The highly profitable world of high-frequency trading is under threat after the US derivatives regulator allowed a futures exchange to slow down activity on its platform.
Atlanta-based Intercontinental Exchange will impose a split-second delay in the trading of two derivatives contracts, following a decision on Wednesday by the Commodity Futures Trading Commission not to object to the proposal. ICE’s three-millisecond “speed bump” will stall trading in gold and silver futures contracts, and is the first delay introduced into the $39tn market for exchange-traded US futures contracts.
The decision opens the door for further moves in futures markets that would erode the revenues of high-frequency trading companies that earn vast sums by taking advantage of prices faster than rivals.
The speed bump slows down trades coming into the market, but does not apply to the orders that sit in the market waiting for a buyer or seller. As such, the measure gives the slower trading firms the chance to cancel an order before a faster trader can execute it, neutralising the speed advantage that has led, critics claim, to predatory behaviour.
Companies such as Virtu Financial and Citadel Securities have profited from technology-driven trading that has reshaped market for stocks and derivatives over the past decade.
A slower US futures market would mimic moves in the stock market, where NYSE and CBOE have introduced speed bumps. IEX, the exchange group profiled in Michael Lewis’ book Flash Boys, pioneered a 350 microsecond delay for trades on its exchange, achieved by lengthening the physical wires that shoot electronic messages through its system.
The rise of high-frequency trading has opened up a debate among investors, brokers and exchanges. Critics have long claimed that speed-driven traders unfairly hurt traditional investors, including the fund managers that represent pensions and insurers. Supporters argue that faster traders are now a vital element of modern markets as banks have retreated in their role as market makers since the financial crisis.
The CFTC said that ICE would have to file a separate application to implement a delay to trading in other futures contracts, alleviating industry concerns that speed bumps could be expanded to any futures on its exchange.
The Futures Industry Association’s Principal Traders Group, which represents high-frequency trading companies, and the Managed Funds Association, whose members include hedge funds that have adopted high-speed trading, both opposed the measure.
The mandatory slowdown “could create a precedent that could be copied across the entire futures market,” according to the Committee on Capital Markets, whose members include Citadel and BlackRock, the world’s largest fund manager.
Douglas Bry, senior strategist with Welton Investment Partners, a fund manager, supported ICE’s proposal, saying in a letter to the CFTC that the technology-driven trading “inherently puts other market participants at a disadvantage”.
ICE welcomed the CFTC’s decision. In its initial filing in February, the exchange group said the speed bump would reduce the advantage of high-speed traders that use technology to arbitrage activity in related markets.
“This short delay helps to level the playing field,” the exchange group said. It added that it hoped to “encourage additional market participants, who may not otherwise trade certain exchange markets due to a [speed] disadvantage”.
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