Thomas Peterffy is the chairman and chief executive of Interactive Brokers, which operates the Timber Hill market-making firm. He spoke in Washington at a joint SEC-CFTC hearing and later with Traders Magazine about the May 6 “flash crash” and high frequency traders.
On the cause of the May 6 “flash crash”
As the market fell on bad news, portfolio-hedging ETF sell orders came to the market and plowed through relatively small bids. Then ETF arbitrage programs from high-frequency traders stepped in to buy ETFs and sell short the stocks in the basket. These short sales sliced through the relatively sparse bid size of the stock books. Then ETF market makers’ programs diagnosed unreliable stock prices and widened out or stopped quoting. This feedback loop of ETF stop orders hitting ever smaller and wider ETF quotes and high-frequency traders selling short baskets of the individual stocks at lower and lower prices continued even after saner heads prevailed in the broad-based stock index futures.
On a solution to prevent future flash crashes
The new circuit breakers will solve the problems of May 6, provided that we add that any ETF in which more than 3 percent of the underlying stocks are halted also be halted. This is extremely important to eliminate the ETF arbitrage feedback loop.
On the value of high-frequency traders
High-frequency traders contribute to the liquidity of the market. The isssue is they do not always do so. Sometimes they are users of liquidity even though more often than not they are contributors of liquidity. I think we should incentivize high-frequency traders to become market makers. Not just fair-weather ones, but real market makers-meaning that they should be contributing to liquidity almost all of the time.
On converting high-frequency traders into bona fide market makers
We need more and committed market makers. High-frequency traders should be encouraged to become bona fide regulated market makers. So let’s transfer them into a state where they always provide liquidity. Let them assume affirmative obligations and give them certain advantages.
On potential market-maker advantages
Market makers would have preferential access to the markets. This could be achieved if all orders, modifications and cancellations sent to any trading center were buffered for 100 milliseconds before being sent to the matching engine except when sent by a market maker registered in that product at that trading center.
On potential market-maker obligations
Registered market makers would have to post two-sided quotes of defined width and size 97 percent of the time. Furthermore, market-maker buys should take place on minus or minus-zero ticks-and their sales on plus or plus-zero ticks 97 percent of the time.
