Faster and less transparent markets pose risks that require more study, according to the Federal Reserve Bank of Chicago, which said high-speed trading may create dangers that aren’t properly appreciated or policed.
In a document posted on the Chicago Fed website, senior policy adviser Carol Clark highlighted five questions for policy makers and regulators to consider, including how to oversee trading that’s spread across different asset classes around the world and whether rulemakers have adequate technology and systems in place to oversee markets.
“The factors that have contributed to the adoption of high-speed trading and affected market structure in recent years include competition, technology and regulation,” Clark wrote. “The unexpected ways in which these dynamic forces are coming together raise a number of important policy issues.”
The Fed is the latest voice to join the debate over whether the $22 trillion U.S. equity market is organized appropriately. In December, the U.S. Treasury said high-speed trading is among the American financial system’s vulnerabilities. A majority of the five-member U.S. Securities and Exchange Commission wants the agency to review stock exchanges role in regulating trading firms. Jeff Sprecher, whose IntercontinentalExchange Group Inc. bought the New York Stock Exchange in November, this week called for a revamp in fee structures to simplify trading.
High-speed firms that measure their trading in microseconds, or millionths of a second, or less have largely supplanted people as market makers during the past decade. This has alleviated institutional investors’ concerns that humans were front-running their orders, according to Clark. At the same time, Clark said, studies showing that faster trading has cut costs and alleviated market volatility are criticized because they come from high-speed trading firms, exchanges that cater to them, or academics with ties to the industry.
“One may also argue that the movement toward HST is part of a natural, evolutionary outcome within financial markets, not unlike the adoption of automated or computer-based systems in every other major industry,” Clark said. “Nevertheless, it is difficult to find examples of firms in other industries that were rapidly brought to the brink of bankruptcy due to technological malfunctions like the 40 minutes it took Knight Capital to lose $460 million.”
Knight Capital was hobbled in August 2012 after bombarding markets with trades made in error, requiring a bailout from financial peers and later a merger with high-speed trading firm Getco LLC.
Clark praised regulatory attempts to make markets more robust, highlighting a U.S. Securities and Exchange Commission effort to require trading firms to have “comprehensive policies and procedures in place for their technological systems,” she wrote. The SEC plans to vote on Regulation SCI, as the initiative is called, this year, Chairman Mary Jo White said in January.
While market manipulation has always been a worry, it could be harder to spot today because high-speed firms “trade correlated products across multiple asset classes and trading venues around the world,” Clark said.
“Moreover, trading venues may be monitored by different regulators using different technologies,” the letter said, pointing to the SEC and U.S. Commodity Futures Trading Commission as examples.
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