New York probe puts pressure on high-frequency traders

The most important rules governing high-speed electronic trading weren’t written by market regulators, New York’s attorney general or a computer whiz. They were formulated a century ago when Albert Einstein figured out nothing could travel faster than light.

High-frequency traders, seeking to exploit moneymaking opportunities first, are moving information at velocities approaching Einstein’s barrier. The competition has become so extreme that earlier this month, one vendor published a news release to boast it had shaved 12 millionths of a second off the transmission time between New Jersey and Illinois.

Caught up in a race that must end in a tie, firms that buy and sell securities in seconds while jumping across trading venues and assets are looking into new strategies that actually involve slowing down. The laws of physics are running into the laws of the state of New York, where Attorney General Eric Schneiderman said this week that he wants to rein in thefastest traders.

“No one’s messing with Einstein,” Ari Rubenstein, chief executive officer of Global Trading Systems LLC, said in an interview Feb. 28, before Schneiderman’s investigation was announced. “Our absolute speeds might be increasing, but our relative speeds are approximately the same. Investments right now in technology are more aboutdetente than arms race.”

In an industry where faster has always meant better, high-frequency trading firms are now reaping fewer rewards from incremental speed gains as brokerages improve their technology to defend themselves. At the same time, Schneiderman’s investigation targets the “unfair” services that allowthem to pursue many of their strategies. Speed traders are also being pressured by a lessvolatile stock market, which makes it harder to profit from very short-term techniques.

As high-frequency trading gets harder commercially, legally and scientifically, use of super-fast strategies has expanded beyond high-frequency trading, according to a Feb. 11 report by analysts Anshuman Jaswal and Muralidhar Dasar at research firm Celent.

Last year, Morgan Stanley, whose equities trading unit accounted for more than 10 percent of average daily volume in the U.S., completed an overhaul of its infrastructure so it could save clients fractions of a millisecond. Brokerage firm Investment Technology Group Inc. spends more than $40 million a year on capital expenditures, most of it on technology to help clients keep up on speed, spokesman J.T. Farley said.

Transmission time is one of many areas Investment Technology Group’s clients wanted to improve in an “industry with a lot of firms with big balance sheets, a lot of capability, and who are highly sophisticated in terms of artificial intelligence and algorithms,” Chief Executive Officer Robert Gasser said last month.

The decline in price swings in the stock market is also a challenge for speed traders. Although the details on how high-frequency trading firms make their money are closely guarded secrets, many strategies revolve around old-fashioned market making - simultaneously providing both bids to buy and offers to sell.

Rubenstein’s Global Trading Systems operates as an automated market maker handling about 3.5 percent of U.S. stock-market volume and between 4 percent and 5 percent of U.S. Treasury futures trading.

High-frequency trading firms profit more in volatile markets because prices movefaster and to a greater extent, enabling them to buy lower and sell higher.

The Standard & Poor’s 500 index has swung an average of about 0.9 percent between its daily high and low in the past 12 months, compared with 2.7 percent in 2008. The Chicago Board Options Exchange Volatility Index, a measure of U.S. stock volatility, rose above 80 in 2008 and traded at an average of 32.69 that year. This year, it’s averaged about 14.86.

The calmer markets have dented earnings in the industry. High-frequency trading profits fell to as little as $810 million in 2012 from $4.9 billion in 2009, according to the latest estimates from Rosenblatt Securities Inc. High-frequency trading was involvedin about half of volume in 2012, compared with 66 percent in 2009, according to the firm.

The competition for speed was a result of common trading rules at exchanges and alternative venues. In the system known as “ price-timepriority,” equivalent-priced orders to buy or sell are executed according to when they reach the exchange’s tradematching computers.

So firms made large investments in reducing their systems’ latency, or the time it takes to make the electronic connections required to trade in dozens of data centers around the world. By 2011, performance-monitoring firm Corvil Ltd. was offering products that could track latency down to the nanosecond, or one-billionth of a second.

“Technology allows for the automation and scale that greatly lowers costs for investors,” Peter Nabicht, senior adviser to the Modern Markets Initiative trade group and former chief technology officer at high-frequencytrading firm Allston Trading, said in an email. “Professional traders do not compete with investors, they compete with each other to provide the liquidity and fair prices that today’s investors enjoy, investing in low latency and cuttingedge technology to do so.”

Business, Pages 25 on 03/22/2014

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