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From Securities Regulation Daily, March 18, 2014

NY Attorney General calls for crackdown on unfair advantages given to high-frequency traders

By John Filar Atwood

Unfair arrangements that give elite groups of high-frequency traders early access to market-moving information — a practice that New York Attorney General Eric T. Schneiderman calls “insider trading 2.0” — is one of the greatest threats to public confidence in the markets, in Schneiderman’s opinion. In remarks at a symposium hosted by New York Law School, he called on exchanges and other regulators to consider market structure reforms and tougher regulations to eliminate the practice.

Co-location arrangements. Schneiderman highlighted a number of services that trading venues offer to high-frequency traders, including allowing them to locate their computer servers within trading venues themselves. These co-location arrangements give high-frequency traders access to information milliseconds before the rest of the market. According to Schneiderman, this enables high-frequency traders to make rapid trades before the rest of the market can react.

He said that co-location also helps high-frequency traders monitor all of the exchanges for incoming orders. If a firm can detect a large order from an institutional investor, it can instantaneously position itself on the other side of the trade, driving up the prices artificially, he noted.

The result of this practice, according to Schneiderman, has been to force large institutional investors to develop complicated defensive strategies to try to conceal their legitimate orders from high-frequency traders, including the routing of orders into alternative trading venues. The alternative venues, called “dark pools,” are less regulated, have fewer reporting requirements, and are far less transparent, he stated.

Other advantages. Exchanges also often provide extra network bandwidth to high-frequency traders, and attach ultra-fast connection cables and special high-speed switches to their servers, adding to the timing advantage enjoyed by high-frequency traders over the rest of the market. Schneiderman noted that these special services provide time for high-frequency traders to get a first look at direct-data feeds provided by trading venues with pricing, volume, trade, and order information. High-frequency traders can use the data to look for arbitrage opportunities among the various exchanges, moving on price and order information before the rest of the market is even able to digest it to capture momentary differences in stock prices, he added.

Markets are catering to high-frequency traders instead of working to curb the threats they pose, Schneiderman said. He reiterated his commitment to cracking down on arrangements that give elite groups of traders early access to market-moving information.

Market structure reforms. To address the imbalance, Schneiderman urged the exchanges and other regulators to consider certain market structure reforms. One proposal would require order processing to be done in batches in frequent intervals, to ensure that price, not speed, is the deciding factor in who obtains a trade. Presently, securities are traded continuously, so that orders are accepted and matched by price, with ties broken by which order arrives first. This system emphasizes speed over price, rewarding high-frequency traders for flooding the market with orders, he said.

press release on Schneiderman’s remarks points out that his speech is part of a broader initiative launched in 2013 looking into the unfair advantage provided to elite and technologically sophisticated market players at the expense of others. Last fall, Schneiderman announced that his office had secured an interim agreement with Thomson Reuters to discontinue its practice of selling high-frequency traders a two-second sneak peek at certain market-moving consumer survey results. More recently, he announced interim agreements with a number of financial firms to stop their practice of cooperating with analyst surveys administered by certain elite, technologically sophisticated clients at the expense of others.

MainStory: TopStory Enforcement NewYorkNews ExchangesMarketRegulation

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