Commentaries

Bridging the Week by Gary DeWaal: June 2 to 6 and 9, 2014 (A Tale of Two Senior Regulators' -- One US, One UK -- Views on Low-Latency Trading and Market Structure; New CFTC Chairman; Market Access Violations)

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Published Date: June 08, 2014

Heads of both the US Securities and Exchange Commission and the UK Financial Conduct Authority expressed similar concerns about market structure and low latency trading but with different tones before the annual Sandler O’Neill exchange and brokerage conference last week in New York City, while a public discussion was sponsored on the same topic by the US Commodity Futures Trading Commission in Washington, DC. Meanwhile, at the CFTC, a new chairman began his term. As a result, the following matters are covered in this week’s Bridging the Week:

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Heads of Financial Regulators from the UK and US Express Similar Concerns About Market Structure and Low-Latency Trading But With Different Tones Before Sandler O’Neill Conference

Two leading international regulators provided different perspectives on low-latency trading last week before the 2014 Sandler O’Neill & Partners Global Exchange and Brokerage Conference in New York City. Although Mary Jo White, Chair of the US Securities and Exchange Commission, conceded during her presentation on June 5 that US equities markets today are “not fundamentally broken, let alone rigged,” she said the Commission is embarking on a number of initiatives to address issues raised by low-latency trading and market fragmentation. On the prior day, June 4, Martin Wheatley, Chief Executive Officer of the UK Financial Conduct Authority, struck a more measured tone, stressing the importance to “…reflect on automated trading coolly and not get carried away by headlines.”

In her presentation, Ms. White acknowledged that empirical evidence demonstrates that “investors are doing better in today’s algorithmic marketplace than they did in the old manual markets.” Among other things, for large investors the costs of executing large orders (in terms of price) have declined more than 10% from 2006 to 2013; the level of intraday volatility of the S&P index is “nearly the same” in 2013 as in 2006, and spreads between bid and ask prices, including for retail investors, “are as narrow as they have ever been.” However, said Ms. White, market structure rules and practices that were principally developed to accommodate manual markets “cannot be expected to optimally address all of today’s market practices.”

As a result, Ms. White revealed a number of initiatives the SEC and the industry have adopted or are considering adopting to address various contemporary equity markets issues. These include previously implementing “limit up-limit down” rules to prevent trades from occurring in specific equities outside designated price bands and circuit breakers to militate against excessive market-wide volatility. The SEC also has adopted a market access rule that requires brokers to enhance certain of their risk controls to help avoid manipulation, and has proposed Regulation SCI that, if adopted, will require enhanced controls around technology used by exchanges, large alternative trading systems, clearing agencies and securities information processors. Overall she is calling for the creation of a new market structure advisory committee of experts to assist the SEC consider potential new initiatives and rules.

Ms. White did not identify any specific abuses attributable to low-latency traders. However, she indicated that the SEC is looking at trading practices that “may be working against investors rather than for them.”

Specifically, the Chair indicated she has directed SEC staff to develop an anti-disruptive trading rule, as well as recommendations to enhance “…firms’ risk management of trading algorithms and to enhance regulatory oversight over their use.” She also suggested that trading speed may have “passed the point of diminishing returns” and that she is considering measures to slow trading down:

"I am personally wary of prescriptive regulation that attempts to identify an optimal trading speed, but I am receptive to more flexible, competitive solutions that could be adopted by trading venues. These could include frequent batch auctions or other mechanisms designed to minimize speed advantages. They could also include affirmative or negative trading obligations for high-frequency trading firms that employ the fastest, most sophisticated trading tools.”

In her presentation, Ms. White also raised concerns regarding the large number of trading venues including so-called “dark venues” that lack transparency, as well broker conflicts that arise because of the large number and types of orders “designed to deal with the maker-taker fee model.”

The prior day, Mr. Wheatley also discussed issues that arise from low-latency trading, but, in a tongue and cheek manner, pointed out that these issues have been around since the time of the first high-frequency trading (HFT), which he claimed occurred on the London Stock Exchange on June 19, 1815. These issues are, he said, “the link between speed, market fairness and safety.” On that day in 1815, Nathan Rothschild used a relay of faster horses to obtain and trade on information regarding the Battle of Waterloo prior to the news becoming generally available. According to Mr. Wheatley,

 “[Mr. Rothschild] employed faster horses with more frequent changeover points – superior communications and technology; he ‘co-located’ himself on the floor of the Stock Exchange; and (shockingly) he initially short sold small parcels of gilts to create a downward market (momentum ignition) before proceeding to buy-up – before the position news reached the market.”

Mr. Wheatley called for a measured review of low-latency trading that he said he’s “not sure has yet been honestly assessed by all players.” He also pointed out that issues may not be the same from jurisdiction to jurisdiction and argued against a “one-size-fits-all” regulatory response. That being said, he pointed out how the European Securities and Markets Authority (ESMA) already has “detailed expectations around systems and controls for both trading venues, as well as firms using these [HFT] techniques.” He noted also that when MIFID II and MIFIR are rolled out in Europe in 2016, there will be new requirements for low-latency trading.

In conclusion, however Mr. Wheatley cautioned it is important to consider low latency trading dispassionately:

“We do not want to be in a position where acting in haste precedes repenting at leisure. Innovation will always bring with it some risk. Sometimes too much risk. But it also creates serious possibilities to explore. Finding the balance between those two poles is one of the great financial challenges of our time, with the most far-reaching consequences for the many billions of investors, savers and pension holders around the world.”

(For further coverage regarding Ms. White’s speech, access the article in last week’s Katten Muchin’s Rosenman’s Corporate & Financial Weekly Digest entitled “SEC Chair Gives Speech on Equity Market Structure” by clicking hereAll quotations in this article are from the speakers’ prepared remarks.)

And briefly:

And even more briefly:

For more information, see:

CFTC Extends Transaction-Level Requirements Relief in Certain Cross Border Situations:
http://www.cftc.gov/ucm/groups/public/@lrlettergeneral/documents/letter/14-74.pdf.

ESMA Sets Dates for Public Hearings on MIFID II and MIFIR:
http://www.esma.europa.eu/news/ESMA-announces-three-open-hearings-MiFID-II?t=326&o=home

FINRA Begins to Shed Light on Certain Dark Pool Data:
https://ats.finra.org.

FCA Head Argues for Measured Approach to Regulate Low Latency Trading:
http://www.fca.org.uk/news/regulating-high-frequency-trading.

FINRA Begins to Shed Light on Certain Dark Pool Data:
https://ats.finra.org.

FINRA Settles With Three Firms for US $1 Million Apiece for Filing Inaccurate Blue Sheet Data; Charges Pending Against Fourth Firm:
http://www.finra.org/web/groups/industry/@ip/@enf/@ad/documents/industry/p521301.pdf.
http://www.finra.org/web/groups/industry/@ip/@enf/@ad/documents/industry/p521302.pdf.
http://www.finra.org/web/groups/industry/@ip/@enf/@ad/documents/industry/p521303.pdf.
http://www.finra.org/web/groups/industry/@ip/@enf/@ad/documents/industry/p521304.pdf.

SEC Chair Calls for New Anti-Disruptive Trading Rule and Reflection on Whether the Agency’s Own Rules Have Caused Excessive Market Fragmentation:
http://www.sec.gov/News/Speech/Detail/Speech/1370542004312#.U5DNShbXrRo.

SEC Cites Liquidnet With Not Safeguarding Subscribers’ Confidential Trading Information:
http://www.sec.gov/litigation/admin/2014/33-9596.pdf.

Second Circuit Reverses District Court’s Refusal to Approve SEC Settlement With Citigroup:
http://www.ca2.uscourts.gov/decisions/isysquery/52b75f87-28d3-41b9-a305-09846b4e3bf5/3/doc/11-5227_opn.pdf#xml=http://www.ca2.uscourts.gov/decisions/isysquery/52b75f87-28d3-41b9-a305-09846b4e3bf5/3/hilite/.

See also SEC Statement:
http://www.sec.gov/News/PublicStmt/Detail/PublicStmt/1370541993346#.U5CEARYrfnc.

Wedbush Securities and Two Supervisors Charged With Market Access Violations:
http://www.sec.gov/litigation/admin/2014/34-72340.pdf.

The information in this article is for informational purposes only and is derived from sources believed to be reliable as of June 7, 2014. No representation or warranty is made regarding the accuracy of any statement or information in this article. Also, the information in this article is not intended as a substitute for legal counsel, and is not intended to create, and receipt of it does not constitute, a lawyer-client relationship. The impact of the law for any particular situation depends on a variety of factors; therefore, readers of this article should not act upon any information in the article without seeking professional legal counsel. Katten Muchin Rosenman LLP and/or Gary DeWaal may represent one or more entities mentioned in this article.  Mr. DeWaal is a member of the CFTC TAC referred to in this article.

Circular 230 Disclosure: Pursuant to regulations governing practice before the Internal Revenue Service, any tax advice contained in this article is not intended or written to be used and cannot be used by a taxpayer for the purpose of avoiding tax penalties that may be imposed on the taxpayer.

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Gary DeWaal

Gary DeWaal is currently Special Counsel with Katten Muchin Rosenman LLP in its New York office focusing on financial services regulatory matters. He provides advisory services and assists with investigations and litigation.


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