Coordination Needed in Stock, Futures Oversight, Gira Says
Consolidating oversight of equities, options and futures markets would help regulators deter trading aimed at defrauding investors or manipulating markets, a Financial Industry Regulatory Authority executive said.
More coordination is needed because strategies designed to deceive may operate across asset classes, Thomas Gira, executive vice president for market regulation at Finra, said today at a meeting sponsored by the Commodity Futures Trading Commission.
“That means having all the equities markets” in the surveillance program, Gira said in Washington. “It also means having all the options markets. At some point, I think, it would make sense for futures to be in there as well because this type of activity is going across products and it’s important for regulators to have a holistic view.”
U.S. regulators are seeking ways to improve supervision in faster-paced, automated markets where firms may employ tactics that disperse orders across stock venues and exchanges handling related products. Some high-frequency strategies try to “ignite” activity by traders whose computerized quoting systems respond to bids and offers, while others may manipulate prices and pursue profits by buying or selling related products in different asset classes, Gira said.
The CFTC oversees futures and commodities while the Securities and Exchange Commission manages securities trading. Finra monitors transactions that make up 80 percent of U.S. equities volume, including those on venues run by NYSE Euronext (NYX) and Nasdaq OMX Group Inc. (NDAQ)
Finra uses about 300 automated surveillance patterns to detect activity it may investigate, Gira said. Some are designed for products such as options and fixed income. In equities, it monitors about 8 billion quotes a day, 2 billion orders and 75 million transactions, he said.
“We developed patterns because of high-frequency trading,” Gira said. None are specific to automated firms since Finra is “indifferent” to how the trading occurs, he said.
Gira commented at a meeting of the CFTC’s technology advisory committee. Speakers including Richard Gorelick, chief executive officer of RGM Advisors Inc., and David Leinweber, head of the Center for Innovative Financial Technology in the Lawrence Berkeley National Laboratory’s computational research division, discussed trading by high-frequency firms and efforts to assess the impact their activity has on markets.
The CFTC, SEC, Finra and foreign regulators are trying to improve their understanding of diverse strategies lumped together as high-frequency trading. These include market making, computer-driven programs that seek to arbitrage price differences between an index and its component stocks, and other automated strategies that make trading decisions based on the data they receive.
Gorelick said investment banks, hedge funds, commodity trading advisers, automated firms and some retail investors use high-frequency techniques when they buy and sell products. Many firms use quantitative and statistical approaches to determine the prices at which they’ll buy or sell and submit their orders to the market, he said.
About 55 percent of U.S. equities volume comes from firms using high-frequency trading strategies, according to Adam Sussman, a partner and director of research at Tabb Group LLC in New York. More than half of that -- 32 percent of total stock volume -- is from market makers, he said.
Market making accounts for about 55 percent of U.S. equity index futures trading, with about 23 percent coming from firms using high-frequency strategies, according to Tabb Group. For fixed-income derivatives, 60 percent of exchange-traded volume comes from market makers, while about 22 percent is from high- frequency firms, Tabb said.
Finra has found that brokers it monitors employ “very disparate practices in terms of the controls” they use to make sure their algorithms or strategies are not trading more than they intend or exceeding price or volume limits, Gira said. The regulator examines firms to see how they manage their algorithms, how they’re tested prior to being put into use and whether traders are able to override built-in controls.
Many of the cases Finra is examining involve activity that may result from “supervisory deficiencies” rather than “purposeful intent,” Gira said.
Some of the “more abusive” strategies that employ high- frequency techniques are a “crime of pennies,” Gira said. The regulator’s surveillance systems may generate thousands of alerts of activity that doesn’t appear profitable or that looks benign until it’s collected and patterns emerge, he said.
“The algos that are being used morph over time and people adapt when you shut certain doors,” Gira said.
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