The Anonymity Of HFT Whales May Be About To Expire, Together With Their Revenue Streams
If you have been wondering why Rentec, GETCO, Citadel and Highbridge are sweating these days, it is because the SEC is preparing to finally remove the rock they all crawl under as they execute millions of trades each and every second. As Traders Magazine reports, "the Securities and Exchange Commission, in an effort to get more
information about high-frequency trading, plans to dust off an old
statute that allows it to require large traders to "self-identify"
themselves. As part of the plan, the SEC will propose a rule
implementing a large trader reporting system for non-broker-dealers." So if you see any particularly abnormal market behavior these days, don't be surprised if it is simply due to Jimbo and Kenny doing all the can to pocket last any minute revenue before the hammer comes crashing down.
So why does the SEC care about identifying these huge, market moving non-broker institutions? Because, apparently the brilliant regulatory idiots do not have an idea of who trades what right now. Correct: the market regulator is unaware if GETCO moves a trillion shares of AIG stock all on its own. How the hell are these people policing the markets if they don't have access to something as simple as that?
This new effort is expected to give the SEC more visibility into the
activities of some high-frequency trading firms. Currently, the SEC
does not have this access to this information.
David Shillman, associate director of the SEC's Division of Trading
and Markets, said the SEC can use its authority under Section 13(h) of
the Securities Exchange Act to force large trading firms, including
hedge funds and proprietary trading shops that are not broker-dealers,
to file a form with the SEC and use an identification number when they
trade. That would allow the SEC to gather information about their
executions and help determine what impact, if any, they may be having
on the marketplace.
"We need to get better baseline information about who the
high-frequency traders are and what they're doing," Shillman said. He
noted that high-frequency trading has grown significantly in recent
years. "It has become such a dominant part of the market that now may
be the time to revisit exercising our authority under Section 13(h),"
"Among other things, the Commission has authority to require all
large traders to self-identify and to use a large trader identifier
when they trade," he said.
What is the basis of Section 13?
The authority to establish a large trader reporting system hails from
the Market Reform Act of 1990, which Congress adopted in the wake of
the 1987 market crash. The set of initiatives in that legislation was
conceived to address the "causes of precipitous market declines,"
according to the SEC's 1991 annual report. Those initiatives also
authorized the SEC to collect financial information on broker-dealer
holding companies for risk assessment purposes, among other things.
The SEC in 1991 proposed Rule 13h-1, which sought to establish a large
trader reporting system. The proposed rule required large traders to
file a form with the SEC and receive a large trader identification
number. That number would have to be used by all broker-dealers
effecting trades for that firm.
The large trader reporting system never got off the ground. Foreign
banks resisted the rule because of confidentiality laws in their home
countries [no worries there anymore, eh UBS?], and in 2000 the SEC instead proposed Rule 17a-25. That rule
requires brokers to electronically send the SEC information about
"customer and proprietary securities trading," when the Commission
requests that information. The rule, adopted in 2001, enhanced the
Electronic Blue Sheet system, which enables the SEC to get transaction
and related information from brokers. The EBS system got its name from
the blue paper that the SEC's information requests had previously been
As for why regulation on a by exchange basis is idiotic, and why Rentec will always be able to nickel and dime the populace absent a global overhaul in regulation that tracks the order flow by execution not by venue:
"Right now, we are looking through a translucent veil, and only seeing
the registered firms, and that gives us an incomplete--if not
inaccurate--picture of the markets," he said. FINRA is the primary
regulator of broker-dealers and is making a pitch to conduct
consolidated market surveillance across market centers. Ketchum noted
that market surveillance is made more difficult by the ability of firms
to move order flow from one market center to another "on a
But what is making the East Setauket boys most nervous, is that practically overnight their entire strategic advantage (recall numerous filing under seal in any litigation involving Renaissance) will be taken away:
That additional legislative authority, Shillman said, could provide the
SEC "with more direct oversight of unregulated high-frequency traders."
That oversight could allow the Commission to more effectively probe the
trading strategies of firms and propose rules to address activities
that are considered problematic, he said.
We appreciate the SEC being ahead of the curve on this one, just as it has been so prescient on all other matters. Should this initiative become effective we would be even willing to acknowledge, in a manner taking after the Obama administration, that the SEC has prevented or forestalled 600,000 market crashes. Unfortunately any regulator is only as good as its most recent horrendous judgment (and the SEC has many of those).