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Becca Lipman
Becca Lipman
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Aequitas Approved: Canadian Regs Green-Light Anti-Predatory HFT Exchange

The newly approved Aequitas exchange wants to correct unfair advantages given to HFTs over retail investors. Competition had prompted TMX Group to plan a similarly minded relaunch of the Alpha exchange. But is the devil in the details?

Aequitas Innovations received the green light from Canadian regulators Monday morning to launch the Aequitas NEO Exchange, effective March 2015. The exchange plans to address what its founder, Aequitas president and CEO Jos Schmitt, calls a market unbalanced by predatory high-frequency trading practices to the detriment of retail and institutional investors.

"We are thrilled to receive approval" from the Ontario Securities Commission (OSC) "to move forward and launch the Aequitas NEO Exchange," Schmitt told WS&T. It's been a long but good journey. "The amount of participation from multiple stakeholders has been quite unique, and we're extremely pleased with the way everything evolved. It is a strong acknowledgment for the need for change. I think what we are doing is the beginning of something much bigger."

To eliminate the HFT advantage, Aequitas will apply a speed bump on HFT taking liquidity and provide priority to non-HFT orders resting in the book. HFT's algorithms generally lose their effectiveness with the loss of priority execution, thus disincentivizing these strategies from trading in the Aequitas exchange, leaving retail and long-term traders with a fair market.

The value of a speed bump
The exchange hit headlines only a few weeks ago, when TMX Group, Canada's largest exchange and Aequitas's competitor-to-be, announced a plan to launch its own anti-HFT platform on the Alpha exchange. The news was received as a near-direct effort to compete for Aequitas's target market.

TMX, which has a long history of technology leadership, acquired the Alpha exchange in 2013, when Schmitt was ATS chief. TMX claims the move is part of an effort to keep market share from dispersing among new exchanges in the Canadian market and to the US markets.

The Alpha exchange will also use a speed bump to neutralize the market. That may come as a surprise after TMX told the OSC weeks earlier in a public comment on the Aequitas exchange that such a tactic was too complex and would overcomplicate market structure in Canada.

But Schmitt told WS&T there seem to be some notable differences between Alpha and what Aequitas aims to accomplish for the marketplace. His first reaction to the news of Alpha's relaunch was a positive one. He was pleased to see new investor-friendly solutions and competition in the market, but he was also sad to see the "hidden side" that drove the initiative:

"A lot of people have not yet looked at the details that the solution comes with. It is in total contradiction with their message. The message they give is more a message to compete with who we are [at Aequitas] and our message, but the reality is it is smoke and mirrors. If you look at their solution, you'll notice the solution is even further tilting the platform towards the benefit of HFT."

TMX Alpha's proposal for mitigating speed-based strategies includes a speed bump of 5 to 25 milliseconds, as well as minimum order sizes. Alpha is also introducing a "long life" order flow, which will be given execution preference over more fleeting orders. Further, Alpha will move from a fee model to a taker/maker model (you pay to post bids and offers and get a rebate if you bid or take the offer).

Schmitt and analysts from firms in support of Aequitas, including Themis, ITG, RBC, and TD, admit these seem like compelling pro-investor changes, but they say the devil is in the details.

Schmitt continued:

"They talk about a speed bump on the Alpha platforms for all participants, but there is one exception: The post only orders type. That is an order typically designed to allow HFTs to jump the queues. It allows someone to enter an order that would get immediately canceled if it were to trade. Large quantities of those orders are continuously being sent into the markets until one sticks and sits at the top of the queue. Only HFTs use it."

Critics of Alpha have said that the speed bumps do little to turn away high-speed market makers, and that its new order will ultimately isolate high-speed market makers to trade only with retail flow. This, the critics argue, is effectively enabling a legal payment for order flow mechanism, and it effectively serves the dealer community, rather than institutional traders.

To be clear, the Alpha platform may be discentivizing high-frequency traders, but it will not necessarily turn away high-speed market markers, which are considered a less predatory version of HFT. They provide important liquidity to the market, but they also seek to exploit spreads at great speeds. There is no regulatory definition for market makers, so the difference is in the eye of the beholder, and the degree to which it is an issue in the markets depends on where you draw the line in the sand on high-frequency trading.

"There are lots of promising statements in the announcement, confirming our views of the lack of fairness in the markets, but the reality is that nothing changes with the new proposal," Schmitt said. "It continues to be solutions catering to the HFT community and going further to protect them and giving even more opportunities to those who want to deploy predatory strategies."

He also calls into question TMX's ability to truly break away from the HFT stakeholders and cater to the long-term investor crowd, due to its long history of developing technology for HFT benefit:

"From what we have seen so far, what drives them is the maximization of shareholder profit, and they put that ahead of the interest of investors, issuers, and bona fide dealers. We have seen that in the way they handle market data, enhance their trading platforms, and establish fee structures… I have no doubt in my mind this has been designed by HFT for HFT. They can sit in front of retail flow only, take no risk, and be protected. And that is definitely not in line with the statements that have been made."

He also said the Alpha platform announcement rides on the heels of upgrades to TMX's main trading platform for faster trading speeds, along with its acquisition of microwave technology to connect Toronto, Chicago, and New Jersey -- costly investments largely for the benefit of HFT firms.

TMX seems to disagree with the claim that it can cater to only one market. In the October press release announcing its anti-HFT plan, Kevan Cowan, head of the TMX equities group, addressed this seemingly bipolar model of launching an exchange that both enables and disincentivizes HFT. "We are keenly aware that it is critical for all participants to feel confident in the markets they use," he said, "and we are fully committed to listening and adapting our market model to meet their evolving needs." TMX did not respond to requests for an interview with WS&T.

Aite Group analyst Spencer Mindlin told us TMX Group is fighting two battles. "Let's not forget they are battling for market share against smaller ATSs while championing the battle to keep liquidity in the Canadian markets in general." TSX's share of trade volume has fallen nearly 60% since 2007. Payment for order flow, which is illegal in Canada but not in the US, has sent a lot of volume to the US, leaving TMX to devise unique ways to stay competitive.

Core technology choices
Now, with approval in hand, Aequitas has a great deal of work to do to meet its March deadline, though it says it is on track to roll out with the timelines it has communicated so far. "Our technical infrastructure is in place and our software is running," Schmitt said. "And we're still going through some changes and evolution until we reach the 'golden copy.' We are far in operations but still have some time and activity ahead of us to make sure we are 100% ready."

The core Aequitas trading engine is provided by MillenniumIT, which powers a number of global exchanges, including the London Stock Exchange. "We went through a thorough review of several potential platform providers," Schmitt said. "We did thorough testing, and we ran a production-like proof of concept to ensure the MillenniumIT platform would be able to handle our various requirements."

At the end of the day, technology is an enabler, he said. It must be reliable and meet business and performance criteria, but it also needs to be agile, so it can be easily adapted to keep up with innovation. "The business needs to drive it. Many of our trading features are new and innovative in what we do, and we need an agile solution and partner [that can] rapidly and reliably understand and implement them."

So far, the experience has been positive for Aequitas, he said. "We are not going to change our minds about our mission in two years and operate in different ways. We have an ownership structure across stakeholders in the industry, and… there's not one of those owners that will allow us to put in solutions or mechanisms that go against our values and initiatives."

Becca Lipman is Senior Editor for Wall Street & Technology. She writes in-depth news articles with a focus on big data and compliance in the capital markets. She regularly meets with information technology leaders and innovators and writes about cloud computing, datacenters, ... View Full Bio
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Jonathan_Camhi
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Jonathan_Camhi,
User Rank: Author
11/18/2014 | 1:59:12 PM
HFT
Good story Becca. It's interesting to see how exchanges are reacting to public perception around HFT. It's such a divisive issue and they definitely want to cater to different types of traders on both sides. That's a difficult tightrope to walk.
IvySchmerken
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IvySchmerken,
User Rank: Author
11/19/2014 | 10:47:26 AM
Re: HFT
Competition is obviously driving TMX's acquisition and development of the Alpha Exchange to cater to HFT with post-only order types and maker-taker rebates that are prevalent in the U.S. On the other hand, if TMX is battling ATSs in Canada and now Aequitas, so it has to do something to attract liquidity providers. Institutions that are wary of HFT will pick up on the "bipolar" aspects of TMX's order types. The consistency of Aequitas'  anti-HFT message will be important to the buy side, though it still must build liquidity, which has mainly come from HFT-like electronic market makers.
Becca L
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Becca L,
User Rank: Author
11/30/2014 | 10:33:09 PM
Re: HFT
I'm rather curious to see what Canada's regulators say about the Alpha proposal. If Jos is right about the disgenuous marketing, and it's also been theorized that the TMX's Alpha exchange is mimicking payment for order flow (legal in the US, not in Canada), will it get past OSC as it is now? Surely they'll have to address these claims? There's so many grey lines here, it's hard to tell.
Becca L
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Becca L,
User Rank: Author
11/30/2014 | 10:20:47 PM
Re: HFT
Time will tell how the talk around anti-predatory HFT translates to trading activity - just because the opitions are there, will it attract the volume it needs to stay in business?
Becca L
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Becca L,
User Rank: Author
11/30/2014 | 10:28:09 PM
Re: HFT
Certainly Aequitas is riding on the coattails of Flash Boys and surrounding conversaions, but these conversations about market structure have been going on since before that book came out. These aren't fundamental problems that can be resolved with a speed bump, but I suppose it's a start.
IvySchmerken
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IvySchmerken,
User Rank: Author
11/30/2014 | 11:53:56 PM
Re: ant-HFT
The issues seem more complicated than a speed bump. But slowing down a market gives the buy side some confidence that the venue is interested in long-term investors. It also allows more time for bids and offers to materialize on the order book and allows liquidity to aggregate. We saw IEX impose a speed bump as a dark pool and that has been part of its rapid rise and plans to become an exchange. PDQ ATS uses a market pause to assemble liquidity from an algorithmic trading crowd. Both of these markets still include HFT as liquidity providers, so they are not entirely anti-HFT. They are seeking to strike a balance.
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