Matt Schrecengost, a self professed high frequency trader and the COO of Jump Trading, gave a great anecdote to explain why HFT traders will continue jumping in and out of the market and trading whenever they well please.
In short: because it will be hard for the SEC to incentivise HFT traders to make markets and keep providing liquidity throughout a May 6-like trading environment.
But Matt gave a really good anecdote to explain why it will be hard to provide incentives without crippling the market. The anecdote came about during a panel discussion at the recent SEC/CFTC panel about May 6 and high frequency trading (HFT).
First, he explained why they’re not always in there making markets to begin with.
He told the panel:
“People withdraw out of the markets because of significant losses or because of overall confusion.”
“If the proper incentives were there,” he said, “We would make markets.”
“You can’t just come to us and say, hey! We want you to make markets for us. [It’s really hard and requires a lot of man power and time.] If the incentives are there, we participate. But it’s a choice, rather than a mandate.”
“There’s got to be a way where we’re not just working for the exchanges.”
Tom Peterffy, the CEO of Interactive Brokers, agreed with Matt and proposed a 100 millisecond buffer on quotes, a minimum quote life. An MQL would prevent flash orders and require bids and offers stay put for 1/10 of a second. Now many orders are flashed quickly to multiple exhanges and ultimately, some are cancelled.
(An MQL is one of the few proposed solutions we’ve heard to regulate HFT traders. Another, for example, is to require that at least some per cent of all quotes submitted into the market result in a successful deal.)
We imagine the incentive is that, if a firm is making markets, they would not be subjected to the MQL. If they aren’t, their quotes would have to remain in the market for 100 milliseconds before they could be interrupted.
Here’s what Matt said to that.
In the cash foreign exchange world, there are some exchanges that fool around with minimum quote life. EBS, which has a cash foreign exchange market, had a gold market, they trade cash gold there.
At one point, there was a big debate about minimum quote life. Should we use it, should we not use it?
They decided to set up one product that had the minimum quote life and one product that didn’t just to see what happens. They said, “let’s drag race the two and see what happens.”
What happened was, the product with the minimum quote life was extremely wide and didn’t trade nearly as much as the product that did not have the minimum quote life, that product was much tighter. So they dropped the minimum quote life entirely and just went to no minimum quote life for the quality of their product.
Basically, he gave an example that suggests that won’t work. The anecdote suggests that MQLs will hurt the quality of products and therefore hurt the health of the market.
There are probably a million more stories where that one came from, all suggesting that adding mandates in the market will be bad for business, which is exactly the point Matt wanted to make. Adding mandates = unhealthy market.
(Interestingly, Merkel just completely said “#$%& You” to that concept and passed a transaction tax on big banks that bring in more than 2 billion euros anually.)
Last week, the panel was split over whether bids or offers submitted by market participants should be subject to a MQL.
They’re wary of adding mandates because they fear what might happen if they decrease market liquidity.
So for now, HFT traders will continue to make markets or to not make markets as they please.