Mary Shapiro weighed in on high frequency trading again. Well, sort of:
The rules the SEC is contemplating are vague, but could involve fees on high volumes of order cancellations or a minimum time enforced for quotes. “While we haven’t landed on concrete things that we will do next,” Schapiro said, “all these ideas are live and subject for discussion within the agency.”
The WSJ has a little more:
Among the ideas the agency is considering, she said, is the implementation of obligations for certain high-frequency traders to provide quotes near the national best bid and offer prices—the highest buy and lowest sell orders across the market—during a certain percentage of the trading day.
The SEC also is weighing imposing fees on order cancellations, which constitute “a vast majority of orders” submitted by high-frequency firms, Ms. Schapiro said. An estimated 95% to 98% of orders submitted by high-speed traders are canceled as the firms rapidly react to shifts in prices across the stock market, according to Tabb Group, which tracks trends in electronic trading. The possible fee, previously mentioned in a joint advisory committee of the SEC and CFTC, would likely be a tiny fraction of a cent per canceled order, experts say.
Imposing obligations is not costless. Requiring people to quote when they don’t want to quote means that they will quote poorer prices. With respect to cancellations, yes, some abusive HFT strategies do allegedly involve quote stuffing followed by cancellations. But many salutary HFT strategies, including the cyber equivalent of scalping-market making-also involve large numbers of cancellations. Market makers are at risk of being picked off, or of trading at stale prices, and hence want to cancel orders, and perhaps submit new ones at different prices, when new information arrives. And in an electronic environment, new information arrives rapidly. Locals scalping in futures pits were only obligated to trade at their quotes “as long as their breath was warm” to limit their exposure to these problems: cancellations by HFT traders making markets serve the same purpose. Taxing cancellations could well impair these legitimate uses of cancellations more than the abusive ones, leading to less liquidity and costlier trading. This is a very blunt tool indeed.
The fundamental issue is that HFT is not one thing. There are a variety of HFT strategies, some of which are beneficial, others arguably opportunistic. Moreover, it is quite possible that a given HFT firm uses a variety of strategies, some of which are beneficial, some of which are opportunistic. The focus should be on trying to identify order submission patterns that are characteristic of opportunistic strategies, and those that are characteristic of beneficial ones (e.g., market making) and develop pricing or enforcement measures that are targeted at the abusive strategies. Meat axe approaches like taxing cancellations are indiscriminate, and risk doing far more harm than good.
Shapiro doesn’t inspire confidence when she says things like this:
Schapiro expressed concerns of her own Wednesday, lamenting the current volume of trading that is “unrelated to the fundamentals of the company that’s being traded.”
“It’s got very little to do with whether you think IBM’s got a great business plan and solid earnings growth in its future … and a lot more to do with what’s the minuscule aberrational price move that you can take advantage of because you’ve co-located your computer with the exchange and can jump on that in microseconds,” she said.
“And that worries me in some ways.”
There has always been trading unrelated to fundamentals, that has been technical in nature and focused on profiting from minuscule price moves. That’s what most market making is about. Indeed, the existence of that kind of trading produces the liquidity that facilitates long term trading. And there have always been time and space advantages in trading. Why do you think people paid hundreds of thousands, and sometimes millions, of dollars to be on the exchange floor? The views? The charming company? No. Because being on the floor gave you an edge.
Shapiro’s testimony suggests that the SEC is befuddled by HFT. This is understandable, because there’s a lot about it that is not well understood, and because it is surrounded in a fog of mystery and controversy. But her testimony also suggests a deep-seated suspicion of HFT, and preference for indiscriminating solutions that will throw the baby out with the bath.
Not too swift.