Stopping The Financial Arms Race
August 30, 2012
Traders, not regulators, may end up pushing for better coordination of share market orders.
[This interview originally appeared on our sister site, IndexUniverse.eu.]
Seeking to gain an informational advantage over your financial market competitors is not only a long-established practice; the ability to do this successfully has laid the foundations of great fortunes.
Nathan Rothschild reportedly made a killing on UK government bonds by obtaining news of the outcome of the battle of Waterloo ahead of his competitors. Baron Julius Reuter, founder of the news agency, cleverly exploited a hiatus in the new European telegraph system between Berlin and Paris, using carrier pigeons to move stock quotes between Brussels and Aachen, the 95-mile gap between the two existing telegraph lines.
There are uncanny echoes of what Reuter did in the recent behaviour of high-frequency traders, as recounted in a superb recent article by Jerry Adler in Wired magazine. Infrastructure providers are competing to build chains of microwave relay towers between Chicago, home of the futures markets and New York, the seat of equity trading, Adler writes, merely in order to shave a few milliseconds off the time taken for messages to travel between the two cities. Clients, largely trading firms, who pay subscription fees running into millions of dollars a year, thereby have a chance to get an advance peak at financial information.
But, as Chris Sparrow tells us in the interview we published this week on IndexUniverse.eu, this technological arms race is not cost-free.
First, says Sparrow, there are diminishing returns on all the money invested in expensive data storage facilities and switching equipment.
But, more importantly, says Sparrow, if a by-product of the chaotic evolution of trading technology is decreased faith in the equity markets as a whole, then something needs to be done.
There’s surely plenty of evidence of this. According to a recent survey conducted by Tabb Group, institutions’ confidence in the structure of US equity markets continues to fall, and is much lower now than immediately after the 2010 Flash Crash. Whereas in May 2010 53% of respondents had “high” or “very high” confidence in US market structure and only 15% had “weak” or “very weak” confidence, by August 2012 the numbers in the high/very high and weak/very weak categories were the same, 34%.
“We believe that this erosion in confidence has been due to tough market conditions, declining market volumes, the Pipeline Trading scandal and, more recently, botched IPOs,” writes Tabb’s Adam Sussman, citing the Facebook debacle as a specific example of the latter.
And, judging by the feedback I hear from market making firms, there are plenty of traders who resent the impact on their bottom line of the increasingly expensive technological demands of the race for speed. Trading firms and exchanges are also suffering from the extended slump in equity market volumes and the diminishing appetite for stocks.
So while Chris Sparrow is surely correct in arguing that the equity trading business needs its own version of air traffic control to ensure that everyone gets treated fairly, might it be the market’s participants, rather than regulators, who ultimately decide that enough is enough and push for a fairer, more synchronised system of share dealing?