Could Self-Policing By the Industry Tame High-Frequency Trading?

With exchanges like Nasdaq OMX, Deutsche Borse, and Borsa Italiana moving forward with plans to penalize high-frequency traders for sending in too many orders that don't result in actual trades, Advanced Trading discussed with Progress Software Chief Technology Officer John Bates whether the industry would be better off with self-regulations like these rather than government-imposed rules. Portions of this interview appear in the April digital issue.

A number of exchanges around the world are planning to punish high-frequency traders for sending in too many unfulfilled orders. Do you see more exchanges opting for this strategy?

John Bates, Founder and Chief Technology Officer of Progress Software:

I do, I'm surprised it hasn't happened before. They have to put a large amount of money into machines, network capacity, backups, disaster recovery. And for not much return if you're putting orders out there and they're not trading. So when can you stop that? How can they recoup some fees? There's also the very fact that are they hiding things in these orders? And there's some bad apples out there that are potentially hiding quote stuffing.

So I think those two things – the expense and cost of being able to support all this stuff, plus the fact that it's a smokescreen that's hiding abuses is going to lead exchanges around the world to follow, I think.

With self-policing like this in place, will it curb the need for government regulations?

Bates: It would be a good step. Scott O'Malia has been trying to tie down a definition of high-frequency trading. What's the definition of this, what's the definition of that? What's good, what's bad? It will really be a good step of almost the industry self-regulating. It would weed out some bad apples, it would encourage smart algorithms that don't put such load on the system and are more intelligent and possibly self-learning. It's not necessarily a bad thing. It's not going to stop algorithms. It's just going to change the way a lot of them work.

The Flash Crash is at the heart of the push to better regulate high-frequency trading. How common have such events been since May 6, 2010?

Bates: Well they've been pretty common, actually. Probably around 15 you can list. Nothing is of the order of the Flash Crash but many incidents of algos gone wild, of fat finger trades, just market abuse and rogue traders. Probably the most notable one was the UBS rogue trader who popped up. But there have been mini flash crashes in FX, the oil markets, in all sorts of different geographies. Mini flash crashes in Japan from algos gone wrong.

They're a fairly common occurrence and that's another area where the regulators are interested. What should we have in terms of testing best practices? Where should we regulate, where should we try and let the industry self-regulate?

As the Senior Editor of Advanced Trading, Justin Grant plays a key role in steering the magazine's coverage of the latest issues affecting the buy-side trading community. Since joining Advanced Trading in 2010, Grant's news analysis has touched on everything from the latest ... View Full Bio