After years of trying to cater to their quickest customers, the world’s biggest futures exchanges are now looking to slow them down.
Deutsche Börse’s Eurex will start a pilot scheme next week that introduces tiny delays, or “speed bumps”, to the trading of options on French and German stocks. The London Metal Exchange is also set to receive approval for a similar initiative, from UK authorities.
Just two weeks ago US regulators approved Intercontinental Exchange, the second-largest US futures operator, to apply delays on trades of two precious metals contracts.
The moves represent a significant shift for the futures industry, which has long supplied high-frequency trading (HFT) shops such as Citadel Securities and Jump Trading with ever-improved connections, so they could try to profit from the difference between the most up-to-date trading price and older prices offered by slower players in the market. But in doing so, other market-making groups have had no choice but to spend heavily on technology to keep pace. Some are now growing weary of the fight.
Winners and losers may be separated by just one-millionth of a second but the cumulative costs of missing out have left some players marginalised, the exchanges say, which has contributed to declining liquidity in the market.
“[Futures] markets exist for the transfer of risk by increasing liquidity,” said Carl Gilmore, president of Integritas Financial Consulting in Chicago, who is a supporter of speed bumps. “If it draws people in, it makes the markets fairer. If they’re perceived to be unfair, then something needs to be done to correct that perception,” he said.
The HFT industry, understandably, has protested efforts to throw sand in their wheels. Rob Creamer, chief executive of Chicago-based Geneva Trading and chairman of FIA PTG, a lobby group, said that while the exchanges’ various projects seemingly only affect small parts of the market, “the broad language” of the proposals “makes us very concerned that this could be like opening a Pandora’s Box of changes to market structure”.
Speed bumps in futures markets discriminate against some classes of participant, the HFTs argue, while potentially destabilising other assets in periods of volatility. That is because big markets such as US equities and Treasuries are pegged to prices set by futures.
“The goal of financial markets is not to protect or shelter the less informed,” said Brian Quintenz, a Commodity Futures Trading Commission commissioner who opposed the agency’s approval of speed bumps for ICE. “Market efficiencies are earned — they are created through research, investment, and intellectual property.”
But ICE and Eurex say certain categories of high-speed traders have become a problem, even if they have generally refrained from practices such as “spoofing”, where orders are rapidly entered and cancelled to trick other traders into buying and selling. The cost of staying in the arms race is concentrating business among a few companies that can afford it, ICE argued in a filing to the CFTC.
Efforts to slow down trading have been seen in other asset classes. In equities, for example, IEX Group burst on to the scene on a wave of publicity generated by Flash Boys, Michael Lewis’s book about HFT. The platform’s speed bump — sending all orders down 38 miles of coiled fibre, amounting to a delay of 350 millionths of a second — had a limited impact, though, as IEX accounts for just 3 per cent of all US equities trading.
Futures contracts, however, are typically open for long periods and their risk is assessed daily. That tends to concentrate trading in an asset at a sole venue, on one order book: a “winner takes all” approach that means exchanges are in a stronger position to try and change behaviour in the market.
ICE and Eurex say they will delay certain types of orders from hitting their books. For ICE it will be three milliseconds — or thousandths of a second — for gold and silver contracts. For Eurex it will be one millisecond for German options and three for French options. In theory, those fractional delays should give market-makers the chance to update their price or cancel an order before a faster trader can hit it, and lock in the price. “More and better posted orders would represent an improvement in overall market quality in the markets,” ICE argued in its CFTC filing.
Opposition from the HFTs is tempered for now because the projects carried out by the exchanges are billed as experiments, and affect small parts of the overall market. ICE’s rival, CME Group, for example, is the dominant venue for gold and silver futures trading.
But the lobby groups for HFT on both sides of the Atlantic are ready to step up their arguments if the pilots show signs of gaining traction.
“You have to let markets evolve and let them decide,” said Niki Beattie, founder of Market Structure Partners, a consultancy, and non-executive chair of XTX Markets, which supports speed bumps.
“You can give people choice but if you haven’t got competition then you can’t do it.”