Stock exchanges once were operated as not-for-profit public utilities, managing the listing and trading of companies in the public marketplace. Today, they have morphed into rent-seeking, publicly traded companies in the zero-sum game of executing orders.
Where once there were many winners, now there are distinct winners and losers. High-frequency, algo-driven traders — and the exchanges that now exist to serve them — are the winners; everyone else is a loser.
Trading on Speed
The result is that a business that once helped to create wealth now only serves to shift some of it around. Exchanges now operate primarily to move money from investors to HFTs — and of course, to themselves. They charge for services that are not exactly the epitome of a public good — server colocation for firms that spoof, packet sniff, quote stuff, flash and ultimately, front-run orders.
Traders have long complained that New York Stock Exchange specialists owned a license to steal, but at least they were required to maintain an orderly market. There were no flash crashes during the specialist era (Black Monday not withstanding). Those who complained about specialists — an exchange member who posts quotes, executes trades and serves as the buyer and seller of last resort — now must contend with something far worse: the predatory practices of high-frequency traders.
Yes, yes, I know, it is all perfectly legal. That phrase used to have meaning, before lobbyists were writing legislation on behalf of the people who hired them. That such things as HFT are allowed should come as no surprise. When you write the rules that govern your own industry, it is difficult to see why you would make your main money-making activity illegal.
Although the debate over whether HFT is an improvement over the specialist system or merely an unintended consequence of Regulation National Market System continues, a few participants are not waiting to see what happens. Some major players have decided that HFT doesn’t serve them or their clients; they have taken their ball and gone to a fairer, more level playing field, where no ringers are allowed.
We learned about this from a Wall Street Journal article on a new private trading platform called Luminex:
The most exclusive new club on Wall Street opens for business next week and there are a few things you won’t find: members with under a billion dollars or high-frequency traders. Those are among the rules laid out by the founding members of Luminex, a private trading platform designed to give the world’s largest asset managers a new place to buy and sell large blocks of stock.
This isn’t merely a group of cranks complaining about HFT: Luminex was developed by some of the biggest asset managers in the world specifically to thwart what has become a tax on orders exacted by HFTs. Its ownership includes BlackRock Inc. (largest money manager in the world by assets), Fidelity Investments (second-largest mutual fund family by assets), Capital Group Cos. ($1.4 trillion in asset) and Invesco Ltd ($755.8 billion in assets), and others.
That these behemoths are seeking ways to avoid HFTs is quite telling. It implies that the HFTs are not providing the liquidity and narrower spreads they claim, but rather, are imposing a rentier’s tax. To a retail investor buying 100 shares, it probably amounts to a nickel or a dime; but to these trillion-dollar firms, trading billions of dollars of stocks daily, it adds up to real money. They apparently have had enough of it.
Luminex, headquartered in Boston, has rather strict membership rules. You must have at least a $1 billion or more under management and commit to a long-term investment strategy. Translation: no high-frequency traders or quantitative hedge funds. Minimum orders must be at least 5,000 shares or shares worth at least $100,000; trades are executed at the low, low price of 0.25 cent a share.
The Journal reported that 73 institutions have been authorized to trade on Luminex. Nineteen firms were denied membership because “they were too small or had “overly complicated business models.” I take the latter to mean they were fronts for algo or HFT firms.
Over the years, I have written about the perils of high-frequency trading (See this, this, this, this, this, this, this, and this). Our Masters in Business interview with Brad Katsuyama of IEX, an alternative trading venue designed to exclude speed traders, made clear the way HFT negatively affected market structure. That the biggest asset managers in the world agree with this sentiment says something significant about the problems with the current market structure.
It was inevitable that in the absence of smarter regulation, some players would seek a market-based solution. Between IEX and Luminex, HFT is finding major market participants seeking shelter from their predatory ways.
I have a simpler solution: Quotes must last at least one second, a lifetime in the world of HFT, and a fee of 0.01 cent would apply to any order, filled or not. That would curb the abusive practices. In the meantime, it’s heartening to see a market solution.
Rentiers beware: the big boys are gunning for you.