HFT Bill Would Give CFTC Enforcement Powers

Terry Flanagan

The debate over high-frequency trading has taken a new turn with a proposal of a law that would give the Commodity Futures Trading Commission broad authority to regulate the practice.

The bill, introduced by Rep. Ed Markey (D-Mass), would require traders involved in HFT in commodities to register with the CFTC, ban simultaneous buy and sell orders by traders using HFT in commodities, and give the CFTC the power to fine HFT traders based on the amount of time of their violation (e.g., if found violating the regulations for more than a second or two, am HFT would receive a higher fine than violating a regulation for one microsecond).

“High frequency traders have contorted markets and impacted consumers,” said CFTC commissioner Bart Chilton in a statement. “Congressman Markey has initiated an important and imperative step to ensure they will be monitored and observed which can avoid future market meltdowns.”

In January, Markey called on the SEC to use the Market Reform Act of 1990 to oversee HFT in the nation’s stock markets.
With most retail odd lot orders being consumed by large market makers, concerns exist that visible odd lot orders are being posted by high-frequency traders.

‘Given there tends to be a significant direct correlation between the size a market participant is willing to trade in a single transaction and the length of that participant’s investment horizon, it can be assumed that those market participants willing to trade in lots less than a round lot are high frequency traders,” said Alex Hagmeyer, U.S. equity trader at Franklin Templeton Investments. “It is prudent to evaluate the trade-off involved in denying interaction with any type of liquidity, which may vary depending on the trading strategy, the type of stock and the time of day.”

According to a report by the World Federation of Exchanges, a substantial majority of the empirical research has concluded that HFT has had measurable beneficial impacts on a variety of core market quality metrics, including tighter spreads, increased liquidity, more efficient price formation, reduced transaction costs for market participants and lower market volatility in most circumstances.

In less liquid stocks, sourcing liquidity is more challenging and other channels must be used to avoid unnecessary signaling.

“We monitor and evaluate our interaction with odd-lot trades and tend to trade more with those execution channels that offer the largest average trade size as percentage of market interval trade size,” Hagmeyer said. “We also work with our electronic trading vendors to favor those exchanges/ATSs with a setup that attracts more natural order flow.”

While the rules concerning HFT are clearly defined on transparent or ‘lit markets’ such as exchanges, it is difficult to find rules or statistics about the ways that HFT is used in some dark pools, over-the-counter markets, and by brokers who internalize their order flow.

HFT, like automated trading more generally, “represents the rational evolution of electronic markets as participants adapted to new market structures to optimize the quality, speed and operational efficiency of trade execution,” according to WFE.

According to a blog by Themis Trading reflecting the anti-HFT viewpoint, “the WFE failed to mention some controversial issues that exchanges have been criticized for in the past. Payment for order flow, conflicted order types and the sale of enhanced proprietary data feeds all seem to conflict with the WFE goals of ensuring a level playing field.”

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