Joseph Saluzzi (jsaluzzi@ThemisTrading.com) and Sal L. Arnuk (sarnuk@ThemisTrading.com) are co-heads of the equity trading desk at Themis Trading LLC (www.themistrading.com), an independent, no conflict agency brokerage firm specializing in trading listed and OTC equities for institutions. Prior to founding Themis, Sal and Joe worked for more than 10 years at Instinet Corporation, pioneers in the field of electronic trading, and at Morgan Stanley.
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As we had anticipated, leading institutional investors of primarily retail money are beginning to speak out against the market structure that has helped foster HFT. Here are three major examples:
Kevin Cronin, Director of Global Equity Trading at Invesco
Invesco (NYSE: IVZ) is a leading independent global investment manager, providing a wide range of investment strategies and vehicles to retail, institutional and high net worth clients around the world. According to an August 10, 2010 news release, Atlanta-based Invesco (www.invesco.com) reported preliminary month-end assets under management of $580.3 billion.
The following are comments Mr. Cronin made in public testimony before the SEC’s June 2nd and the CFTC’s August 11th roundtables on market structure:
· “The large and sudden price dislocations on May 6 were, in large measure, the result of flaws and inefficiencies in the current U.S. market structure.”
· “In its examination of the market events on May 6, the Advisory Committee should not lose sight of the broader market structure issues raised by the SEC’s concept release examining the structure of U.S. equity markets, including the adequacy of information provided to investors about their orders, the impact of high frequency trading, and undisplayed liquidity.”
· “While INVESCO believes there are many beneficial high frequency trading strategies and participants which provide valuable liquidity and efficiencies to the markets, we also believe there are some strategies that could be considered as improper or manipulative activity.”
· “There is an immediate need for more information about high frequency traders and the practices of high frequency trading firms. Additionally, regulators should act to address the increasing number of order cancellations in the securities markets. It has been theorized that as many as 95% of all orders entered by high frequency traders are subsequently cancelled. Incentives that currently exist for market participants to route orders to particular venues, such as liquidity rebates, and any related conflicts of interest that may arise due to these incentives also need to be examined.”
· “Fragmented trading markets and the differing rules and practices governing those markets were a significant factor in the price declines experienced on May 6. Specifically, there is a need for an examination of the use by exchanges of mechanisms to pause trading in a security and the impact such action may have on other exchanges which may not have similar mechanisms in place.”
· “New challenges also have been created by recent market structure developments, for example there is still virtually no incentive for institutions to publically post limit orders. This point was clearly on display on May 6.”
· “We also question whether high-frequency traders should be anointed yet as the modern-day market makers, given that it is unclear whether they are truly providing liquidity to the great majority of stocks in the markets.”
James P. McCaughan, President – Global Asset Management, and CEO, Principal Global Investors
Mr. McCaughan oversees all global asset management activities, including developing global strategies and identifying and analyzing market opportunities. The Principal Financial Group (NYSE: PFG) is a leading global financial company offering businesses, individuals and institutional clients a wide range of financial products and services. According to an August 19, 2010 news release, Des Moines-based Principal (http://www.principal.com) has $284.7 billion in assets under management and serves some 18.9 million customers worldwide.
The following are comments McCaughan made in a July 9, 2010 interview with the FT and an August 23, 2010 interview with CNBC.
· “Order to one trading venue get shared with others. The problem is there is very strong circumstantial evidence that it’s front run in many places. And that is why both the SEC and FINRA have been looking at who is doing the trading in order to get more forensic about trading patterns.”
· “I am talking when orders get pinged out to multiple trading venues, there is at least circumstantial evidence that there’s quite widespread use of that information to front-run trades…That’s fraud.”
· “There are traders who send out orders with no intention of filling them, simply to try and see what activity it provokes.”
· “It is getting to the point that the investors are put off by the volatility that these phenomena are causing, and that is actually quite dangerous. We want to be able to look our investors in the eye and tell them the market is fair, and unfortunately in the market it’s quite difficult to do that.”
· “The trigger of May 6th is not all that important; the key issue is the vulnerability of the market to a rapid move. The instability that led to the flash crash arises from a number of places. I think one source of instability is high frequency trading.”
· “Many of the HFT efforts amount to destructive front running schemes.”
· “Oh yes, I think the SEC was correct into moving towards uniform circuit breakers. But what the flash crash is a good example of, is the unfairness, and the inequity that is built in to the market by giving, in particular, high frequency traders access to information that other investors don’t have.”
Jeff Engelberg, Principal and Senior Trader at Southeastern Asset Management
According to Mr. Engelberg’s June 22, 2010 statement to SEC‐CFTC Panel Regarding the Events of May 6, 2010, Memphis-based Southeastern manages approximately $35 billion, serving investors via The Longleaf Partners Funds (www.longleafpartners.com) and through 210 separate accounts, most of which are non‐taxable pensions, endowments, and foundations.
The following are comments Mr. Engelberg made in his April 28th comment letter to the SEC, and public testimony before the SEC’s June 22nd and the CFTC’s August 11th roundtables on market structure.
· “Our psychology has fallen victim to a notion that, without qualification, technology and speed should be embraced. Contrary to the claim that speed reduces risk, the introduction of excessive speed and unrestrained technology destabilized the markets and made them wholly indecipherable on May 6. We ask the Committee to weigh the benefits of microsecond by microsecond access against the costs of market instability and loss of investor confidence and ask why humans with direct access to the markets need to be licensed but technology does not. There are few events in life requiring decision making which can be altered in less than the blink of an eye. We do not feel that securities trading falls into that category.”
· “Further, it strikes us as discontinuous that the markets sanction microsecond speed in calm waters but slow down in times of turbulence through circuit breakers and Liquidity Replenishment Points (LRPs). Why are remedial responses a preferred course over preventative actions? Has speed reached an inflection point and become a liability to the markets?”
· “Some participants have access to proprietary market data feeds while others do not. Short-term traders with premium data feeds receive an instantaneous view into the future, i.e., the order flows through the feeds. This is similar to a casino with odds favoring the house.”
· “This Committee and the regulatory community at large should not try and will never be able to buffer the markets from unexpected and challenging news. However, the mechanisms by which the market digests information, discovers price, and continues to function through any and all events should be of significant focus and concern. I believe May 6 should be seen as a symptom of underlying weaknesses in market structure, and our response should seek to correct the underlying structural problems in the market which are currently being exploited, and, in the case of May 6, most likely mishandled.”
· “The US equity markets are meant to facilitate investors’ allocation of capital to businesses, thus expanding production and improving the quality of life in America. The markets have strayed from this social purpose, and presently resemble casinos more than orderly markets. As a result, the economy is hindered, fewer jobs are created, and reasonable returns for true investors (not traders) are compromised.”
We applaud the leadership of these individuals, and the firms they represent. It is encouraging to see the “Owners of The Market” step forward and probe our current equity market structure. Not only is the tide turning against HFT, but clearly industry leaders are seriously concerned. We anticipate more institutional money managers speaking out, and welcome their voices in this long marathon of a debate.
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