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December 1, 2010

Minimum Quote Life Faces Hurdles

By John D'Antona Jr.

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It's only an idea now, but there is widespread discussion in the equities markets about instituting a rule to require exchanges to freeze quotes or orders for a minimum amount of time, also known as "time-in-force."

Time-in-force first surfaced in the Security and Exchange Commission's Concept Release in January. The idea has since gained traction because high-frequency traders' speed in executing trades and canceling orders might have contributed to the May 6 "flash crash."

Chris Isaacson

But implementation of any such notion into a rule seems a long way off and faces many hurdles. In short, a TIF rule would mandate a minimum amount of time an order or quote could remain active before it is executed or is canceled. The thinking goes that a TIF requirement would slow trading down and maintain an orderly market in times of market stress.

The likely minimum duration for a quote under such a proposal could be 50 milliseconds, suggested several sources. Quotes can currently be updated in the low-millisecond range.

The problem, as opponents of such a rule see it, is liquidity providers would be less likely to trade and post limit orders. That would ultimately hurt liquidity and widen spreads, making trading more expensive for all investors.

The topic of a minimum time for quotes came up during this summer's joint meetings on the flash crash between the SEC and Commodity Futures Trading Commission. In September at the Economic Club of New York, SEC Chairman Mary Schapiro said the SEC is considering introducing a minimum "time in force" for orders to offset the frenetic cancellation of orders by high-frequency traders.

During her speech, Schapiro asked whether high-frequency firms should be prohibited from withdrawing liquidity out of the market during times of volatile price movements or be treated as market makers and have an obligation to provide liquidity at all times.

"We know that, in the ordinary course, many high-frequency trading firms cancel 90 percent or more of the orders they submit to the markets," Schapiro said. "There may, of course, be justifiable explanations for many canceled orders to reflect changing market conditions."

According to data distribution firm Nanex, on an average trading day 15 to 20 of the most actively traded stocks receive more than 5,000 quotes a second that never result in a trade.

Congress is weighing in on the matter, as well, in an effort to push for constraints on high-frequency trading. Sen. Charles Schumer, D-N.Y., has expressed concern over the speed of trading and whether some sort of restriction, such as a minimum time requirement, is in order. In a Sept. 7 letter to the SEC, Schumer said he was "increasingly convinced that the costs of reducing execution speeds by an extra microsecond here or there outweigh the benefits in terms of allocating capital efficiently."