It looks like there might be another war of words developing on Wall Street.
The Chicago Stock Exchange in August outlined plans to adopt what it calls a Liquidity Taking Access Delay, a 350-microsecond delay for those who trade against resting orders on the exchange. The Chicago Stock Exchange said in the filing that the LTAD was designed to neutralise high-speed traders engaged in latency arbitrage.
Latency arbitrage is where traders take advantage of price disparities between the same or related securities on different markets. What the Chicago Stock Exchange is trying to do is put an end to this practice.
Now, a high-speed trader has hit back at the Chicago plan. Hudson River Trading, a huge high-frequency trading firm that is responsible for around 5% of all US stock trading, filed a letter to the Securities and Exchange Commission on October 6, and it’s a pretty brutal takedown of the proposal.
It reads (emphasis added):
“CHX justifies the proposal by stating ‘[T]he Exchange submits that the proposed rules for LTAD are designed to operate in a manner that is consistent with the Act in that they are designed to protect investors and the public interest, are not designed to permit unfair discrimination, and would not impose any unnecessary or inappropriate burden on competition.’ Contrary to this rote recitation, the proposed rules are not designed to protect investors and the public interest; aim to permit unfair discrimination; and would impose an unnecessary and inappropriate burden on competition.”
The Chicago Stock Exchange said its move was in response to a change in the trading of the SPDR S&P 500 trust exchange-traded fund. The exchange said it first noticed latency-arbitrage activity in the SPDR in January and as a result of this market makers had “dramatically” reduced displayed liquidity. The August filing said:
“The Exchange believes that the best way to minimise the effectiveness of latency arbitrage strategies on CHX with respect to resting limit orders is to implement an asymmetric delay, such as LTAD, to de-emphasise speed as a key to trading success.”
Suffice to say, Hudson River does not agree. It argued that the latency arbitrage it is describing is simply a case of some firms being better at what they do, and that CHX doesn’t seem to like that because it’s preferred market participants are on the wrong side of this battle.
“Conveniently, when CHX’s preferred market participants engage in the activity of updating prices of SPY due to changes in the price of S&P 500 futures using sophisticated pricing algorithms, it is generally beneficial, whereas when another market participant does the same thing, it ‘diminishes displayed liquidity and impairs price discovery.'”
And (emphasis added):
“CHX has, without understanding why one firm appears inferior to the other(s), decided that the other firms must be engaging in “latency arbitrage.” The idea that two firms doing the same thing exhibit varying levels of skill or speed is not surprising — it is a general property of the natural world. Because CHX’s preferred member is not the firm that appears to be better at this trade, it seeks to modify its rules in order to tilt the playing field in its preferred member’s direction.”
Hudson River went on to say that, in basic terms, some firms are better, faster, and more skillful, and that the Chicago Stock Exchange needs to accept that. It said (emphasis added):
As a liquidity provider, HRT understands that other firms may be faster than it is, may have better information than it does, and may simply be better at pricing securities than it is, and it must factor that into the displayed prices at which it is willing to buy and sell. This is not a new concept as there have been speed, information and skill advantages since markets have existed.
CHX is proposing to implement a feature that allows it to pick winners and losers. It has no reasonable justification for why it is attempting to discriminate among its market participants, and CHX’s commercial interests should not allow it to unfairly discriminate among its members or to put an undue burden on competition among competing exchanges or among its members.
Now, if all this sounds familiar, it is because it is.
IEX, the company founded by the heroes of Michael Lewis’ book “Flash Boys,” is known for its “speed bump,” a 350-microsecond delay. The trading venue just launched as an exchange, having won regulatory approval in July.
That followed a drawn-out and often ugly consultation process, where the likes of Citadel, NYSE and Nasdaq taking aim at the firm, and IEX and its supporters firing back.
More broadly, the battle over IEX’s exchange application pitted those who think there is predatory high-speed trading taking place on Wall Street, and those that are comfortable with the status quo. This debate played out over several weeks, primarily through comment letters to the SEC.
Now, it looks like the Chicago Stock Exchange’s proposals could provide another lightning rod for the industry. Virtu, another high-speed trading firm, has said it supports the Chicago proposal, while a trader named Beste Bidd (presumably a pseudonym) has also offered support. Watch this space.
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