SEC Once Slowed by Data Gap to Report High-Speed Trader Research
The U.S. Securities and Exchange Commission will soon issue research from its new system for monitoring markets, including a look at practices that some blame for giving high-speed traders an unfair edge.
The reports will use data from the SEC’s Midas market-surveillance system, according to two people briefed on the plans. The findings could help inform whether new regulations are needed to address strategies such as canceling a high percentage of orders, said the people, who asked not to be identified because the plan isn’t ready to be announced.
The SEC lacked such a tool during the May 2010 plunge known as the flash crash, when the agency was criticized for taking four months to report the cause of turbulence that erased about $862 billion in U.S. equity value in minutes before share prices recovered.
“This shows to the outside world that the SEC has been quite active in terms of thinking about these issues in sophisticated ways,” said Henry Hu, a professor at the University of Texas who led the SEC’s research division from 2009 to 2011. “Too often, people outside the SEC are not really aware of just how much effort goes on.”
The SEC acquired its Midas system last year from high-frequency trading firm and technology vendor Tradeworx Inc. Midas, an acronym for Market Information Data Analytics System, collects about 1 billion trading records per day from 13 U.S. equity exchanges, which sell similar data to high-speed firms and brokers that want information milliseconds before the public.
Midas provides the regulator with more complete data than traders and researchers can see from the public feeds operated by NYSE Euronext (NYX) and Nasdaq OMX Group Inc. (NDAQ), SEC Associate Director Gregg E. Berman has said. The SEC’s feed includes every displayed order for shares on exchanges, not just the best offers reported to the public tape. It also gathers data on orders that are modified, canceled or filled.
One of the first reports to be published will present information on whether stock-market liquidity is affected by the high volume of orders that are canceled before being filled, which can give the false appearance of real bids and offers for stocks. Some automated strategies may cancel more than 90 percent of the orders they send to exchanges, the SEC said in a 2010 report.
“People have questioned the fact that there are so many order cancellations and that there is a relatively small fraction of orders from certain market players that get executed,” former SEC Chairman Elisse B. Walter said last week in a phone interview. “To have better data analysis about that is going to help the SEC in making a policy decision about whether or not that presents a problem and, if so, what to do about it.”
Midas allows the SEC to view what exchanges and some high-speed traders already know about markets, Berman said in a June speech at the Securities Industry and Financial Markets Association’s Tech conference. It’s not a perfect view of market surveillance, because it doesn’t show the SEC how orders are routed or include information about the brokers or customers behind trades, Berman said.
Berman is leading the SEC’s effort to analyze Midas data and publish analyses based on findings. It’s not clear when the SEC will publish its first report, but the two people said it would be soon.
In a phone interview last week, Berman declined to discuss specific reports or when they would be made public. He said each analysis began as a research project that his staff has worked to translate for a general audience.
“We focus on using this data in ways that makes sense to understand market structure,” Berman said. “This is all around helping people better understand markets and shed light on a variety of different topics.”
The decision to present research from Midas began under Walter, who said in a February speech that the reports would explore subjects such as the speed of quotes and subsequent cancellations. The information could help people understand the impact of new rules sought by critics of high-frequency trading, said Walter, who left the agency in August after serving a five-year term as a commissioner and chairman.
Midas gives the SEC a view into market behavior that some of the most sophisticated trading firms don’t have, Berman said in a speech in June. The data allows the regulator to study the speed at which traders respond to quotes, as well as what fraction of orders are canceled “within 1 second, 100 milliseconds, or even 10 microseconds,” Berman said in the June speech.
“Answering these basic factual questions must be the starting point for any serious dialogue about market speed, and I’m very glad we now have the tools and technology to be able to do so,” Berman said in the speech.
Canadian regulators have similarly used a data-driven approach as they seek to analyze the role of high-frequency traders, said Adam Sussman, director of research at New York-based Tabb Group LLC. The Investment Industry Regulatory Organization of Canada has used its real-time market surveillance database to identify traders who produce a high number of orders relative to the number of trades that were consummated, Sussman said in a phone interview.
The Canadian regulator’s study found that high-frequency trading accounted for one-fifth of all trading in that country and 94 percent of order messages.
Providing different types of aggregated market data to the public is a good thing, said Haoxiang Zhu, assistant professor of finance at Massachusetts Institute of Technology’s Sloan School of Management who specializes in market structure issues.
“Many everyday investors, and even some smaller institutions, have little idea how their stock orders are routed, for example, let alone the complexity of market structure,” he said in a phone interview. “More transparency on the structure of markets can only help.”