Chris Blackhurst: Of course the flash boys of Wall Street have behaved awfully, but they've not acted alone over high-frequency trading
Midweek View: In truth, it is the entire system that should be in the dock and needs urgent overhauling
Chris Blackhurst writes regular columns for The Independent, i and The Independent on Sunday, and conducts weekly interviews for London Live TV. Blackhurst was City Editor of the Evening Standard for nine years, before becoming Editor of The Independent for two years. He was then promoted to Group Content Director, and in September 2014 he took on the multi-media business role. He’s won numerous awards for his journalism.
Wednesday 30 April 2014
Some of the most engaging lectures on my law course at university concerned insider trading. They came under the subject of company law, and they took us into a world of nefarious, colourful activity, of whispered tips and leaks, and dodgy characters who tried to steal a march on everyone else. There was, as well, a philosophical, discursive element that centred on whether insider dealing was a crime because it was difficult to ascertain who was the victim. Indeed, it was only made illegal in the UK in 1980.
Years later, as a journalist, I remember devoting many hours to the pursuit of an alleged insider-trading ring involving a well-known political figure and his dentist. We never got to the bottom of the claims, and for all I know they were hokum, but they kept us occupied and entertained. The story was that he was picking up all manner of confidential tips from his connections and passing them to his dentist, who would trade away on his behalf and make a killing.
How times have changed. This week, the US author Michael Lewis is in town to promote his new book, Flash Boys, about high-frequency trading (HFT), and the talk on TV and radio is of traders using powerful computers and complex algorithms to manipulate the markets to their advantage.
Like Mr Lewis's previous work, the bestselling Flash Boys is a compulsive, entertaining read. He has mastered the art of taking a seemingly dry subject – one that could not possibly sustain the average reader over one page, let alone a few hundred – and by finding a cast of wonderfully maverick characters, and portraying a David versus Goliath narrative, the little man taking on the giant corporate, makes it as exciting as any movie.
But while the attention in the reviews, and on-air discussions mostly focuses on the evil, nasty, giant banks that pump zillions into building state-of-the-art, world-crushing IT systems, the real villains of the piece barely merit a mention. That is not to criticise Flash Boys – it's brilliant, but in a knockabout way.
The popular thesis has been helped by New York Attorney General Eric Schneiderman, who calls HFT "insider trading 2.0". His office has launched an investigation into the practice. The FBI is already on the case – it's been looking at the HFT firms for a year.
It all seems a long way from my dusty lecture halls and the pursuit of a dentist. That was amateur stuff compared with today's "insider trading 2.0".
However, as ever where City greed is concerned, it is not that simple. Yes, the bankers are behaving awfully, engaging in an activity that has no socially useful function whatsoever, lining their pockets first and everyone else can go hang. We've been here before, though. Who was to blame for the last banking crisis? The bankers who flogged sub-prime to punters who could not afford to repay, or the regulators who saw the selling unfolding and chose to do absolutely nothing about it? I would argue they were both responsible.
Similarly, on the perennially thorny subject of bankers' bonus payments, is it the bankers wanting to earn as much as they can or the shareholders that never do anything to stop them who are at fault? Only last week, the Barclays' annual general meeting saw 34 per cent of the bank's shareholders fail to back its remuneration package. This was hailed as some sort of triumph in the campaign to curb bankers' bonuses.
Since when is 34 per cent a victory? When it concerns supine investment managers who don't want to upset the share price. Of course, the bankers must take the rap but, equally, they've not acted alone: too often, investors and regulators (them again) have turned a blind eye to their avarice. And, human nature being what it is, their desire to make hay should not come as any surprise.
So it is with HFT. How do the traders or "algos", in reference to their reliance on algorithms, get their information quicker than anyone else, details upon which they know they can commit millions in a nanosecond? Three ways. They locate their trading platforms as near as dammit to the exchanges' own systems. It removes any prospect of delay: they're right there, often in the same warehouse building.
In Wall Street's case, these premises are frequently sited in units across the river in less expensive New Jersey. Mr Lewis writes how, as a result, one New Jersey data facility was able to charge trading firms tens of millions of dollars over a few years for a service that would cut their trade times by a few thousandths of a second.
"Wall Street was, once again, a place. It wasn't actually on Wall Street now. It was in New Jersey," he writes.
Second, they use all manner of state-of-the-art equipment to connect their premises, including fibre optic cabling, microwaves and lasers. Mr Lewis describes the work of Dan Spivey, a former futures trader who chased ever-faster trading speeds and ended up boring a hole through the Allegheny Mountains to lay a straight line of fibre optic cable from Chicago to New Jersey.
The cable connected the Chicago Mercantile Exchange with the Nasdaq stock market's operations. By being straight, it was able to shave off milliseconds for the orders that traders sent back and forth.
Third, they pay to get ahead. There is nothing duplicitous or underhand about this: they pay for their own data feeds. While everyone else relies on the public feed, the securities information processor, or SIP, the modern equivalent of the old ticker tape that used to churn out stock market news to brokers, those who can afford it are able to access something quicker and better.
Their feed arrives faster and contains more solid information, such as all the prices being offered, not just the best ones. That detail is fed into their computers and they can get ahead of the rest of the market. Often, they can use a sliver of information to detect a large order in the offing, an "iceberg".
For the exchanges these private feeds are big business, and more lucrative than the traditional public service. Nasdaq, for instance, now makes more money from the private or proprietary data feeds than it does from the SIP. From 2006 to 2012, its "prop" data revenues more than doubled to $150m (£89m) a year.
It can't be coincidence that exchanges have been hit with complaints that their public SIPs have been neglected and are not as reliable and have fallen further behind the super-slick private feeds.
If someone is willing to sell, why are the HFT operations at fault for agreeing to buy? Mr Schneiderman's "insider trading 2.0" is a nice soundbite and may look good and tough on paper, but in reality, where is the crime? How can high-frequency traders be committing an offence if they strike a deal with an exchange for the fastest possible data feed?
When he looks to put on the handcuffs, Mr Schneiderman could do worse than begin with those in the exchanges who supply a smarter product, at a price, than the public ones. In truth, as with sub-prime and bonuses, it is the entire system that should be in the dock and needs urgent overhauling.
With exchanges so willing to help them, the flash boys are not so flash after all. It's David versus Goliath all right, but a battle in which Goliath has been armed by a careless David.
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