WRG High Frequency Trading: Evolving Market Structure

Thursday, October 28, 2010

The first panel on day one of the World Research Group's Buy-Side Tech: Global Equities Trading Summit was titled "Examining the Evolution of Market Structure for North American Equities: US & Canada".

Thoughts on the evolving market structure

The first panel was questioned as to whether high frequency traders add liquidity to the market or drive fragmentation. Joe Saluzzi of Themis Trading, an outspoken critic of many HFT practices, started the discussion by arguing that the current market is far too fragmented. While the duopology structure of several years ago with just the NYSE and Nasdaq was not ideal, the dozen exchanges and 40-odd dark pools creates far too much fragmentation. Deborah Mittelman, Executive Director at UBS, chimed in to say that she believes HFT does both, adds liquidity and drives fragmentation.

Matt Samelson, Principal at Woodbine Associates, contended that his studies of the top 40 securities by volume show that HFT certainly adds liquidity. I was a harsh critic of Samelson in my summary of the last conference because he didn't seem to recognize that the debate has moved beyond what he was researching. I was happy to hear him admit, after speaking with Saluzzi, that the complaint about the lack of liquidity in small caps may be legitimate. He clarified that his study was based on the 40 most liquid names and substantial research has yet to be done on the explicit and implicit execution costs in lower volume stocks.

Anthony Barchetto, Head of Corporate Strategy Group at Liquidnet (a leading dark pool provider), laid out some hard numbers on the state of US equity market structure. There are currently 13 registered US exchanges with 10 of them owned by the top four players: DirectEdge, Bats, NYSE and Nasdaq. These 10 account for 98% of the lit volume. While opinions on dark pools range dramatically, Barchetto maintained that current volume is about 30% in dark markets and 70% in lit, and this ratio has been relatively unchanged for the last few decades.

Another panelist talked a bit about market makers and said he believes these participants need to be granted greater advantages in today's markets. In order to smooth out volatility in prices, market makers are essential. Yet, without any significant advantage over other players there is no ability to enforce obligations on them.

Saluzzi ended the discussion by arguing that the core of the issue is with the exchanges which over time have transitioned from issuer, investor-focused models to for-profit constituent-driven pricing models. In his words, the equity market "ecosystem" is out of balance with such a large share of volume dominated by HFT. Investors are disadvantaged because exchanges now cater to the HFT players that create volume. Saluzzi proposed the creation of two distinct markets, a superhighway with HFT and then one that caters in particular to small and mid caps and reduces HFT participation. While the mechanics of how this would work are unclear, the sentiment is shared by many.

More posts to come on this conference...

Previous posts on the WRG Conference:

WRG High Frequency Trading: Bookstaber on The Future of Finance ~ October 27, 2010

Brandon R. Rowley
"Chance favors the prepared mind."

*DISCLOSURE: Nothing relevant.
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