The Federal Reserve continues to monitor the increasing presence of high frequency traders in the capital markets and in its latest survey asked respondents about their trading practices and how these firms affect the marketplace.
In its latest quarterly survey, the Senior Credit Officer Opinion Survey on Dealer Financing Terms, the Fed asked 14 specific questions about speedy traders.
The Senior Credit Officer Opinion Survey on Dealer Financing Terms (SCOOS) is a quarterly survey providing information about the availability and terms of credit in securities financing and over-the counter (OTC) derivatives markets.
The survey panel for the SCOOS includes 20 dealers and may be expanded to include other firms over time. These firms account for almost all of the dealer activity in dollar-denominated securities financing and OTC derivatives markets. The survey is directed to senior credit officers responsible for maintaining a consolidated perspective on the management of credit risks.
The report noted that market commentaries have pointed to the increased participation of high-frequency trading (HFT) firms in a number of financial markets. A set of special questions in the December survey asked about markets in which dealers extend intraday and overnight credit to their HFT clients. In addition, dealers were queried about changes over the past three years in the use of intraday credit by HFT clients in U.S. cash equity markets as well as changes in terms extended to such clients over the same period. Dealers were also queried about practices employed to monitor and manage intraday exposure to such clients. Finally, survey respondents were asked how increased HFT participation in the interdealer market for cash Treasury securities has affected dealer behavior in the dealer-to-customer market over the past five years.
Credit extended to high-frequency trading clients in a number of financial markets
About two-thirds of respondents indicated that they have HFT clients. However, dealers did not apply a consistent definition of HFT clients when answering the survey. The exact definition applied seems to differ according to the dealer’s business model and the visibility they have into the activity of such clients. More specifically, some respondents narrowly defined HFT firms to be proprietary accounts that use low-latency technology and generate high trading volumes during the day but generally tend to close the trading day with little or no exposure. Other dealers defined HFT firms to be clients who utilize low-latency technology, including those that may employ a significant amount of leverage in intraday trading and that may carry sizable positions overnight. Yet others defined HFT firms much more broadly to include all algorithmic traders, even if such traders do not necessarily use low-latency technology. The range of definitions suggests that there are significant differences in dealers’ interactions with what are described as HFT clients, including in the terms of services they provide to such clients and the resulting risk exposures.
Of those respondents that have HFT clients, four-fifths reported that they extend intraday credit to such clients in U.S. cash equity markets, and nearly two-thirds responded that they do so in the U.S. cash Treasury market, spot and futures foreign exchange markets, and U.S. equity futures markets. About two-fifths of firms indicated that they extend intraday credit to HFT clients in the U.S. Treasury futures market.
Between two-fifths and three-fifths of respondents reported that they also provide overnight credit to HFT customers in cash and futures markets (Treasury, equity, and foreign exchange markets). Responses to this question were importantly driven by the definition of HFT firms adopted. Broadly speaking, dealers that had a narrower definition of HFT firms were more likely to report that they did not provide overnight credit, consistent with the notion that these firms tend to end the day flat in terms of exposures. Any overnight positions reported were said to be de minimis when compared with intraday positions. Some respondents also included settlement-related exposures in their definition of overnight credit, especially with respect to futures contracts. By contrast, respondents that adopted a broader definition of HFT clients indicated that such clients may carry sizable positions overnight (especially in cash markets). In these cases, respondents reported that they may provide overnight credit in the form of securities financing (often through prime brokerage relationships).
Lastly, the increased presence of HFT firms in the interdealer Treasury market has resulted in a tightening in terms quoted by dealers to their clients in the dealer-to-customer markets. In particular, more than two-fifths of respondents, on net, pointed to a tightening in price terms (such as widening bid-asked spreads) and nonprice terms (such as smaller quote sizes) over the past five years.
