Responses To Proposed Dark Pool Regulation

Tyler Durden's picture

From Senator Ted Kaufman:

Two months ago, I wrote a letter to SEC Chairman Mary Schapiro calling on the SEC to undertake a comprehensive “ground up” review of the U.S. equity market structure, including dark pools, high-frequency trading, flash orders, co-location of servers at the exchanges, direct market access, liquidity rebates, and payment for retail order flow.  Today’s open meeting and  rule proposals on dark pools, coupled with the proposed ban on flash orders issued last month, demonstrate that SEC Chairman Mary Schapiro and the Commission are taking this review seriously. 
I support the three amendments to the rules outlined by the Commission today, in that they are consistent with suggestions I have made in the past to address dark pool concerns:  defining indications of interest as quotes, lowering threshold limits on dark pools, and stricter reporting requirements. We need a comprehensive review, but that should not prevent the SEC from moving forward to adopt obvious improvements supported by evidence.
At the same time, these issues cannot be considered in isolation, as we already face systemic market structure problems resulting from the unintended consequences of prior rules.  The growing volume in dark pools itself, for example, is an unintended consequence of Regulation ATS.  Every time the Commission squeezes one side of the balloon, a bulge appears on the other side. The SEC must be conscious of those effects as well. 
Banning flash orders and imposing limits on dark pools should not be the end of the story, nor should they be seen as sacrificial lambs offered up by a substantial majority of Wall Street players as the price to ward off deeper review. 
Chief among the systemic issues that must be carefully reviewed is high frequency trading, which now makes up over 70% of the daily market volume.  The SEC needs to closely review these strategies -- whether employed in dark pools or the public markets -- to ensure that high frequency traders are not able to take advantage of the long-term investors who are the backbone of our capital markets.  It is the SEC’s mission to protect long-term investors, who care about the valuations of the underlying companies, not those who quest for trading profits achieved in milliseconds. 
As I have said frequently, I’m all in favor of liquidity in the markets – but when it works against transparency and fairness, transparency and fairness must win.  As a Commission staffer said at today’s meeting in response to a Commissioner’s question:  spreads have narrowed, but prices quickly move back and forth, and high-speed professional investors are better able than retail investors to take advantage of those price impacts.
Moreover, I’m deeply concerned that high frequency trading, left unchecked, could develop into a systemic risk, becoming simply too big and too fast to regulate.  Direct access to the exchanges by hedge funds -- which still are unregulated entities and which employ high frequency strategies without even the checks associated with rules applicable to broker-dealers -- also increasingly jeopardizes systemic stability. 
Achieving effective and efficient regulation of these profit-maximizing strategies will not be easy.  Already many industry participants have opposed even a mere review of high frequency trading.  Their position seems to be “nothing to worry about, move along.”
Given all we know about recent history, we cannot blindly accept these assurances.  I hope the SEC will continue to press for meaningful reforms, and so I’m pleased that Chairman Schapiro at today’s meeting mentioned these issues as important to the Commission’s review.  When the news reports that even sophisticated institutional investors are asking their major broker-dealers “not to simply hand over their orders on a silver platter” to high frequency traders, we know clearly that investor confidence in the fairness of the market has been jeopardized. 
Our credit and equity markets should be a national treasure.  They should direct capital to its highest uses – profitable, job-creating investment, not opaque, fast-buck speculation.  We need a careful review of high frequency trading, dark pools and other practices in a comprehensive “ground up” review of how our equity markets function.  Only then can the SEC restore investor confidence, establish a level playing field for all investors, protect the public from another systemic failure, and secure the foundations of our economic future.

And the response from Themis Trading:

We believe the SEC is striking an appropriate balance by shining a light on so much of the murky and small-execution size dark pools, and forcing their flow to the public quote, while still acknowledging the role of block trading and innovation for the institutional and retail community alike. We also appreciate the SEC looking broadly at our market structure as it exists today, and broadly looking at issues like co-location, specifically in how it relates to unfair advantages in the delivery of market data. We expect overall liquidity to not be materially affected, and perhaps the spreads even tighten, especially in the lower capitalization stocks.

Beginning with REG ATS in the late 90’s, the SEC has had the stated goal of transparency, and equal access to pricing by all market participants. Unfortunately, with decimalization and REG NMS, the velocity of trading has skyrocketed. While this spawned some innovative products, nevertheless it has fragmented the market place and hurt the price discovery process in an unintended way. Never did they expect there would be over 30 dark pools trading over 20% of the volume, with a great number of them being internalization engines. And never did they intend for such a large percentage of the order flow to be regulated in a different way than orders on public exchanges. Multi-tiered markets were wrong in 1998, and they are wrong today.

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buzzsaw99's picture

It is the SEC’s mission to protect long-term investors, who care about the valuations of the underlying companies, not those who quest for trading profits achieved in milliseconds... 

Bullshit! The job of the SEC is to hold down the pension funds while GS et al repeatedly rape them.

peterpeter's picture

> As a Commission staffer said at today’s meeting in response to a Commissioner’s question:  spreads have narrowed, but prices quickly move back and forth, and high-speed professional investors are better able than retail investors to take advantage of those price impacts.

Narrow spreads and faster changing prices go hand and hand.

Prices move more quickly now because the unit of change is a penny rather than a 1/16th...  This isn't rocket science, and to the extent that price movements are as a result of finer pricing granularity and their corresponding smaller spreads, retail investors are the biggest winners... and anyone who doesn't recognize this was likely not trading much in the pre-decimalization days.

Of course the professional investors are better able to take advantage of price swings than retail investors - they always have been and always will be.  They are by definition professionally involved in following equity prices and unwilling to overpay for shares by pennies as frequently as retail (and why is that wrong???  a doctor is better equipped to make a medical diagnosis, a professional trader is better equipped to make a fairly priced trade).

However, a retail investor overpaying 1 cent per share 90% of the time (due to HF market making and predatory strategies) is certainly an improvement over overpaying 1/16th per share 50% of the time....

> It is the SEC’s mission to protect long-term investors, who care about the valuations of the underlying companies, not those who quest for trading profits achieved in milliseconds. 

There are always going to be trading entities that facilitate trading for a profit.  Without market makers of the electronic or human variety, equity markets would have far less capital in them, much less liquidity, wider spreads and much less public confidence.

Someone is going to make a market for equities and capture the spread.  In the past, that was done by humans - and now it is done by computers.  The computers are far better at this work than the humans, and can therefore make a profit on much slimmer margins (spreads).

If the computers were magically shutdown - the average retail investor would most certainly pay more in spread to a human market maker... and I continue to be amazed that most of the folks here (who are not out of work floor traders and specialists) think that would be a good thing.

Yes - I know it is a matter of moments before CB calls me a troll... but I just don't understand what you are all thinking.  How does retail benefit from shutting down HFT?

Markets are not "fair" in that the smartest and best equipped always have and always will win... and yet there is a mob out to turn off the machines that have been responsible for making trading costs lower today than they have ever been in history (as measured in real commissions, fees and spreads).


Veteran's picture

That cross sure gets heavy to bear, doesn't it

Anonymous's picture

You said recently that you are a software engineer. Trading is intuitive . Computer programming for profits isn't. Get off your high horse. Markets are about psychology not granular statistics.

Anonymous's picture

Yes, of course markets are about psychology. That doesn't mean that statistics can't be used to predict market behavior.

Human beings are very predictable. That's why computers and statistics work so well in markets.
And that's why software engineers are so valuable to hedge funds, banks, etc..

So I think he's very secure in that saddle. :-)

Anonymous's picture

I think that your claim regarding how well computers statistics work in the marketplace will be discredited
. Investing and trading has always been an art and no amount of mathletes and computer horsepower will change that.
I believe that the great Jim Simons himself has described his world as a "crowded space " . There is no edge left in software engineering. Intuition is a human quality. Try as you may, you can't distill it into code. I realize that runs counter to what you have been taught to believe , but then again I suppose your model has already predicted my response.

Anonymous's picture

I have watched this Peter dude cry about anything that is shutting down his little algo program that puts food on his table at night way to many times. Due to the program/computer/algo/quant/rocket science/physics/mathematical genius "market makers" these markets have turned to utter absolute trash. I trade professionally for a living. I used to trade Nasdaq and now trade FX. No one trades anymore, no one. Every single day, the exact same people hit and lift me all day long. You know who they are? They are hedge funds (quant geniuses) that are using either RBS, JPM, MS, Citi, etc. etc. etc. I will do 5 trades in a row with JPBL, DEDT, CITV, etc. Its all trash, and when the market actually does do something when liquidity is needed, all those pikers aren't even there. You know why every single asset class moves in lock step together, because that is the only way the MIT physicist makes their money. They developed the program that said if the dollar goes down, every single time spoos go bid and commodities get taken. My dad got a masters in physics from MIT, I understand what all of these people think like, I have dealt with it my whole entire life. The only thing that these people have done is say that this is the way it is. They have huge unbelievable amounts of money doing all the same things, and have literally totally taken the human being out of it totally. If you do not stop this absolute nonsense, not only will you lose untold hundreds of thousands of jobs, but you will literally make approx. a handful of people so wealthy it is beyond imagination. If you want that, keep crying for it, if you don't then come over to a cleaner side that wants a fair playground for all. Also, I don't want to hear how it doesn't affect you, how in any market your algo still pounds out 5 a day. In the end, the only winners will be the largest ones.

Anonymous's picture

You seem to be confused - You say that you know exactly how these algos work - ok, then making money shouldn't be a problem for you if they are so predictable.
I seriously doubt that you "trade professionally for a living" - your whining exposes your lie.

Anonymous's picture

This is a straw man. If the retail investor is "overpaying 1 cent per share 90% of the time (due to HF market making..." then I agree. But if the retail investor overpays by 50 or 100 basis points as stocks oscillate throughout the day when market makers reliquify in one direction or another - without price or size continuity obligations - then the retail investor is getting clipped.

It's important for everyone to understand that HF market makers add liquidity moment-to-moment, and only when they want to. Since they finish flat at the end of the day, they don't add any liquidity day-to-day. Intraday, they can easily demand as much liquidity as they provide, depending on when and how they rebalance, and without constraints on their rebalancing activity "prices quickly move back and forth."

Anonymous's picture

The rebate model is a failure. The economic incentive to make markets must be restored. Transaction speeds beyond the physical limits of human comprehension must be made illegal. Any entity wishing to participate as a market maker must have an obligation to make markets and post trade worthy liquidity. Risk taking, capital commitment and displayed interest must be rewarded. HFT must meet the same standards of scrutiny as old fashioned order flow. Public securities must trade on public markets.

Ruth's picture

ok, I'm not in your 'trading' profession, but just think how AI affected AUS systems, approving everything that breathed and abled the pigs to skim and scam everything that moved.  Not exactly what I wanted to say, but you get the picture.  We thought the same thing too when things got out of control in underwriting mortgages, now look where we are.

I'm glad there are still live brains we can count on to think through the processes to make it safer for everyone....just too bad they're all here at ZH.  I heard Washington is hiring.

Anonymous's picture

to anonymous who said I don't trade for a living??? What, you think that JPBL is hitting me on my ameritrade account??? Are you really serious??? Also, I am not whining about anything. I am telling Peter the genius to quit the crying about the backlash on trash program trading. You are correct, I don't trade algo, and I don't care to, literally ever. If you don't think that I have enough ability to correlate trash against trash, then my friend, you are mistaken. For some unknown strange reason, these unbelievably smart geniuses have decided that things can only work their way. Just amazing.

Zippyin Annapolis's picture

Why don't we just pass a law mandating that every order be on a Central Limit Order Book (CLOB) and mandate an auction every 15 minutes?

We Can call it the Mary/ Duncan CLOB. 

That way no one has an advantage. Very Fair no?

Anonymous's picture

discretionary traders underperform systematic traders. screen trading is very inefficient. dark pools are a good complement to limit order books. please don't ban them. that's not a free market and you know it.

please ban the "trading psychology" chapters from every retail trading book. replace it with more on math and software engineering. then you can all design your own market mechanisms to compete with dark pools and stop complaining.

Anonymous's picture

How can you say dark pools complement limit order books when there is no displayed interest ?

Anonymous's picture

As an aside, how did your models hold up last year ? You think psychology is worthless. I think the same can be said for your math and software. The arms race we have witnessed over the last few years has produced a marketplace where people have built their business on the basis of a perceived edge measured in milliseconds. This regulatory loop hole is now closing . So long mathletes !