Tuesday, September 25, 2018

Panelists mull HFT, market resiliency in SEC-NYU dialogue

By Amy Leisinger, J.D.

Industry participants and academics discussed the “need for speed” among traders and the evolution of market making at the SEC-NYU Dialogue on Securities Market Regulation. Several panelists noted that the high-frequency trading (HFT) race and continued efforts to increase automation can lead to decreased focus on the actual work involved in the trading process and, as a result, a less-than-optimal outcome for investors. Further, panelists suggested that market makers aim to provide liquidity throughout the trading process but that shocks to the market can limit the risks they are willing to take. In a discussion of resiliency in markets where HFT firms are most likely to have an influence, panelists considered how uncertainty and fragmented markets affect liquidity provision and ultimate recovery from demand shocks.

SRO practices and automation. Considering whether regulations and SRO practices have incentivized the “HFT arms race,” Terrence Hendershott of UC Berkeley said that firms have always been trying to get information between markets as fast as possible and that, ultimately, HFTs profit from speed. The impact of HFT is not necessarily the same across all investors, he noted, and firms should pay particular attention to weighing the direct and indirect costs and benefits of developing increased trading speeds and focus on developing an optimal market design.

Adam Nunes of Hudson River Trading opined that the question of whether a process should be automated should depend on whether it lends itself to automation, because some processes do not. However, he explained, it would be surprising to the industry and investors if a firm was not working on further automation and increasing speed. Hendershott agreed, noting that “investors like speed,” and, in many ways, speed is important to integrating markets, especially as markets fragment.

Liquidity. In reviewing the evolving state of market making automation, profits, and obligations, Mao Ye of the University of Illinois at Urbana-Champaign noted that HFTs can provide liquidity in times of extreme price movements but often withdraw liquidity when it is most needed. On occasion, this can lead to a trading halt and time to allow trading interests to re-accumulate, he said. Before imposing any new requirements, the SEC needs to evaluate whether existing regulations are actually achieving their intended purposes, according to Ye, as these rules were designed with regard to human behavior.

Market making and automation. John DiBacco of Virtu posited that market makers basically serve as a risk transfer agent, but Jose Marques of Inferent Capital noted that no market maker will stand in front of a freight train and try to stop it, choosing instead to deal with the fallout from failing to step in. The panelists concurred that the industry needs to consider how many resources should be dedicated to market making and automation to improve market resiliency and keep a focus on both retail investors and institutional investors representing their interests.

Maintaining market resiliency. Kumar Venkataraman of Southern Methodist University discussed resiliency in terms of the speed with which liquidity rebuilds after demand shocks, noting that fragmented markets are more sensitive to stress and that periodic call auctions help with uncertainty. If trading is paused, he explained, it needs to be done in a coordinated manner; this has improved since the flash crash, Venkataraman noted.

Andrew Upward of Jane Street opined that the markets have overall become more resilient since that flash crash, partially in response to regulation but more so as a result of market reaction to the event. Echoing this sentiment, Steve Crutchfield of Chicago Trading Company urged regulators to be cautious in developing new regulations; it is important to make sure any changes actually help stakeholders, he concluded.