High-frequency traders: Market friend or foe?
Two reports released this week illustrate the polarity of opinions on market structure that have existed since high-frequency trading was introduced to Canadian markets in 2007
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A report on high-frequency trading published this week by respected U.S. market consultant TABB Group says that despite the hard work of Canadian regulators, balancing benefits with the challenges of this new breed of lightning-fast trader remains a “work in progress.”
A second report published on the same day by the C.D. Howe Institute suggests the fuss over high-frequency traders is overdone, and contends that HFTs — as they are referred to in the industry — actually enhance market quality.
The two reports illustrate the polarity of opinions on market structure that have existed since high-frequency trading was introduced to Canadian markets in 2007, and several years earlier in jurisdictions such as the United States.
Critics include the backers of proposed new stock exchange Aequitas. A key component of the exchange proposed by Royal Bank of Canada, Barclays Corp. Ltd., and money management firms including IGM Financial is to thwart high-frequency traders that use their computer-driven speed to the disadvantage of traditional retail and institutional traders.
High-frequency, or algorithmic, trading accounts for about 42% of trading in Canada, and well over half the trading in the United States.
Last year, the Investment Industry Regulatory Organization of Canada set the stage for a crackdown on what it determined to be “manipulative and deceptive” trading practices associated with high-frequency trading. The “guidance” issued by IIROC was intended to tamp down HFT strategies that involve entering bids a trader has no intention of completing. The bids are entered and then almost immediately cancelled, with the intention of raising or lowering the price of a security so the trader can profit from the price movement.
Provincial securities regulators in Canada rolled out rules around the same time through their umbrella organization, the Canadian Securities Administrator, which are aimed at monitoring and reducing risks to the capital markets from high-frequency trading.
But this week’s TABB Group report by authors Adam Sussman and Lida Preyma concludes that Canadian regulators continue to face “significant hurdles” in attempting to reconcile the benefits and challenges that arose from the introduction of high-frequency trading and competition to traditional exchanges.
“Despite the benefit of hindsight… gained from other markets, including the United States, wrestling with these same issues since 2001, high-frequency trading remains a regulatory work-in-progress in Canada,” the authors conclude in the report published Thursday.
Jeffrey MacIntosh, the author of Thursday’s report from the C.D. Howe Institute, contends that high-frequency trading is not the “bane” of the capital markets that critics make it out to be.
He says the bottom line is that the lightning-fast trading enhances markets by lowering bid-ask spreads, reducing volatility, improving short-term “price discovery,” and creating competitive pressures that reduce broker commissions.
“Retail traders, despite being at a speed disadvantage, realize a net gain from HF trading in the world’s capital markets,” Mr. MacIntosh concludes.
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