Yesterday was my first meeting in Washington, DC as a member of the CFTC’s Technology Advisory Committee, or TAC 2.0 as it is called. The meeting featured reports from working committees on aspects of high frequency trading, or HFT, as well as presentations about SEFs. The first task from Working Group #1 was to define what HFT is.
The working or provisional definition of HFT from Working Group number #1 was:
High frequency trading is a form of automated trading that employs:
(a) algorithms for decision making, order initiation, generation, routing, or execution, for each individual transaction without human direction;
(b) low-latency technology that is designed to minimize response times, including proximity and co-location services;
(c) high-speed connections to markets for order entry; and
(d) high message rate (orders, quotes or cancellations).
Other working groups had more granular assignments, some which depended somewhat on the definition of Working Group #1. Working Group #3, which featured representatives from the CME, ICE, NFA and others gave a report that says all the information the regulators need to analyze HFT and other forms of trading is already available.
One of the questions that was raised was what is the problem with HFT we are trying to solve. There is a belief in some corners that these efforts will lead to, at a minimum, some form of registration of participants using HFT, which from the broadness of the definition at this stage might be nearly all significant market players.
Let me just state my opinion that any player can be disruptive to the markets. Stuff happens and you can’t outlaw stuff happening. We have rocket scientists who do all kinds of tests on their rocket designs, but we still have had some stuff happen with rockets and shuttles. Anyone using a HFT strategy or with that capability can have stuff happen regardless of registration or testing.
Heck, NASDAQ OMX just proved this point from an exchange standpoint. They did all kinds of pre-IPO testing getting ready for the Facebook offering. But stuff still happens.
The second part of the meeting featured five presentations from organizations interested in the Swap Execution Facility, or SEFs, space. CME led off with a description of their SEF aggregation technology, CME Direct, which they want to license to firms registered as SEFs.
ICE gave a short presentation featuring their current technology and how it has SEF features built right in.
UBS also presented their SEF liquidity aggregation strategy. Bloomberg gave a very granular presentation on how their technology works. ICAP gave an interesting presentation on what they are and how they make their money. It was a long, but effective way of getting around to how they would fit in the SEF space.
While I know more about SEFs than I did before the presentations, I am not sure I am confident how all of this is going to work. We are just going to have to wait and see.
One issue I did bring up was the question of settlement prices for identical standardized OTC derivatives that are traded on different SEFs and cleared at different clearing houses. If you trade a swap and clear it at ICE and trade another and clear it at CME, you could have different settlement prices because of different models or price discovery dynamics at the different execution facilities. That means the pays and collects would not be the same for all.
I am told this problem exists today, OK I can see that, but it is strange from a futures clearing model. Firms with offsetting positions at different clearing houses might have to pay more for a position at one than they would be collecting from another. It is just a little market inefficiency because of the structure.
I asked the CME representatives whether CME Direct had any intellectual property issues, either patents the CME might have applied for or conflicts with other patented technology. They said they were unaware of any. Having lived through the Wagner patent and the TT patent stories, and how similar some of the OTC trading screens looked, I had to ask the question.
Other things I learned on my trip to Washington:
- It is good to wear a seersucker suit in Washington, DC on days when it is 101 degrees. (I did.)
- It is hard to explain why you are wearing a seersucker suit and sporting a summer beard (my Ethiopian cab driver was baffled).