At an industry event last week, SEC Chairwoman Mary Jo White seemed to make a case that algorithmic trading has just as much a role in the health of the markets as HFT and dark pools.
In prepared remarks given on June 5th at the Sandler ONeill & Partners Global Exchange and Brokerage Conference in Manhattan, Chairwoman White said, Another important concern raised by algorithmic trading is fairness to investors. Do low latency tools, even though they are available to investors through brokers, tend to advantage certain types of proprietary trading strategies that may detract from the interests in investors?
She added, I have further instructed the staff to prepare recommendations to the commission to improve firms risk management of trading algorithms and to enhance regulatory oversight over their use. Given the overwhelming dominance of trading algorithms, it is time that our regulatory regime is updated to take better account of the risks when they are poorly designed or operated.
To see if algo trading might be as vulnerable as HFT and dark pools, Traders spoke with industry veteran John Adam, global head of product management for Portware, for his insights.
Traders: Is algorithmic trading in the SECs crosshairs?
John Adam, Portware: What I find the most interesting about that comment is that Mary Jo White is putting different entities under the same tent with that comment. In effect shes saying that a market-making algo is related to or at least may share some of the same DNA as a short-term proprietary trading algo and an algo, which is designed to navigate an institutional order in and out of a dark pool.
Now, I think that adding transparency and principles-based regulation is something to consider. The concern that we always have, and certainly this is the case with Reg NMS, is unintended consequences. I think this is a constructive approach and Im not surprised that traders are engaging with the SEC because I think in any industry theres a preference to have a debate rather than a witch hunt. If your choice is the Attorney General or the regulator, then I think that that choice becomes pretty apparent.
Traders: But is algorithmic trading vulnerable to new rules and even extinction?
Adam: Are algorithms in the crosshairs? I dont think so. Obviously Michael Lewis book has created an outcry but what I read is that Lewis looked at the same factors that Mary Jo White is looking at now and he saw a conspiracy whereas the SEC saw a market that needed regulation. Thats the fundamental difference between the two. Both had access to the same data and one is writing an entertaining book while the other is looking at market structure and asking how does it need to be adjusted in order to improve really the two. She names it right up front. The secondary market is there for investors and for companies to generate capital.
Traders: Although Mary Jo White was not a member of the SEC when Reg NMS came out, she is the head of the agency that basically implemented this current playing field. She didnt seem to come out and say we created this mess and now we’ve got to fix it.
Adam: I dont know if anybody could have seen that this would be the result of Reg NMS because one of the things that was happening at the same time was that trading is moving from manual to machine-driven. We happened to be on-station and all-observing and participating in industry at the moment in time where trading went from human speed to machine speed.
I think that the problem that Reg NMS was intended to solve, which is that we had a duopoly with two exchanges — NYSE and NASDAQ — and almost all of the trading was done through that and along with it all the things that come along with a monopoly including accusations and in some cases with convictions of front running amongst the specialists on the trading floor. It took care of that very effectively. As with many things however, a new environment, a new technology, a new market structure creates new problems that again need the engagement of the industry participants and the regulators.
I think its always a good idea for the regulators and the market participants to engage in a dialogue. The outcome of that is never guaranteed though. The likelihood of everybody being happy with what comes out of that, it would be shockingly low. The two ways it can go wrong is either one participant just doesnt go far enough, the other side says this is draconian. It is a matter of balancing and continuing the monitoring of that and I find some of the things in the speech to be quite encouraging in that direction.
Traders: Is this basically about the Flash Crash? Are we still dealing with the events of August 1, 2012 when Knight Capital just lost $440 million in one day?
Adam: Its cumulative. I think the interest rate, which was raised by Lewis book, is a cumulative effect on top of that. It wasnt quite enough when the flash crash happened. The issue there was more relevant to [having] different sets of circuit breakers for NYSE and NASDAQ. We now have a national market structure. We need to make sure that the safeguards conform to the type of market weve designed. Now were seeing an additional layer on top of it where were looking at things like latency and [what Chairwoman White called] poorly designed code. That struck me as sort of the most relevant bridge to what happened in 2013 up to now. So finally theres enough of an interest level that the SEC is looking to step in and engage, but I would say its more of accumulative a fact than anything else.