Nov 06, 2013

    SGX, consult the public on HFT

    The Business Times

    THERE is a sense of painful resignation, infused with no small amount of frustration and even impending doom among retail players and their brokers, following news that the Singapore Exchange (SGX) is pressing ahead with plans to introduce high-frequency trading (HFT) to the local equities market.

    Since it appears to be a question of when and not if, the exchange should address the myriad issues before opening its doors to a mode of trading that is controversial and has yet to prove beneficial to markets as a whole.

    The first thing that the SGX and the Monetary Authority of Singapore should note is the absence of a proper understanding of how exactly HFT works, the activity being so complicated that very few individuals can properly claim to have full understanding or to be experts.

    If anything, the fragmentary knowledge that can be gleaned from surfing the Internet or from anecdotal testimony of traders has probably created more confusion than clarity.

    A natural consequence of ignorance and the shock of the new is, of course, fear - and this has manifested itself in complaints to the press and vitriolic criticism of SGX making its rounds in cyberspace and in dealing rooms.

    The exchange may well counter that these fears are unfounded and that HFT offers boundless liquidity and efficiency benefits that would ultimately improve the lot of all traders.

    Be that as it may, it's worth noting that HFT's advantages are as yet unproven and the fear of the unknown pales in comparison to the fear of losing one's livelihood. For this reason, the exchange would do well to tread carefully.

    Over the past few years, retail brokers have suffered a massive loss of income because of declining commissions (inevitable, given deregulation and ultimately to the benefit of end-users but painful nonetheless); thinning volume; a cancelled lunch break; a China or S-chip segment mired in governance scandals whose crash is seen as largely responsible for keeping retail customers away; and, more recently, sudden trading curbs imposed by the exchange that appear to have driven all but the most die-hard retail punters from the market.

    Given this background, it's hard not to see HFT as another blow to trading representatives who serve small customers. The perception now is that SGX, bent on enhancing liquidity and therefore its coffers, is interested only in big players that can move millions in a second, and is not really after retail business.

    That said, HFT traders cannot spend the day trading among themselves - eventually, the game will descend into a meaningless technological arms race to see who can develop faster computers, with no real end in sight. Vibrant retail participation is therefore essential. How then, should the issue be approached?

    Education might be a good starting point. It would be fair to say that most market players, whether dealers, remisiers, investors or speculators (as well as the journalists who cover the market), have only a fleeting understanding of HFT.

    Yes, everyone knows that it involves super-fast computers that can execute millions of transactions per second and, yes, everyone knows that this means traders who have slower computers or reflexes would probably lose out.

    However, there is so much more to HFT that needs careful study before it can be embraced as a legitimate market activity. For example, even if HFT isn't an appreciable presence currently in the local equities market yet, what about algorithmic trading? This is present, so how does this differ from HFT?

    How is it that algos can enter quotes and withdraw them quickly and repeatedly and not face sanctions by the exchange - or if they did, this is not public knowledge - yet when individual brokers do the same, they are hauled up for questioning?

    What is "predatory algos" and "dark-pool pinging" and would these be allowed?

    Then, there's "latency arbitrage", which has evolved because each market player doesn't get the same information about stocks at exactly the same moment in time. Some get it sooner and some later, and the difference is known as latency.

    This creates an arbitrage and profit opportunity because if a HFT trader can position itself even one foot closer to the exchange's servers and therefore gain a nanosecond's advantage over others, it can act on that information first.

    According to material available on the Internet, there is therefore an incentive to pay for faster access, even if this is only for a nanosecond. Does this mean those who pay more can situate their computers closer to the exchange and if that is the case, how does this fit with the exchange's duty of ensuring a level playing field?

    Would SGX consider an HFT tax on all high-speed transactions? Many countries already have this and some have taken it even further - Italy, for example, last month introduced a tax of 0.02 per cent for orders placed and cancelled within half a second.

    Perhaps the exchange should circulate a public-consultation paper before rushing into HFT. After all, the attitude among regulators in many countries is this: HFT operators may claim it brings liquidity benefits but we're sceptical; this doesn't mean we'll bar it but before we allow it, we'll make sure there are plenty of safeguards first.

    Let's hope the same approach is used here.