Another Day, Another Senate HFT Hearing

Terry Flanagan

The second Senate hearing on high-frequency trading in as many days focused on the economic impact of HFT for companies seeking to raise capital and for retail investors.

The hearing, convened by the Committee on Banking, Housing and Urban Affairs, was less concerned with market micro-structure like maker-taker pricing and payment for order flow than the previous day’s hearing, which was held by the Permanent Subcommittee on Investigations.

Instead, the hearing used HFT as a jumping-off point for suggestions for improving liquidity and capital formation for small to mid-cap companies, such as a tick-size pilot, and for measures such as a trade-at rule that would enable institutional investors, who hold the bulk of equity assets of U.S. households, to trade in size without incurring penalties arising from information slippage.

Andrew Brooks, vice president and head of U.S. equity trading at T. Rowe Price, suggested a pilot program where all payments for order flow, maker-taker fees, and other inducements for order flow routing are eliminated, a second pilot program incorporate wider minimum spreads and some version of a trade-at rule, and a third pilot program that would mandate minimum trade sizes for dark pools.

“Dark pools were originally constructed to encourage larger trading interests, and it seems perverse that many venues on the lit markets or exchanges have a larger average trade size than dark pools,” said Brooks.

Brooks added, “At the end of the day, we are here because of our firm commitment to all investors to ensure that the capital markets perform the functions for which they were designed–capital formation for companies and investment opportunities for both institutions and individuals.”

Jeffrey Solomon, CEO of Cowen and Company and co-chair of the Equity Capital Formation Task Force, said that HFT by itself is not the root cause of increased market risk, but is instead a symptom of a more complex market structure that promotes potentially counterproductive trading behavior.

Solomon argued for a pilot trading program to test the effects of wider spreads and limited increments in small-cap stocks, which account for 2 percent of the average daily market volume.
The Equity Capital Formation Task Force advocates a combination of wider quoting increments and limited execution costs in order to encourage institutional investors to provide additional trading liquidity to small-cap stocks.

Hal Scott, director of the program on international financial systems at Harvard Law School, said that contrary to popular misconceptions, HFT has resulted in retail investors returning to the equities markets. Critics of HFT, he said, have pointed out that retail investors have pulled $261 billion from equity mutual funds since the 2010 “flash crash” as evidence that investors have lost confidence in the equity markets.

“However, retail investors have simply moved their investments to exchange-traded products,” said Scott. “The net effect is investor inflows of almost $500 billion since the flash crash.”

In 2012 alone, Scott said, there were net inflows of $57 billion in securities trading in U.S. equity markets. “If investors were indeed overly concerned by HFT then they wouldn’t have added such substantial amounts to their capital at risk in our equity markets.”

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