Defining high-frequency trading, a controversial practice often blamed for some of the most unsettling events in financial markets in recent years, may be the largest obstacle in regulating it, market players told a key U.S. market watchdog.
The Commodity Futures Trading Commission (CFTC) asked for industry feedback on 124 questions about how to safeguard markets against computerized trading. The CFTC's 'concept release on automated trading,' released Sept. 9, is the first comprehensive review of potential regulations for high-speed trading in U.S. derivatives markets.
High-frequency trading relies on computers to trade stocks, commodities and other securities in microseconds, based on often-minute price discrepancies. The practice has ballooned in recent years: HFT made up 49 per cent of U.S. stock trades in 2012, according to the Tabb Group, and the latest figures from the Investment Industry Regulatory Organization of Canada show that HFT generated 35 per cent of all trades in Canada from January, 2012 to June, 2013.
The "flash crash" of 2010, during which the Dow Jones industrial average plunged more than 1,000 points in minutes, set off alarm bells and regulators around the world are now figuring out how to rein in high speed trading.
Charles Evans, president of the Chicago Federal Reserve Bank, supports the CFTC's effort to overhaul computerized trading. "We wholeheartedly agree … that traditional risk safeguards that relied on human judgment and human speeds must be re-evaluated," Mr. Evans said in a comment letter submitted Dec. 11.
Mr. Evans's letter recommended that the CFTC, SEC, and other agencies adopt a common definition of high-frequency trading. But that has proved elusive: the CFTC document devoted no fewer than 16 pages to defining HFT.
"Regulators are under pressure to do something about HFT, but we don't even know what it is. There are accusations of manipulation by high-frequency traders, but it is manipulation by anyone with a computer," said Chris Concannon, vice president of a large high-frequency trading firm Virtu Financial, in a phone interview.
The Futures Industry Association (FIA), a trade group representing automated trading firms, said the CFTC should not adopt a formal definition of high-frequency trading. Rather, regulators should focus on abusive activity "that can occur at all trading frequencies," the FIA wrote in a comment letter submitted yesterday.
"The CFTC struggled for over a year to define it – our answer is to take a broader view, rather than an arbitrary definition. It's not about the frequency that you trade; it's about automation and how traders connect to an exchange," said Jim Overdahl, an adviser to the FIA and former chief economist of the CFTC, in an interview.
Mr. Overdahl recommends the CFTC focus on what it needs to safeguard, rather than targeting a group of traders.
Better Markets, a non-profit aimed at financial reform, warned that efforts to define HFT are a "a black hole" that can allow the status quo to persist unregulated indefinitely, in a letter submitted to the CFTC on Dec. 11.
The CFTC is also scrutinizing how news is received by computer trading systems. A hack of the White House Twitter account in April put the spotlight on the dangers of social media in financial markets; a false tweet of an attack on the white house roiled markets. The CFTC asked for information about how traders use social media and other news feeds to initiate trades. The FIA conducted an internal survey to address this question and found none of its members use social media to make transactions.