High frequency damage control
With recent advances in technology and knowledge, the time has come for exchanges to set their acceptance levels in regard to high frequency trading (HFT); an act that will prove revealing in regard to the allegiances the exchanges hold toward either their investors or their traders. Both parties line the exchanges’ pockets of course, but their raison d’être is to serve the former, not to enjoy the transaction-fee-based-income from the latter.
With a fundamental preference for HFT presences now established in the market, thanks to the improvements to liquidity and pricing that they bring, and with exchanges now able to keep the most polluting aspects of HFT out of the market, exchanges globally are empowered to nurture but control this historically unruly clique of traders.
We know it can be done because we’ve seen it in Australia, where the stock exchange has come down fairly hard on HFT by establishing a definition of high frequency traders that allows them to section off the group at any given moment, should problems arise. It has also declared its intention to punish the worst offenders in the group – who, for instance, bring inefficiencies rather than efficiencies to the market by making large numbers of trades, sometimes hundreds of thousands per second, in order to clog the pipes and dominate trading flow (a form of market manipulation).
The mere mention of such intentions has already brought large reductions across the most negative HFT activities there, and such effective action has impressed investors, exchanges and consultancy firms the world over.
Despite the fact that exchanges worldwide can now act on Australia’s experiences, however, none have elected to do so. HFT problems are extremely significant in major exchanges like Tokyo and New York. The fact that neither has acted raises questions about the extent to which they are enjoying transaction-fee-based-income to the detriment of market efficiency there.
Ultimately, the decision is one of fairness, and it’s important that these institutions display a natural tendency toward such a status. Reinforcing the need for clear, decisive action, major consulting firms insist such controls must be rules-based, rather than principles-based, because people have historically proven highly prone to misinterpreting the principles.
Inaction, as the situation slides on indeterminably, is becoming inexcusable.