Exchanges are eyeing mechanisms meant to protect investors, but critics warn of complexity and uncertainty
The idea of using speed bumps to level playing fields makes for a strange metaphor, but that’s exactly what exchanges on both sides of the Atlantic aim to do in the years ahead.
“By 2020, more than a dozen markets in stocks, futures and currencies from Toronto to New York to Moscow will slow down trading via speed bumps or similar features,” reported The Wall Street Journal.
Adopted by just a handful of markets five years ago, such mechanisms are designed to impose a split-second delay before executing trades made by high-frequency trading (HFT) firms. The ultra-fast strategies, which came into popular consciousness thanks to the 2014 book Flash Boys by author Michael Lewis, account for a large portion of trading volume on exchanges — though financial institutions such as banks and pension funds complain that HFT cannibalizes their profits.
“It’s finally boiled to the point where the exchanges started paying attention to what their clients are saying,” Roman Ginis, founder of US stocks-trading startup IntelligentCross, told the Journal.
HFT firms make use of sophisticated algorithms and speedy data-transmission networks to forecast small price changes on stocks, futures, and other assets and act on them quickly. This results in so-called latency arbitrage, a situation wherein a fast trader takes advantage of a moving price before other players can react. The result, according to critical narratives such as that presented by Lewis, is a great deal of investor harm.
To blunt that impact, the London Metal Exchange is planning to add an eight-millisecond delay to gold and silver futures later this year. Chicago-based Cboe Global Markets is also reportedly planning a speed bump on its own EDGA exchange in 2020, though it is still waiting for regulatory approval. If things go smoothly, LME and Cboe will join Atlanta-based exchange giant Intercontinental Exchange, which in May earned approval for such a mechanism on its US futures market. The derivatives arm of Germany’s Deutsche Börse AG has reportedly had such features deployed on some markets since 2017; Russia’s Moscow Exchange applied one to a dollar-ruble FX market in April.
Most of the latest planned speed bumps feature an “asymmetrical” design, typically meant to favour players who publicly quote prices on an exchange rather than those who seek to buy or sell using those prices.
“In many cases, the new speed bumps cover small, thinly traded markets, and they could help exchanges juice trading volumes by encouraging traders to post more quotes,” the Journal reported.
Supporters of such mechanisms, including Matt Clarke from U.K.-based high-speed trading firm XTX markets, say that anti-latency arbitrage reactions are “a natural reaction to the destructive speed race.”
But Jamil Nazarali, global head of business development at electronic trading giant Citadel Securities, countered that the proliferation of such speed bumps creates a risk of “phantom liquidity” that obscures the true prices of assets on exchanges. That, he argued, “will harm execution quality for both retail and institutional investors.”