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Q&A: Beware a Tax On Cancelled HFT Orders

As the SEC ponders how to slow down the furious pace of high frequency trading, different ideas have come to light. Advanced Trading spoke with Michael Jenkins, partner in the financial services and strategy practices of A.T. Kearney. Portions of this interview appeared in our March 2012 cover story Slow Down, Algo Trader.

Advanced Trading: With high-frequency trading firms going so fast, can the SEC realistically impose a speed limit?

Michael Jenkins: There will definitely be attempts. The SEC has been talking about it for years. The Flash Crash from 2010 put a point of focus on it when the Dow dropped a thousand points in a matter of moments.

I think there are challenges though. There's no agreement as to what caused the Flash Crash. There's no alignment as to whether HFT was the cause. Does it provide liquidity or not? I think we have to think about it methodically before we decide what to do about it.

EXTRA: How would a tax on high-frequency trading work? Ask a former SEC Enforcer.

Advanced Trading: Can the genie go back in the bottle?

Jenkins: This is a holding period. You can't legislate [because] this is a capitalistic pursuit. You can't legislate away a short-term holding period even if it's there for nano seconds.

The common argument is that this is capitalistic pursuit and HFT provides liquidity. When you peel the onion, there is a flaw in the argument. High-speed trading leads to very high degrees of market fragmentation. Liquidity is only valuable when it can be aggregated and aggregated in a space where there's very high transparency and regulation that allows capital and ideas to trade freely. That's why we have very high profile exchanges located in very high profile cities such as New York, London, and Tokyo.

HFT is the opposite of that. When we are down to the microsecond level - one millionth of a second - where we are now - they hit a million markets at every second and this causes high degrees of fragmentation, which is the opposite of liquidity. It's a bit disingenuous to say that high speed trading drives liquidity when in reality it drives fragmentation.

Another aspect of HFT: It's not trading, it's quoting. It is market actions that are not about trading one security for a quantity of money. It's quoting and cancels. It puts noise and volume into the market that do have some ability to distort what is going on.

It's designed to influence the trading of those securities. Thousands of trades going on in parts of seconds; It is important to remember that one element of HFT is really around high frequency quoting.

Advanced Trading: There are proposals of placing a tax on all cancelled orders, such as a fifth of a penny on each cancelled trade. Would that slow down the high speed trader?

Jenkins: You would have to tax all aspects of the system, such as quotes, cancellations and all equally. The idea of a token tax would reduce liquidity but keep fragmentation high.

You need to have costs for accessing the system. If you were to put in a charge for every time you access the system - whether it's a quote, an ask, a market order, or a cancellation - that would eliminate these patterns of behavior in the charts I sent over. You have to have a right cost and not a tax that would have an adverse affect.

Advanced Trading: Would a tax like this be approved in the current political climate? This is an election year after all.

Jenkins: This is a global market and if one country or government body that promulgates rules, traders will most likely trade elsewhere. You can see this going on in France. There's some reasonably significant regulations being debated within their market and I have a view that already some Parisian trades are looking at the Cayman Islands to set up infrastructure there around these laws.

One of the problems with any single government acting to take the lead [is that] everyone has to act at the same time in order to manage it. It's like climate change; what the U.S. does alone is almost irrelevant.

Phil Albinus is the former editor-in-chief of Advanced Trading. He has nearly two decades of journalism experience and has been covering financial technology and regulation for nine years. Before joining Advanced Trading, he served as editor of Waters, a monthly trade journal ... View Full Bio

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