April 28, 2010

Despite a lack of tangible evidence that high-frequency trading damages the equity markets, allegations that certain strategies front-run orders or manipulate prices persist. "Today we operate in a marketplace where many people hold conspiracy theories," says Citi's Reilly.

But, "Customers have appropriate concerns about predatory order flow and information leakage," he acknowledges. "So it's not shocking that GETCO's arrival on the NYSE floor is making some traders a little uncomfortable."

GETCO's Babulak suggests there are many misunderstandings surrounding high-frequency trading. "High-frequency trading is not an industry, it's not a strategy -- it's a technique," he asserts. "Our view is that we use HFT as a technique to help us to make markets. It's just the natural evolution of how people have always made markets. It's applying technology to it."

Not everyone is completely convinced. "There's whole lot that we don't understand about how the electronic market works," says Federated Investors' Setzenfand. "On the front end they have to meet regulatory scrutiny. But I just don't think that anyone understands what happens to our information post-trade."

Something Old, Something New

Despite the concern and controversy, the buy side can't avoid interacting with high-frequency-trading flow. Reg NMS actually compels the buy side to interact with the NYSE quote, Citi's Reilly points out. "Historically there's never been a regulatory obligation to interact directly with these type of prop-driven platforms," he relates.

The NYSE's Mecane admits that the exchange had to address questions from the buy-side when the GETCO news broke. "There's been a lot questions, a lot of curiosity," he says. "People want to see what effect it has on the marketplace. The general way we've communicated it is we expect this will draw more liquidity to the platform. I think if that's the case, institutions will be pleased with it."

But even if it were not for Reg NMS and GETCO's new status as an NYSE DMM, electronic market making simply has become too pervasive for the buy side to avoid HFT order flow, GETCO's Babulak and other sell-side sources point out. "We make markets on Nasdaq, BATS and Arca. We've been an SLP on NYSE," Babulak says. "When you look at a public quote, there's a pretty good chance you're seeing GETCO prices there."

HFT firms already account for one-half to two-thirds of the average daily U.S. equity trading volume, based on estimates by Rosenblatt Securities and TABB Group. "I find it a little bit amusing that there are buy-side firms that don't want to trade with [an electronic market making firm] because just about every buy-side firm [already] is trading with high-frequency firms at some point," says Jeffrey Wecker, CEO of Lime Brokerage, an agency broker that provides connectivity and low-latency infrastructure to high-frequency shops.

According to Vanguard's Sauter, a number of DMMs already pursue trading activity that could be considered high-frequency trading. Pointing to the electronic market making activities of Barclays and Goldman, Rosenblatt's Gawronski notes that several of the NYSE's DMMs have been trying to make the transition from the old specialist world to the new model.

Further, some experts suggest that including high-frequency trading shops such as GETCO -- with their sophisticated computer programs and expertise in trading derivatives -- will bring a new skill set to risk management. "I do believe they control risks -- that's what high-frequency-trading firms do," comments Vanguard's Sauter. "They're really playing into discrepancies in the market and closing those discrepancies. They do that because of the technology, and the by-product is that they're bringing tremendous liquidity to the marketplace."

Ultimately, most buy-side traders acknowledge that electronic market makers are the way of the future. "If they're making a market for me, and it's a tight bid-offer spread, the fact that they're using computer technology doesn't scare me," says Sauter. "People want to paint [high-frequency traders] as bad guys. They're the current day market makers. The world is electronic -- why shouldn't the market makers be electronic? If you don't evolve, you become a dinosaur."

See related sidebar: NYSE's Makeover Attracted GETCO to Designated Market Maker Role

ABOUT THE AUTHOR
Ivy is Editor-at-Large for Advanced Trading and Wall Street & Technology. Ivy is responsible for writing in-depth feature articles, daily blogs and news articles with a focus on automated trading in ...