The sheriff of Wall Street is out to curb its fastest guns.
Eric Schneiderman, the New York Attorney General, is campaigning for tougher regulation of exchanges and trading venues that he says give unfair advantages to high-frequency traders at the expense of other investors.
High-frequency trading is executed by superfast computer programs, buying and selling shares and bonds faster than any human trader could.
Mr Schneiderman says faster access to market-moving information gives these rapid-fire traders a big advantage.
By some estimates, high-frequency trading represented roughly half of all US stock trading in 2012, so the attorney general is targeting a significant chunk of Wall Street’s business.
One issue under scrutiny is the “co-location” of clients’ servers within exchanges and trading venues, and the provision of ultra-fast connection cables and switches.
Mr Schneiderman argues that these services offer a timing advantage that allows high-frequency traders to “make rapid and often risk-free trades before the rest of the market can react”.
This can generate enormous revenues for high-speed traders and force large mainstream investors to develop extensive and expensive defensive strategies to conceal their orders from “parasitic” traders.
“I am committed to cracking down on fundamentally unfair – and potentially illegal – arrangements that give elite groups of traders early access to market-moving information,” Mr Schneiderman said. “We call it Insider Trading 2.0, and it is one of the greatest threats to public confidence in the markets.”
Modern Markets Initiative, the trade association for high-frequency traders, shot back that Mr Schneiderman is behind the times and not up to speed with the latest trading techniques that are available to all.
“Co-location and direct market data feeds are available to all market participants, not just a select few,” the association said. “Not only are these services available, they promote efficiency and transparency. By making proximity and data available to all, co-location and market data feeds have further democratised market access.”
Mr Schneiderman isn’t buying it.
He argues that the “tiny sliver of time” afforded the high-frequency traders allows them to get a first look at direct data feeds, that include details on pricing, volume, trade and order information; and that the trading firms can use sophisticated technology to trade on the information before other investors have time to react.
Mr Schneiderman believes that co-location helps high-frequency firms to watch activity on all financial ex-changes for large incoming orders. Then, if a high-speed trading firm detects a large order about to come in from an institutional investor such as a pension fund, it could quickly position itself to be on the other side of the trade, artificially driving up prices.
Some larger institutional investors now conceal their “legitimate” orders from high-frequency traders by using “alternative” trading venues, or “dark pools”, which are less regulated, have fewer reporting requirements and are far less transparent, Mr Schneiderman said.
The attorney general called on exchanges and other regulators to consider market reforms that include the processing of trading orders in batches at frequent intervals “to ensure that price – not speed – is the deciding factor in who obtains a trade”.
Modern Markets Initiative said: “There is a mistaken assumption... that professional traders using HFT compete with investors. This is certainly not the case... traders compete with each other to provide efficient markets to investors looking to get into and out of positions.”
Intriguingly, the trade association added: “All fair-minded market participants can agree that as long as these services are available to all they are beneficial to the market. To the extent the services are not open to all, they should be made available or removed from the market.”
Mr Schneiderman said that late last year he had secured an agreement with financial information and news giant Thomson Reuters to discontinue its practice of selling high-frequency traders a two-second “sneak peek” at some market-moving consumer survey results.