Market structure recommendations from regulators drew guarded praise from one group of affected parties and scorn from another.
The recommendations came from an advisory committee sponsored by the Commodity Futures Trading Commission and the Securities and Exchange Commission. The group’s February report is intended to serve as a road map for regulators searching for ways to prevent another market flip-flop like the flash crash of May 6, 2010. While many of the 14 recommendations are already in rule form or have been agreed to in principle, a few are likely to produce vigorous debate.
Those recommendations already in rule form include putting circuit breakers on individual stocks; making updates to clearly erroneous trade rules; banning so-called "stub" quotes; a ban on naked access; and a proposal for a consolidated audit trail. Those still in the idea stage, but considered likely to become rules, include limit up/limit down functionality and a revision of existing marketwide circuit-breaker rules.
Any fireworks are likely to come as a result of the report’s third section, which focuses on maintaining market liquidity. The committee targets both high-frequency traders and broker-dealers that internalize order flow.
For HFTs, the group suggests that the SEC consider encouraging firms engaged in market-making strategies to maintain bid and offer quotes that are "reasonably related to the market." Previous suggestions to mandate quoting have been criticized by some high-frequency traders as anticompetitive and bad for the market. In their report, the committee suggests that encouragement could come in the form of pricing incentives rather than by regulatory fiat. The committee suggests the exchanges institute "peak load" pricing schemes to draw liquidity at the times of greatest needs.
For one group of HFTs, such language is encouraging. "We agree with the committee’s conclusion that market-based incentives are more effective than mandatory obligations in promoting well-functioning markets," members of the Futures Industry Association’s Principal Traders Group said in a statement.
An idea unlikely to receive FIA PTG support, however, is cancellation fees. The joint committee also believes the SEC and the CFTC should explore the idea of implementing uniform cancellation fees across exchanges. Placing orders and immediately canceling them is standard operating procedure for many HFTs.
As for the internalizers, the committee recommended that the SEC consider adopting a trade-at rule. Because a lack of liquidity was at the heart of the flash crash, the committee reasons that forcing brokers to send more flow to the public markets would be helpful. A trade-at rule would require brokers to either offer significant "price improvement" to their incoming orders or route them to the exchanges.
Such a rule could make it significantly more expensive for brokers to internalize, or fill their customers’ orders in-house. Last year’s SEC concept release suggested that price improvement could be as much as 1 cent over the market’s best bid or 1 cent under the market’s best offer. That’s a considerable amount in an era where spreads on many stocks are a penny. Higher price-improvement costs could lead brokers to route out more of their flow.
That doesn’t sit well with some internalizers. "One of the advantages of matching up two client orders at the bid or offer is that I don’t have to send it to the public market and run the risk it will be gamed," said Owain Self, UBS’s head of algorithmic trading for the Americas and the EMEA region, at this year’s TradeTech USA conference.
The fear of gaming by high-frequency traders has become a major concern for money managers and their brokers these days, as the amount of fast-paced speculative trading has surged.
"If all of the orders wind up in the lit markets, who’s going to be first in the queue every single time?" Self asked. "It will be the HFT, because he’s faster than everybody else. So I will always be behind him. He knows what my clients are doing. Internalization is a way to limit that."
Dmitri Galinov, head of liquidity strategy for Credit Suisse’s Advanced Execution Services group, operator of the CrossFinder dark pool, also believes trade-at is a bad idea. He noted that it costs more to route an order to a stock exchange or ECN than it does to route to a dark pool. "Why should I be forced to pay 30 mils at an exchange when I can take a dark pool and pay five mils?" he asked at TradeTech. "It doesn’t make sense."
Despite their opposition to a trade-at rule, most of the dark pool operators are skeptical one will be written into the rulebook any time soon. For one thing, the SEC has too much on its plate to tackle such a controversial proposal.
"I don’t see it happening this year," Galinov said. "It’s probably unlikely next year, as well."
(c) 2011 Traders Magazine and SourceMedia, Inc. All Rights Reserved.
http://www.tradersmagazine.com http://www.sourcemedia.com/
(c) 2011 Traders Magazine and SourceMedia, Inc. All Rights Reserved.
http://www.tradersmagazine.com http://www.sourcemedia.com/
