection.

HFT proponent says quantify disruptive trading with factual, data driven approach

Among HFT’s biggest proponents is Peter Nabicht, a former HFT trader himself with a deep background in market structure.  Now head of Modern Markets, an advocacy group for the HFT industry, Nabicht addresses disruptive trading then makes a controversial statement.

“A rule around disruptive trading is something that should be quantified and based on data and hard work should be done to avoid and understand false positives,” he said in an interview. “It should apply to all market participants, not just those high speed. Truly disruptive behavior is disruptive at any speed.”

It is that last sentence that might cause a bit of a debate. The opposite argument is that HFT can manipulate markets over a short term periods because it doesn’t require as much capital as it would to do so on a longer trade of eight months, for instance.  If the liquidity limit of the one of the secondary bond markets was $30 million (using a random number), the HFT firm might be able to move the market for a few milliseconds.  But to keep this type of constant selling in one direction over the course of eight months would be very difficult if not impossible for all but the largest banks – or the US Federal Reserve, for instance.

In regards to studying data on flash crashes, as Nabicht suggests, one issue is the only one currently monitoring for flash crashes appears to be Hunsader and his software company.  Most flash crashes are labeled as “fat finger” events, which comes on the back of the official flash crash report and subsequent flash crash discussion mimicking this excuse.

Nabicht wants to root out wrongdoing that endangers market structure, yet advocates doing so utilizing a careful, thoughtful approach. Transparency is one key to this.  “Almost every section of the speech touched on ways to improve the transparency of the market which should help shine light on wrong doing, give investors more confidence, and allow the majority of participants to continue their healthy and beneficial involvement in the markets.”

Speculation on behind the scenes actions

With yesterday’s speech, a faint murmur of speculation is wondering if White is turning a reformist shade? Although opinions vary, speculation is White is serious about HFT reform and protection of market structure.  Her reformer credentials will not be decided entirely based on HFT, however.  Will she, as did former CFTC Chairman Gary Gensler, brake away from big bank clutches in an attempt to reign in unregulated derivatives, a risk to the entire economy that former SEC Chairman Arthur Levitt called a “doomsday machine?”

The HFT issue is easy for White to be a reformer on because the key big banks aren’t at the heart of the matter.

The real test for White will come when she administers justice with regards to big bank elites who appear to face a different legal standard than do other traders and business executives.