Tuesday morning at the Milken Conference started off at full speed, or rather “high speed”…as in high-speed trading. The first session of the morning was a debate between Jim McCaughan (CEO of Principal Global Investors) and Rishi Narang (founding principal of T2AM) on the subject of high-frequency trading (HFT). Jim has been writing about HFT since 2010, and after the recent attention attracted by the publication of Michael Lewis’ Flash Boys, Jim penned a few more thoughts on his ideas around potential areas for regulatory improvement for HFT activities. Rishi is not a high-frequency trader – his firm focuses on pure-alpha and short-term strategies – but he is a proponent of the positive effects that HFT has brought to markets.
This morning’s debate actually began with some agreement. To set the stage, Jim and Rishi put forth their definitions of HFT. Essentially, Jim classifies HFT as “any approach to trading that aims to add value by rapid-fire execution.” Rishi broadly agreed, but clarified that he felt HFT was trading that was more about the sensitivity to how quickly you can react to markets – or as he called it “low latency sensitivity.” With definitions in hand, the debate began. Jim’s first point was to distinguish himself from other opponents of HFT, who can tend toward the luddite perspective. Rather, Jim said, technology isn’t inherently at fault; pace is good, competition in markets is good. Though, at the balance, the full benefit of that speed and efficiency has not completely made its way through to the end investor. Clear rules of market conduct are what’s needed and they should be the focus of regulators.
Regulation then took over the focus of the conversation. Jim and Rishi also agreed on many points of potential regulatory focus. According to Rishi, the biggest reform needed is to end the ban on “locked markets.” These are markets where bid and ask prices are the same; i.e., no bid-ask spread exists. The SEC requires that national markets not even display prices that would indicate a locked market. The proliferation of order types that HFT firms use is a direct effect of their efforts to get around this locked-market rule. Jim emphasized the need for regulation to focus on eliminating the conflict of interest that exists in the current model that has exchanges paying for order flow. The debaters agreed on another point, though by different means. Jim would like to see a ban on co-location (a practice where HFT firms set up their servers right next to market servers to reduce the distance their orders have to travel), and Rishi would like to speed the official market tape (known as the SIP) to be as fast as direct access. Both of these proposals would actually have the same effect, so there was agreement on this point.
Where Jim and Rishi differed was on the negative effects that HFT bring to markets. Rishi saw fewer “bad actors” in the HFT space than Jim feels exist. Jim maintained that some of the current legal action underway will help determine how many bad actors are actually out there, and welcomes the outcome. One of Jim’s main points has always been is that primary damage that HFT can cause is damage to the confidence that markets have in markets. And to the extent that HFT causes investors to question whether their best interests are being served in capital markets, there needs to be work done.
The debate ended with a question (and support for Jim’s views) from none other than businessman Steve Wynn. Wynn posited that HFT was built on the idea of gaining advantage through speed that would disadvantage other market participants. And, he maintained, that while the opinions that came out during the session were the most cogent and clear that he’d heard, Mr. Wynn closed his comment by saying, “Jim, I’m on your side.”
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