Aequitas survey finds unease with HFT

By James Langton | Mid-November 2013

A big part of what financial advisors do involves participating in the equities markets. Yet, new research reveals that advisors are highly skeptical of the fairness of those markets.

Research by the Brondesbury Group on behalf of Toronto-based Aequitas Innovations Inc. aimed to assess the level of confidence that advisors have in the current markets. Aequitas commissioned the research as part of its lobbying effort in support of the novel market model that the firm is proposing, which doesn't fit within the existing rules. Central to Aequitas's case is the idea that the prevalence of certain predatory high-frequency trading (HFT) strategies is undermining confidence in the markets.

The survey report concludes that its results support Aequitas's belief that there are concerns among advisors about the inherent fairness of the existing markets, and that new market models are needed to address these concerns. According to the report: "Market confidence is not impressive and problems with fairness in the market are the cause."

Further, the report suggests that many of these problems are seen as being caused by HFT, adding: "The results of the survey, particularly among the most knowledgeable respondents, suggests that there is a place for an alternative marketplace, especially one that addresses the problems created by HFTs, tackles issues of fairness and helps to restore confidence for the retail investor."

In an email to In-vestment Executive, Aequitas CEO Jos Schmitt says the results largely support his firm's view of the state of markets: "These survey results, which represent the views of financial advisors and their retail clients, further validate our desire and mandate to address the current unlevel playing field and work to restore balance toward the long-term inves-tors — those who actually want to hold something at the end of the trading day, those who are critical to corporations seeking funding to fuel their growth and our economy.

"We believe," the email continues, "that curbing predatory HFT strategies will go a long way to help restore that balance, and advisors appear to agree — as demonstrated by the predominant view that HFT strategies have negative impacts."

The survey found that advi-sors appear to have a relatively low opinion of the markets. On a scale of 0 to 100, the median (market) confidence rating from advi-sors was just 44; the average rating was 45. Only 2% of respondents give the market a score above 70; 11% give it a score below 30.

Slightly fewer than 700 advisors responded to the online survey of eight questions to assess their level of confidence in equities markets. The most significant factor undermining market confidence is the emergence of "flash crash" events, which often are attributed to HFT. The report on the survey also notes that there is "considerable opinion that HFT strategies have negative impacts and these may hurt market confidence as well."

There also was strong sentiment among survey participants that trading rules aren't fair, and that retail investors believe both that the market is stacked against them and that HFT doesn't contribute to overall market quality. Advisors indicated that they are less concerned about issues such as increased intraday volatility and the impact of HFT on liquidity. About half of the advisors participating in the survey said they believe that HFT creates costs for mutual funds, which ultimately reduces retail investors' returns.

Defenders of HFT would dispute much of this. A recent paper from University of Toronto law professor Jeff MacIntosh, which was published by the C.D. Howe Institute, argues that HFT actually benefits retail investors, and that it has not been found to be responsible for the "flash crash"-type of events that markets have experienced in recent years.

In fact, there is little conclusive academic research on the impact of HFT. What does seem clear, though, is that there is a perception that the markets, as currently constructed, fundamentally are not fair. But, whether or not that perception can be empirically validated, it may as well be reality when it comes to investor (and advisor) confidence.

Given the widespread concerns about the market, it's not surprising that the survey also found that about half of advisors believe that there should be greater choice when it comes to equities marketplaces. This belief is stronger among the advisors that the research classified as "stockbrokers," vs those who are "mutual fund dealer reps" or other types of advisors: 56% of brokers said they support more choice, vs 33% of other advisors.

This willingness to entertain market-driven solutions to these issues of fairness and confidence is reflected in the views of the investor advocacy group, the Canadian Foundation for Advancement of Investor Rights (a.k.a. FAIR Canada). That group's submission to the regulators on the Aequitas proposal, which was submitted several weeks after the deadline, stresses that these issues are too complex for most investors to truly grasp, but their interests should be a central concern for regulators.

The FAIR Canada paper argues that the debate about these issues shouldn't be dominated by market players that do understand the complexities and have a vested interest in them, such as trading venues, large securities dealers, and traders who engage in HFT: "The views and concerns of investors should be of significant interest to regulators."

FAIR Canada's submission supports what Aequitas is trying to achieve, but cautions that the group isn't certain whether the proposal will achieve those objectives: "Market-based solutions to current market structure and market integrity issues are welcome, and innovation should be encouraged. Innovative solutions must satisfy core principles of market regulation that aim to protect investors, ensure fairness in trading markets and promote market integrity." IE