By Joshua Gallu and Silla Brush
‘High-frequency
trading firms are drawing scrutiny from U.S. regulators seeking evidence that
they may be distorting market prices by conducting transactions with
themselves, said two people with knowledge of the matter.
So-called
wash trades, in which a party buys a contract from itself, could be executed
inadvertently by firms with multiple algorithms active in the same stock or
derivative, said the people, who requested anonymity because the review isn’t
public. Such trades, which can alter the price of shares if they are executed
above or below market rates, would be illegal if deemed intentional efforts to
manipulate stocks.
The
Securities and Exchange Commission and Commodity Futures Trading Commission
have sharpened their focus on high- frequency and algorithmic trading since May
6, 2010, when about $862 billion was erased from stock values in 20 minutes
before share prices recovered from the plunge. Regulators have expressed
concern that some firms and electronic exchanges don’t have sufficient controls
to prevent a range of events -- from improper trades to programming glitches --
that could roil markets even when there is no wrongdoing.
High-frequency
trading, in which computer algorithms are used to buy and sell stocks in
fractions of a second, accounts for more than half of equity trading volume. Getco LLC and Citadel LLC, both based in Chicago, and New
York-based Virtu Financial LLC are among the biggest
automated-trading firms.
Exchange
operators including Nasdaq OMX Group Inc.
(NDAQ) and NYSE Euronext (NYX) have started
services to help firms avoid accidental wash trades.
Bats
Global Markets Inc. updated a service on its two exchanges last month to help
users avoid “undesirable executions against themselves,” the Lenexa,
Kansas-based exchange operator told the SEC. Direct Edge Holdings LLC began a
similar service on two exchanges in 2010 to prevent “the potential for (or the
appearance of) ‘wash sales’ that may occur as a result of the velocity of
trading in today’s high-speed marketplace,” according to a filing with the SEC.
“Regulators
cannot assume that algorithms in the markets are always well-designed, tested
and supervised,” CFTC Chairman Gary Gensler said at a June 20 meeting of the agency’s
technical advisory committee. “To give hedgers and investors the confidence in
markets that they really need and deserve, I think regulators always need to
adapt.”
The
CFTC has been considering issuing a so-called concept release, a step prior to
a formal rulemaking, which could lead to new testing, supervision and oversight
requirements for high- frequency and automated trading. At a meeting of a CFTC
advisory committee on June 20, representatives from Getco,
NYSE Euronext and Deutsche Bank AG (DBK) suggested that regulators adopt a
broad definition of high-frequency trading to limit the potential for
regulatory arbitrage.
“We
wanted to keep it easy to interpret and difficult to game,” Deutsche Bank’s
Greg Wood said at the meeting. “We deliberately did not want to define types of
high-frequency trading strategies.”
Requiring
registration and audits of automated trading algorithms would be a waste of
regulators’ resources because of the cost and complexity of establishing unique
identifiers, a working group of the CFTC advisory committee said in a summary
of its findings presented at the meeting.
“Market abuse is not fundamentally a function of the
means, speed or frequency of order entry and transactions,” according to the
summary. “Focus should be on specific behaviors that
undermine market integrity irrespective of the means or pace of order entry.”
To
contact the reporters on this story: Joshua Gallu in
To
contact the editor responsible for this story: Maura Reynolds at [email protected]
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