Laboring To Define HFT
June 21, 2012
My last blog on high-frequency trading generated a fair amount of angry responses, most of them deserved.
There’s no question that I treated a complex subject with all the subtlety of a street riot.
Yet the issue won’t go away. The way that ETFs and their underlying securities trade lies at the heart of how ETFs work, and plays a huge role in investors’ experience using ETFs.
Because high frequency trading, or HFT, accounts for roughly half of all trading, we need to understand the nature of the beast.
The CFTC is working to define exactly what HFT is. That a tightly worded definition is taking three months to draft highlights how difficult the issue has become. It’s a contentious work in progress, and the outcome – the final definition and how it will be used – is anything but clear.
Many of the participants in the debate will be probably unhappy with the result. There’s no doubt that stakeholders sought to tweak how HFT is defined with an eye towards how it might be regulated. That’s understandable.
Thursday’s Wall Street Journal touched on the many angles at work here, including exchanges trying to protect market share, fund issuers wanting to be outside the definition and market makers wanting to be left alone so they can do their job.
Drafters are working to balance all this to create a definition that won’t be gamed. The odds of coming up with something everyone can agree on seem small.
Still, I believe that working toward a common definition makes sense. A definition can help to frame the debate more constructively than the binary HFT good / HFT bad approach that I and others have fallen into.
By separating the concepts of HFT trading from manipulative HFT trading, a definition clarifies the point that not all HFT is manipulative and not all manipulative trading is via HFT. That’s my hope anyway.
The diverse group of stakeholders can probably agree on one point: Any manipulative trading – whether done with a supercomputer or a phone call– should be detected and prosecuted.
Are regulatory bodies up to the task? That is the rub. I don’t know. But they need to try in my view. Other may disagree with me, and that’s fine.
Understanding HFT as the latest step in the evolution of how securities are traded, and what it means to all market participants – institutional giants, fleet-footed hedge funds, and individual investors – seems to me to be critically important to all those who care about investors and markets.
Working to create a common definition is a good place to start.