TO SAY that high-frequency trading (HFT) is blamed for every big financial mishap is to exaggerate – but only slightly. Regardless of the hard evidence from academics, exchanges and regulators about the positive impact of HFT, the critics continue to dominate headlines.
It’s not hard to see why. Innovation in any industry has always attracted critics. To compound matters, the media and policy makers alike are receptive to anti-HFT rhetoric because it is anti-financial industry. But the evidence tells a very different story.
Take the May 2010 flash crash. Again and again the critics cite it as exhibit A in their indictment of HFT. Yet a joint report by the Commodity Futures Trading Commission and the Securities and Exchange Commission, the two government agencies that oversee the US markets, concluded that HFT wasn’t the cause. Moreover, a report by the Chicago Mercantile Exchange shows that far from causing the flash crash, high-frequency traders actually absorbed the initial sell orders.
The latest example of anti-HFT criticism came with the Facebook fiasco. Once again the critics pointed their fingers at high-frequency traders and blamed them for the bungled offering. This is an absurd accusation. Nasdaq has acknowledged that its own technical issues were to blame for the problems that dogged Facebook’s market debut. Contrary to claims, HFT firms caused no disruption to Nasdaq’s problems in opening up Facebook’s shares for trading.
Yet the myths persist. Our mission at the FIA European Principal Traders Association (EPTA) is to bring balance to the HFT debate. We recognise that fact can be less compelling than fiction, and we know that we often stand in the way of the media’s never-ending search for a good story for tomorrow’s paper. But financial market policy must not be driven by emotive language, anecdotes and fabrications.
The great thing about electronic markets is that there is plenty of market data available for analysis, and we think this empirical evidence convincingly demonstrates the benefits of HFT.
Let’s look at some of that evidence. HFT has substantially reduced frictional costs in the markets and is therefore of benefit to end-users, including pensioners. As Vanguard has stated, transaction costs in US equities have decreased by about 60 per cent in the last 15 years. These lower transactions costs will enable mutual fund investors to expect an investment balance around 30 per cent higher than they would have otherwise.
Equally misguided are assertions that HFT causes volatility. Much academic evidence shows that it either does not affect volatility, or even reduces it. Volatility is more likely to be caused by macroeconomic and financial developments. And rather than leaving the market at times of high volatility, as is claimed, the evidence suggests that HFT firms do the opposite. Our organisation’s figures on the amount of trading by our members shows that our market shares peak in periods of volatility.
Then there is the charge that high-frequency traders provide “fake” liquidity, withdrawing quotes before they can be acted upon. This is impossible. Automated and regulated exchanges simply do not enable fake quotes. These markets are not a cat and mouse game, where the mouse gets back in its hole as soon as he sees the cat. In the exchange traded markets the only way the mouse knows that there is a cat is when he’s already been eaten. In addition, in a large amount of the trades executed on exchanges, our members are involved on at least one side of the trade. The liquidity that we provide is very real and very essential.
Our critics choose to overlook the value we add to the real economy. We lower transaction costs and increase liquidity. As such, we urge policymakers to weigh up the costs of regulatory reforms. No one benefits if badly designed regulations disrupt liquidity and drive up costs for traders and investors.
Remco Lenterman is chairman of FIA EPTA. FIA EPTA represents firms that trade their own capital in the European exchange-traded markets.