Curious why investors are bailing out of the market, or rather "market" - which trades a few basis points away from its all time highs on nothing but central-bank liquidity and multiple expansion fumes - at a pace unseen since 2009? Well, the fact that not only an SEC commissioner, but the Chairman of Finre himself admit the market is rigged may have something to do with it...
First, here is SEC commissioner Luis A. Aguilar, who unlike his former CFTC peer Bart Chilton hasn't been purchased by the HFT lobby yet, with "Enhancing Oversight of Our Equities and Options Markets." An excerpt:
A Rule Better Aligned with the Current Marketplace
Being able to identify and respond to emerging trends is the hallmark of any effective regulator. Although long overdue, the proposed amendments are intended to bring Rule 15b9-1 in line with the realities of today’s securities markets. Specifically, the proposed amendments, if adopted, would achieve three things:
- First, they would do away with the de minimis allowance and its corollary, the proprietary trading exception.
- Second, they would create a new, limited exemption for hedging. This proposed exemption recognizes that dealers trading primarily on one exchange may have a legitimate need to hedge their exposure through trades on other exchanges. To qualify for this exemption, however, dealers must be able to prove that their hedging transactions are legitimate hedges. Dealers can do this only by demonstrating that the sole purpose of their hedging transactions is to offset the risk of their floor-based activities. Dealers must also establish and enforce written policies and procedures ensuring that each hedging transaction meets this requirement.
- Third, they would require HFT firms that currently rely on the de minimis and proprietary trading exceptions to register either with an association, or with all of the exchanges on which they transact.
These changes are generally appropriate and should achieve their stated goals. But, there are some causes for concern. First, the Commission currently has no data regarding the nature or extent of floor members’ current hedging activities. Unless firms provide such data, it will be difficult for the Commission to make an informed decision as to whether the proposed hedging exemption is warranted and appropriately tailored. Second, the release includes questions suggesting that the Commission may consider expanding the hedging exemption to include other, as yet unspecified, activities. This is a discordant note in an otherwise measured approach, and it would not be prudent to pursue this course unless commenters demonstrate a legitimate need for such an expansion, and justify that need with reliable data.
The Need for Enhanced Market Oversight
Turning to the proposal to end certain HFTs’ reliance on Rule 15b9-1, it is important to understand that this will bring the largest HFTs within the supervision of an association or the exchanges that execute their trades. Why is this so important? There are several reasons.
First, it will enhance oversight of cross-market trading. Currently, when an HFT that is not a member of an association executes an off-exchange trade, the HFT’s identity is usually not reported to the Financial Industry Regulatory Authority, or FINRA, which is the only association currently in existence. This frustrates FINRA’s surveillance efforts as it cannot quickly link trades to the HFTs responsible for them. This is a serious problem because, according to FINRA’s current Chairman, certain market participants disperse their trading activity across multiple markets in an attempt to hide various forms of market abuse, including layering, spoofing, algorithm gaming, and wash sales. The proposed amendments to Rule 15b9-1 will help provide FINRA and any other associations that may be formed in the future with a richer and more detailed audit trail, which will help them spot abusive trading practices more effectively.
Second, it will help ensure accountability. Even when an HFT engages in abusive trading, FINRA is powerless to address it if the HFT is not a member. The proposed amendment would require HFTs to join an association like FINRA or all the exchanges on which they trade. This will ensure that these HFTs can be held responsible for any potential misconduct.
Third, it will ensure that the intent underlying Regulation ATS is not frustrated. Regulation ATS precludes ATSs from acting as self-regulatory organizations, and instead requires them to register as broker-dealers and join an association. Associations like FINRA are thus charged with monitoring trading activity on ATSs, but this regulatory scheme is undermined if the HFTs that account for almost half of all trades on ATSs are not subject to any association’s jurisdiction.
Fourth, requiring all HFTs to join an association or additional exchanges will help provide the Commission with a more complete and detailed picture of HFTs and their cross-market trading activity. It is crucial for the Commission to have an accurate understanding of HFTs’ behavior so that it can make informed and objective decisions in deciding how best to regulate HFTs. This is especially important given the various competing claims that have been made about the legality and social utility of certain trading practices used by HFTs.
With Great Data Comes Great Responsibility
Requiring HFTs to become members of a registered national securities association or of all the exchanges on which they trade will provide a more complete and detailed picture of their cross-market trading activity. This will help regulators develop a richer understanding of HFTs’ behavior, and every effort should be made to leverage this understanding into a more effective market oversight program. In particular, regulators should use the additional information they would receive under the proposed amendments to fine-tune their surveillance techniques to the unique issues posed by HFTs. This will improve efforts to ferret out potential trading abuses, and help regulators spot new types of abuses that may develop in the future.
And here is Richard Ketchum, Finra Chairman with selected excerpts from his remarks from the 2014 FINRA Annual Conference:
FINRA is determined to be a key engine in restoring trust in the securities markets. Can we solve all of this country's consumer and market issues? No. But we can tackle many of them—and how we do that is what I'm going to focus on this morning.
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Even though the markets are widely fragmented, FINRA's ability to pull together data across exchanges and alternative trading systems allows us to see one big, virtual market instead of a disjointed patchwork of individual markets.
This is powerful stuff—because there are market participants out there who are actively dispersing their trading activity across markets in an attempt to avoid detection. With our cross-market surveillance program, we can run dozens of surveillance patterns and threat scenarios across our mountain of data to look for, among other things, layering, spoofing, algo gaming, wash sales and other manipulative and distortive conduct.
Because of the sophistication of these patterns, we are detecting things that we had not been able to see before:
over 80 percent of our cross market alerts involve conduct occurring on more than one market;
over 50 percent of our cross market alerts involve two or more market participants.
- we have more than 170 investigations open concerning abusive algorithms, inadequate supervision of algorithms and deficient order controls; and,
- we have brought cases against firms for inadequate market access controls and manipulative conduct. In fact, just last week we brought a case jointly with CBOE (on behalf of our options exchange clients) involving a cross product manipulation scheme where waves of equity trades were used to artificially impact options pricing.
While we believe our cross-market surveillance program is a major step forward, there is so much more that we can do. Other market integrity initiatives we have underway include:
- We recently received SEC approval for our "self-trade" rule that is designed to limit self-trades that could have an adverse impact on the markets and price discovery.
- In November, a rule will go into effect that will require all ATSs to use a unique market identifier (an MPID) to report volume executed on an ATS. This will bring certainty and consistency to how ATSs are flagged in our audit trail and surveillance systems.
- And we are thinking of other rules that might be useful to help detect and take action against abusive trading.
And while these changes and initiatives stand to be beneficial, the biggest game changer will be the implementation of the Consolidated Audit Trail or CAT.
And so on, you get the picture: not only do both the SEC and FINRA finally admit they have been largely clueless to HFT manipulation in the market over the past decade, ever since they so wisely allowed Reg NMS to pass and make a mockery of price discovery, but - more importantly - they also admit that there are "certain market participants disperse their trading activity across multiple markets in an attempt to hide various forms of market abuse, including layering, spoofing, algorithm gaming, and wash sales." Replace "certain" with most when it comes to HFTs who now are the vast majority of all "traders", and you have a pretty good picture of what is going on in the market.