Financial Regulator Poised To Impose Rules On High-Frequency Trading


NYSE ARCHIPELAGOA key financial regulator is poised to release a draft proposal of new rules to govern computerized high-frequency trading (HFT), according to the Republican member of the agency who is spearheading the effort.

The Commodity Futures Trading Commission (CFTC) has a 100-page “road map” that includes a proposal to increase regulatory scrutiny of HFT activity at a general level by formally identifying firms that specialize in the practice, making it easier for market regulators to hone in on the companies. CFTC commissioner Scott O’Malia has been in charge of the effort and told the Wall Street Journal it could be made public as soon as next week.

The length of the proposal reflects the sheer variety of risks, problems, and practices that fall under the HFT label. As firms have come to exploit high-powered computerized trading algorithms and high-speed network connections to gain crucial milliseconds of edge over other traders, the markets have become increasingly unstable. Beyond the most headline-grabbing consequences, like the 2010 “flash crash” where the stock market collapsed by hundred of points in a matter of seconds before rebounding, HFT also appears to be bad for the economy as a whole in more subtle ways. A University of Michigan study showed that one common form of HFT “harms the average investor” while enriching those with the fastest fiberoptics. Another report from the think tank Demos found the practice leads to “high trading volume and no investment,” subverting the social value financial trading is supposed to provide to the broader economy. The Center for American Progress has called for policy changes to curb HFT for similar reasons.

It isn’t just academics or progressive think tanks who argue against HFT, either. Warren Buffett’s deputy Charlie Munger, a longtime financial professional, said in March that high-frequency traders “have all the social utility of a bunch of rats admitted to a granary.”

It’s possible the CFTC’s 100-page proposal will eventually yield some of the curbs experts have called for on HFT’s damaging tendencies. But in the meantime, a simpler approach that would also bring in tens of billions of dollars in revenue has picked up support from congressional progressives and various European governments. A Financial Transaction Tax, set at a microscopic rate so as to protect the typical investor, would remove much of the incentive HFTs have to engage in their current practices. It is therefore no surprise that high-frequency traders have doubled their lobbying expenditures and increased their campaign contributions by a factor of 7 since 2008.