Following the wild years of high frequency, low-latency trading, being fastest to the market is no longer the biggest concern. A few leaders have consolidated at the top, and they are clearly identified as a select group that maintains the “Race to 0.” Elsewhere, other high-performing firms have changed their business strategies and decided to avoid the astronomical costs required to have the top one or two trades.
The new race is for the third or fourth best trade, and it’s a competition that doesn’t necessarily require microsecond latency. For contestants in this second wave, smart, transparent selection is the key competitive advantage.
This era of HFT has prompted regulators to act quickly to patch up any abusive behavior, with a range of regulations which have rippled through the entire capital markets. The goal was to make the market as transparent as possible. Yet the ambiguity of many of these regulations may have resulted in quite the opposite.
The Wild West of HFT is over, and there’s a new sheriff in town. But what does the new long arm of the law mean for market participants big and small?
In this blog I won’t talk about the multimillion or multibillion dollar fines that are being handed out to the largest of the financial institutions. More notably, but less discussed, are the smaller market participants who increasingly suffer from poor navigation through these murky waters because they do not have proper visibility. I am seeing clients getting slapped on their wrists with 20 – 30 thousand dollar fines every couple of weeks for small violations. These add up over months and years to be a substantial burden for these small firms.
What can you do as a market participant when the regulators warn you that you occasionally send too many orders to the market? You can check your algo…or all of your algos to see if it’s even possible. But you know that each one of these applications acts on its own - so how do you control what actually goes out on the wire to the market? Without sufficient monitoring systems in place you are flying blind.
Now that in and of itself may not be detrimental to your trading strategy – unless of course something goes wrong and you don’t know what is going wrong because you cannot see it, but that’s for another story. It, however, most certainly puts you in greater risk when you’re summoned by the regulators to prove that you were indeed innocent. And that is the core of the problem here. If you don’t have the tools to fight back, you will likely end up on the losing side when facing the sheriff.
Time and time again I have had a client tell me that only by using an independent third party, industry standard, nanosecond precision, wire data monitoring tool they were able to come out with a clear proof and escape any potential harsh punishment.
We refer to this as regulatory tail-risk and it’s very real. So how do you protect your firm and prove your innocence?