High-speed trading alive and well on Wall Street
This blog originally appeared on MSN Money.
In two years since the Flash Crash, not much has changed for robot traders despite calls for increased regulation.
On May 6, it will be two years since high-frequency traders played a role in the flash crash that sent the Dow Jones industrials ($INDU +0.67%) into a free fall. Since then, the SEC has done little beyond introducing circuit breakers on daily price gyrations. Regulators have not set limits on the number of orders firms can make or cancel each second and still lack the ability to track such trading in real time.
Recent research has fueled concerns that the robots may be not only manipulating markets but could very well go haywire and drag us through another crash. T. Rowe Price and other financial industry heavyweights have accused aggressive high-frequency traders of undermining market confidence and questioned their raison d'être. Securities and Exchange Commission head Mary Schapiro admits she's worried and says the agency is exploring various ways to slow down rapid trading.
According to the TABB Group, a few hundred proprietary trading houses carry out 48% of high frequency trading. The prop trading desks of big investment banks account for another 46%, and some 10 to 20 hedge funds the remaining 6%. Together, speed traders performed about 55% of all trading on U.S. stock markets last year.
Who are the speed demons and how are they fighting back against calls for more regulation? Here's a look at some of the major players in each category:
Proprietary trading houses
Unlike hedge funds that play with other people's money, these guys use their own capital for high frequency strategies. Known for secrecy, they formed their first industry lobby, the Principal Traders Group, in 2010. The 35 member firms spent $730,000 on lobbying in 2011, compared to $300,000 in 2009 and only $80,000 in 2007, based on data from the Center for Responsive Politics.
Some 30 of the firms are headquartered in the Chicago area, not Wall Street. And forget the image of the pin-striped banker. These shops are full of serious geeks -- mathematicians, physicists, and engineers -- using their skills to develop trading algorithms rather than, say, making public transport more efficient or improving climate-change predictions. One firm's job posting for a quant developer emphasizes "we welcome candidates who have had no exposure to finance whatsoever."
One example of a proprietary trading firm is Charles Whitman's Infinium Capital. Infinium's robots went nutso one day in 2010, sending thousands of erroneous buy orders to oil markets in a few seconds, sparking a $1 surge in oil prices. The Chicago Mercantile Exchange fined the firm $850,000.
Whitman is a member of the CFTC's Technology Advisory Committee, which gives input into regulation of issues that are likely to include "co-location," the practice of gaining a speed advantage by locating your robots in close proximity to exchange servers. According to Forbes, Infinium computers on the same floor as those used by the Chicago Mercantile Exchange can transmit up to 5,000 orders per second with less than 10 milliseconds of lag time. Infinium has other servers near exchange computers in New Jersey, London, and Singapore.
Another example is Dan Tierney and Stephen Schuler's firm, Getco. With only about 250 employees, this Chicago firm still often out-trades the mega-investment banks in sheer volume of buying and selling on certain exchanges. On some days, it has executed as much as 15% of U.S. stock trades.
And while it doesn't have the platoons of lobbyists typical of the Wall Street giants, it is very much in the Washington game. It has proved particularly adept at the revolving door competition, hiring a stable of former SEC officials and snagging former SEC Chairman Arthur Levitt as an adviser. Recently, it won a seat on an advisory body looking at how its own industry's activities should be regulated. The firm spent $250,000 on lobbying in 2011.
Of the 40 men on Forbes magazine's list of highest-paid hedge fund managers in 2011, five are also on the list of the 100 largest donors to SuperPACs in the current election cycle. Ken Griffin, CEO of Citadel Investment, and Robert Mercer, co-CEO of Renaissance Technologies, made both lists.
In a rare interview with the Chicago Tribune, Griffin says he's "living in a hyper-regulated industry." Somehow, though, he was able to make $400 million last year as the head of Citadel hedge fund, which has claimed to account for as much as 10% of global equities trading in a single day.
Renaissance's mathematician founder, James Simons, is known as the "Quant King" for his early mastery of high frequency trading. In 2010, current co-CEO Robert Mercer made a $200,000 Super PAC donation for ads attacking Rep. Peter DeFazio, as part of a broader campaign to oust the 13-term progressive for championing financial transactions taxes. Since the robots make money through razor-thin profit margins on zillions of trades, a transactions tax of even a small fraction of a percent could throw a major wrench in their business model.
Goldman Sachs CEO Lloyd Blankfein has used his perch at the helm of the Financial Services Forum, a club for CEOs of 20 top banks, to protect this lucrative business from financial transaction taxes. In a letter to Treasury Secretary Timothy Geithner, he urged the administration to block such taxes, not just in the United States but also in Europe.
With the rising political power of the high-frequency traders in Washington, other governments may be more likely to take the lead in slowing them down. The French Parliament recently approved a national financial transactions tax of 0.1% tax on securities, plus a tax of 0.01% on certain high frequency trades by establishments located in France, including French branches of non-French banks. The European Commission is pushing member governments to adopt transaction taxes on securities and derivatives, which Germany and several other governments' support.
The political clout of the U.S. financial industry does have some limits, it seems.
Sarah Anderson directs the Global Economy Project at the Institute for Policy Studies in Washington, DC.