Bart Chilton, a former commissioner of the Commodity Futures Trading Commission, is a senior policy adviser at DLA Piper and the author of “Ponzimonium: How Scam Artists Are Ripping Off America.”
The accusation by the New York attorney general last month that a British bank misled some of its customers about the likelihood their orders would interact with high-frequency traders gives a glimpse into a big secret: speedy electronic trading is deeply entrenched in modern financial markets and investors’ orders aren’t being filled without them. In today’s world of global stock trading, high-frequency trading results in highly frequent liquidity.
At any one time, it is likely that 50 percent of all trades are made by high-frequency traders in United States equity markets. Even trading volume on the IEX exchange, which is trumpeted as creating “institutional fairness” in the Michael Lewis book “Flash Boys” about the topic, is now made up of roughly 50 percent high-frequency traders, according to conversations with market participants, though the exchange says it is significantly lower. The real lesson of the recent, and deserved, attention to such trading is this: technology in modern markets is here, will not disappear and is providing significant benefits to institutional and retail investors.
For four years, I have been raising issues with high-frequency traders, but we should have our eyes open to the positives and negatives. For example, even though the New York attorney general’s complaint and the general public conversation use demonizing words like “predatory” and “toxic” to describe high-frequency trading, study after study has proved that modern markets are cheaper and safer than ever before. The chairwoman of the Securities and Exchange Commission, Mary Jo White, said on June 20: “Our markets are not broken and they are not static. In that sense, our work on market structure is never finished — the speed with which technology and markets change makes that impossible — instead, we must always be focused on what in our market structure can be improved for the benefit of investors and companies.”
The bottom line is that high-frequency traders provide professional grade intermediation in modern capital markets and are an important part of the industry discussion espoused by Ms. White. High-frequency trading — done for profit, for sure — moves supply and demand among long-term investors quickly and efficiently. This serves an important function, reduces volatility and helps make markets better. This is why IEX needs them, the stock exchanges need them and so do all the bank dark pools.
The question now is: What can be done to improve the circumstances and investor confidence in markets and trading?
We want the benefits of high-frequency traders and their technology, but we need to make sure the technology is being deployed safely and responsibly because everyone has a stake in the outcome. It is still an amazing mystery to me, and shocking to some, that many high-frequency trading firms are not even required to register with the S.E.C. or the Commodity Futures Trading Commission. That means regulators at times may not have direct access to books and records needed for investigations.
Furthermore, there are only limited requirements that trading programs be tested or have kill switches, although the best high-frequency trading firms would not dream of not doing so. These basic, fairly pedestrian steps would allow those that use such market technology to be vetted and would better safeguard against the human error and better protect markets.
Critics have said it would be too difficult to define the threshold by which a market participant should be considered a high-frequency trader and therefore regulated. That’s nonsense. If a firm is trading directly in our capital markets using computer automation, a privilege in my opinion, it ought to be easy to pull them up on the regulatory radar.
Fortunately, there is an emerging view among some in the world of high-frequency trading that in addition to a fulsome discussion about the benefits of such trading, we should require more advanced regulation. Numerous high-frequency traders, some of them already fully regulated, have suggested additional steps. They want to be regulated more because they know that a safer, well-policed market will yield higher investor confidence. And guess what? It will create even deeper and more liquid markets, which is a great outcome.
And that’s an important development, which if acted upon by industry participants, lawmakers and regulators, will keep improving markets, a vital economic engine of our economy.