From Nick Colas of Convergex
Stimulus & Response: HFT Survey Results
Summary: We recently completed an online survey of ConvergEx customers and partners on the subject of U.S. equity market structure, with 357 responses largely (65%) from our institutional buy-side clients and prospects. The headline number is startling: fully 70% of survey participants do not believe that equity markets are “Fair for all participants”. Part of the blame resides with the role of High Frequency Trading (HFT) in current market structure. A small majority (51%) believes it is either “Harmful” or “Very Harmful” to market participants, while only 19% believe it is “Helpful” or “Very helpful”. Our survey also indicates very much a “Wait and see” approach to how these professionals view the current landscape. Seventy one percent have made no changes to the way they interact with U.S. equity markets. Opinion is pretty evenly split – 43% versus 38% - on whether more regulation is better than the rules currently on the books. Our takeaway: when 70% of market participants think markets are unfair, something’s got to give.
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The typical human has a response time of about 0.25 seconds, or 250 milliseconds. That’s the time it takes us to process a stimulus and generate a response. Light tends to generate faster responses than sound, and world-class athletes can have quicker reflexes than the average population. Sprinters at the Beijing Olympics logged an average 189 millisecond response time to the starter’s gun, and a few could get down to 109-121 milliseconds.
Human response time is an outsized topic in capital markets at the moment with the ongoing debate over High Frequency Trading (HFT). In reality, the topic has been on a slow burn for years, as anyone who reads Zerohedge will know. But with Michael Lewis’s book “Flash Boys: A Wall Street Revolt”, the previously arcane questions of how equity markets actually function has become mainstream. Lewis’s book is currently #1 on Amazon in three different Investing/Economic categories and #6 overall. It sits right between Elizabeth Warren’s “A Fighting Chance” (5th) and Disney’s companion book to the movie “Frozen” (7th).
The important question now is whether the scrutiny on equity markets driven by Flash Boys will actually engender any lasting change in how stocks trade in the United States. Response times will clearly not be measured in milliseconds; weeks and months is more like it. Yes, regulators and law enforcement have launched various investigations in an effort to untangle what is ultimately a very complex topic.
To get a sense of where institutional investors sit on this topic, ConvergEx recently completed an online survey on the subject of market structure and HFT (link here). Here is a brief summary of the responses:
- A total of 357 individuals answered the survey, which was available online. Respondents included people on the email list to receive this daily note.
- Of that population, 233 (65%) self-identified as working on the Buy-side. A further 73 (21%) came from the Sell-side (we have a number of brokerage client relationships at ConvergEx). A total of 50 other respondents were exchange operators, service providers, journalists and “Other”.
- The most startling response came to the question “Are the U.S. equity markets fair for all participants?” Keep in mind that we were polling professional investors, brokers and other investment industry professionals. They understand the notions of differentiated competence and information asymmetries. These are big boys and girls.
- Yet a full 70% responded “No” – markets are not fair. In many ways this observation is more damning than Michael Lewis’ claim of ‘Rigged’ markets. Fairness, as regular readers of these notes will know, is a powerful human need and individuals routinely do things that are not in their best interests if they feel unfairly treated. Make no mistake: when 70% of market professionals think the game is unfair, that game is going to change.
- On the subject of High Frequency Trading, our respondents are thus far unimpressed with the argument that HFT helps U.S. equity market participants. Fully half answered that it is “Harmful” or “Very Harmful”. Only 19% said it was “Helpful” or “Very Helpful” to participants. Clearly, advocates of the current market structure need to sharpen their arguments if they want to move the debate in their direction. Right now, the notion that HFT is helpful to market players is falling on deaf ears fully 80% of the time.
- Now for the part about how market participants have responded to Flash Boys, dueling BATS/IEX heads on CNBC, and all the other attention this topic has generated. The short answer is they haven’t. Of the 355 people who responded to the question “Has the recent debate regarding HFT caused you to change the way you interact with the U.S. equity markets?”, 253 check the box labeled “No, I have not made any”.
- This should not be a surprise, for several reasons. First, this debate is still fresh and there are strong advocates on many sides of the discussion. Second, market professionals already knew many of the problems discussed in “Flash Boys” from their day jobs; there isn’t much new for them here. Lastly, it is clear that regulators are looking into this topic but it will take some time to see how that storyline develops.
- As for how regulators should respond to the challenges raised in recent weeks, our survey shows a slight majority (43%) favor either “Much more” or “More” regulation while 38% favor the same amount of regulation.
- The question I was personally most curious about relates market resilience: “How confident are you that the U.S. equity markets could handle the volume created by a sudden geopolitical crisis or other large volatility shock. Only 38% of respondents were either “Very Confident” or “Confident”. The remaining 62% were either “Not Confident/Not at all Confident” or “Neutral” (22%). Over the last two decades we have had numerous events, both geopolitical and macro/financial, that engendered a spike in equity market volumes, so it would be more heartening if the majority of respondents felt the current system could handle this kind of stress. Less than 40% is essentially not a ringing endorsement.
In short, our survey seems to tell a very clear story. Most professional investors and institutional brokers do not feel that markets treat all participants fairly. They worry about how fragile markets might become during periods of abnormally high volume. At the same time, they are cautiously picking their way through the minefield in which they find themselves and are unsure what role regulators should play. How the landscape will change as a result of their unease is still unclear. What is certain is that change is coming.