High-frequency trading (HFT) enhances market quality, and benefits other traders, both retail and institutional, claims a new report from the C.D. Howe Institute.
The report calls on regulators to resist the urge to curb HFT, and recommends rule changes to encourage its use.
The report, which authored by University of Toronto law professor Jeffrey MacIntosh (who also serves as a director of CNSX Markets Inc., the owner of the Pure trading platform), reviews some of the existing empirical research on the impact of HFT, and concludes that HFT enhances market quality. “It lowers bid/ask spreads, reduces volatility, improves short-term price discovery, and creates competitive pressures that reduce broker commissions,” it says.
The report aims to rebut criticism of HFT, including the claim that it contributes to market fragility (and was to blame for the “flash crash” in May 2010, specifically); and that it disadvantages other sorts of traders. In fact, it argues, “retail traders have realized a net gain from the presence of HF traders in the world’s capital markets.”
Following this conclusion, the report calls on regulators not to intervene to prevent HFT. In particular, it says that they should not interfere with the maker/taker pricing models used by exchanges to attract HFT. The report says that the Investment Industry Regulatory Organization of Canada (IIROC) should scrap its fee model that charges for message traffic, and return to charging based on trading volume; that rules against trading amid “locked markets” should be abolished; and, that routing to different trade venues be randomized to enhance the ability of smaller, upstart markets to compete.
The report also says that regulators should maintain the order protection rule, which they adopted to prevent “trade throughs” in the market. “To prevent abusive trading practices, protect client interests, and create a level playing field among different trading venues, policymakers should defend the consolidated order book by maintaining and policing the order protection rule and minimizing the leakage of trading from the ‘lit’ markets to ‘dark pools’,” it says.
Additionally, it recommends that regulators focus on using circuit breakers to prevent the recurrence of “flash crash” type events.
The report comes as the regulators are considering many of these market structure issues amid a proposal from Aequitas Innovations Inc. (a new firm founded by a handful of buy- and sell-side firms) to create a new exchange that would attempt to curtail predatory HFT, among other goals.
IIROC is also currently engaged in a large, independent study of the HFT phenomenon in Canadian markets, known as its High-Order-to Trade (HOT) study. That research has yet to reach any definitive conclusions on the impact of HFT on market quality.
And, earlier this week, the U.S. Securities and Exchange Commission (SEC) launched a new website designed to help inform the debate over equity market structure by providing public access to the latest in data and research in U.S. markets, which are grappling with many of the same issues.