Pipeline's Berkeley Roasts High-Frequency Traders as "Natural Enemy" of Institutions
Traders Magazine Online News, July 23, 2009
In this Q&A, Alfred R. Berkeley III, a 30-year industry veteran, argues that the growth of high-frequency trading has hurt the ability of traditional buyside firms to execute orders with limited market impact. Exchanges and broker-dealers, pursuing market share, cater to high-frequency firms at the expense of institutions, said Berkeley, chairman of Pipeline Trading Systems, a block-trading platform geared to institutions and broker-dealers.
Al Berkeley, Pipeline Trading
Berkeley joined Pipeline in 2004. From 1996 to 2003, he was president and then vice chairman of Nasdaq Stock Market. Prior to that, he was a managing director at investment bank Alex. Brown & Sons. He co-founded the firm's technology group in 1975, three years after joining Alex. Brown. In this interview, conducted by Senior Editor Nina Mehta, Berkeley discusses block trading, high-frequency firms, pattern-recognition software, the national best bid and offer, and the regulatory landscape.
Traders Magazine: In your view, what distinguishes market centers from one another?
Alfred Berkeley: It's about what systems are optimized to do, and who they're optimized to serve. A recent TABB Group report said that 73 percent of trading is attributed to high-frequency traders. Displayed markets and large brokerage firms, in order to have a large market share of the larger market, have to optimize their systems to attract high-frequency traders. High-frequency traders are the natural enemy of the individual investor and the large institutional investor. Most market centers are doing things that disadvantage the individual investor and institutional investor, because they're doing things to advantage the high-frequency trader.
TM: What's an example of this?
Berkeley: A great example is co-location. The idea that an exchange would let one set of market participants locate their computers inside their data center and not give the same speedy response to everyone is a blatant tilt in favor of high-frequency trading. There are very few people who can resist the heroin needle of trade volume and do something that optimizes the market for institutions. Pipeline's business model is premised on optimizing around the institution's needs, even though they are just a quarter of the market now.
TM: Are there other ways in which the growth of high-frequency trading has led to changes in business models that disadvantage institutional investors?
Berkeley: The development of algorithmic trading favors high-frequency traders. The creation of so-called dark pools that many broker-dealers run benefits high-frequency trading firms, including a broker's own internal prop desk. That's why you see such small execution size in those pools--250 shares on average. Institutions don't trust those pools and can't put large orders in them.
TM: Does high-frequency trading have an impact on the quality of liquidity in the market?
Berkeley: Of course it does. The best way to see that is to look at the size at the inside and see how many orders are canceled when it looks like momentum is going from the buyer to the seller. And the average trade size is just lousy.
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