Michael Lewis’ book Flash Boys brought attention to the world of high-frequency trading (HFT) that the industry probably would rather avoid. We’ve chronicled that industry before, and periodically bring to our readers’ attention when we hear about shifts in regulators’ attitudes or about potential new regulation of HFT. Thus far, of course, that’s all there has been to report: potential regulations. We wish we could report robust regulation of a market activity that we believe is fundamentally parasitic, even when it functions within the letter of the law. For now we just keep track of the regulatory “temperature” in the hope that we will get wind of that robust regulation when it is really in the works.
We continue that reporting here. Last Thursday, the chair of the Securities and Exchange Commission (SEC), Mary Jo White, gave a wide-ranging speech at the Sandler O’Neill Global Exchange and Brokerage Conference. While broadly supportive of the role of technological innovation in financial markets, she did point out problems of algorithminduced market instability (such as the 2010 “Flash Crash”) and the opacity of “dark pools,” or unregulated trading venues.
What caught our eye, however, was this proposal:
“We also are focused on using our core regulatory tools of registration and firm oversight. I have asked the SEC staff to prepare two recommendations for the Commission: the first, a rule to clarify the status of unregistered active proprietary traders to subject them to our rules as dealers; and second, a rule eliminating an exception from FINRA membership requirements for dealers that trade in off-exchange venues. Dealer registration and FINRA membership should significantly strengthen regulatory oversight over active proprietary trading firms and the strategies they use.”
If those rules were approved and implemented by the SEC, they would signify a major shift in the regulatory status of HFT firms, classifying them as broker/dealers and potentially subjecting them to much stricter oversight. White continued:
“I have further instructed the staff to prepare recommendations for the Commission to improve firms’ risk management of trading algorithms and to enhance regulatory oversight over their use. Given the overwhelming dominance of trading algorithms, it is time that our regulatory regime is updated to take better account of the risks when they are poorly designed or operated.”
We believe that this is an encouraging prospect, and would represent a significant improvement in the current lack of regulatory oversight of HFT firms and of their trading algorithms. We are not tremendously optimistic about the capacity of the SEC to remain a step ahead of high-frequency traders -- but registering them as broker dealers would certainly be a step in the right direction.
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