A proposal by US financial regulator the Securities and Exchange Commission (SEC)
to record the trading data of ”large traders' has been described as Orwellian by some commentators. But it offers comparatively minimal intrusion as a route to restoring trust in the markets and a number of high-frequency trading (HFT) firms have thrown their support behind it.
Under the proposed rules, any market participant that trades upwards of two million shares or shares worth US$20 million in a day, or 20 million shares or shares to the value of US$200 million or more in a month, would be considered a large trader. Any firm that trades above this threshold must register with the SEC to receive an ID number which is then circulated to brokers who are obliged to record all of the firm's transactions and to provide records to the SEC upon request.
The large trader reporting facility is intended to allow the SEC to stage a reconstruction of trading activity after periods of unusual activity or volatility, such as the recent 6 May ”flash crash', to analyse market events and to assess the effect of individual firms' trading activities on the market.
Clearly, this would affect a broader church than the HFT community. Law firm Davis, Polk has noted that the trigger level is “relatively low and has few exceptions” and so a lot of firms could unexpectedly find themselves crossing the threshold. Brokers of large traders would find themselves bearing the brunt of the costs, at least initially, along with the majority of the reporting obligations.
The HFT community can be broadly broken down into two types, the electronic market makers that function as liquidity providers, and quantitative strategy players, who are very often focused on statistical arbitrage opportunities. The high volume of orders placed by both would undoubtedly result in them being categorised as large traders. Electronic market makers have so far shown qualified support for the ”Large Trader ID' programme. But some market participants have suggested that for proprietary HFT firms that otherwise have few reporting obligations, the requirement to report this level of information without a specific issue to address is tantamount to ”Big Brother' intrusion. Concerns are raised that the system is being imposed without a specific hypothesis on offer as to what problem it is intended to resolve. It is also posited that an audit trail of records already exists.
The SEC currently uses a system known as the electronic blue sheet which gathers stock-specific trade information from broker-dealers but does not include details such as customer ID or trade time recorded. Clearly this offers limited support for any investigations of a large scale and that require a bigger picture of trading across multiple stocks.
Understanding the cause of market events is crucial in effective regulation. Following the flash crash regulators discussed the role that HFT played in tones that suggested the activity may be restricted. However, the report produced by the SEC in conjunction with the Commodity Futures Trading Commission into the cause of the flash crash suggested it was triggered by a sell trade made by a long-only buy-side firm. That day the level of trading volume produced by HFT firms, which try to avoid accumulating positions, led to a rapid sale of E-mini futures contracts by the buy-side firm. As such it would be hard to pin the blame solely on HFT firms.
During the five-month period that it took for regulators to produce the report, uncertainty about HFT's role led to a significant level of media and political speculation which has accentuated negative perceptions of HFT business models.
Many firms that operate high-frequency strategies, and wish to do so without a substantial regulatory burden, see the Large Trader ID as a potential solution to this trial by media.
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