2749

Sebi should study the impact of algorithmic trading before taming it

Sebi should study the impact of algorithmic trading before taming it
Comment E-mail Print Share
First Published: Mon, Mar 12 2012. 09 36 PM IST

Shyamal Banerjee/Mint
Shyamal Banerjee/Mint
Updated: Mon, Mar 12 2012. 09 36 PM IST
U.K. Sinha, chairman of the Securities and Exchange Board of India (Sebi), has sounded caution on the growth of high-frequency trading in the past. But his comments last week were particularly scary: “We need to look at whether the regulator has the capacity to handle this (high-frequency trading). I doubt stock exchanges and Sebi have the capacity.”
One would imagine that a securities markets regulator will make efforts to inspire confidence in the structure of the market place. But such a statement does exactly the opposite. According to Financial Chronicle newspaper, Sinha said he doubts if the regulator has the capacity to detect some rogue algorithms and high-frequency trading (HFT) which may create havoc in the system. It almost gives the impression that a monster named HFT has been unleashed in the market place, which could destroy the whole market.
Shyamal Banerjee/Mint
Sinha’s solution is to impose a speed limit on algorithmic trading. The regulator is uncomfortable about the speed at which some trades are done; and the antidote it is prescribing is a speed breaker, to get people to trade at a level it is comfortable with. Needless to say, there will be arguments against this view with respect to the curtailment of efficiency in the market place. And as pointed out earlier in this column, who is to decide what is an appropriate speed limit? Some brokers might be happy to suggest throwing out all computers and going back to the trading floor. But what will that do to efficiency and transparency? And again, will a speed breaker on the path between a trading member and an exchange ensure that the former will never throw caution to the wind and compromise on risk management?
But the much bigger problem with the speed breakers solution is that we don’t know if it’ll help or make things worse. Sure, intuitively, one can say that speed breakers will help. But the regulator has no mechanism to know for sure that such a move will lead to a desired outcome.
Michael J Aitken, chair of capital market technologies at The University of New South Wales and chief scientist of Sydney-based Capital Markets Cooperative Research Centre, says, “We are making market design changes to try and fix up problems such as the flash crash, but we have no mechanism for working out whether the changes that we are making (that regulators are authorising) make the markets better off or worse off. How do we know speed breakers will work? Shouldn’t we have a way of evaluating the implication of this potential change before we implement it?”
“Let’s put our finger on the real problem.” he adds, “It’s not HFT per se (or tweaks thereto) or dark pools or circuit breakers or any other market design change… rather it is the fact that regulators have no idea of how to live up to their published mandate of ensuring a fair and efficient market. Alternatively, they have no framework to facilitate evidence-based policy making.”
To be sure, regulators across the world give the impression that they are groping in the dark with respect to their understanding of the impact of algorithmic trading and its subset, high-frequency trading. Since the advent of algorithmic trading in 2008, market efficiency metrics have improved. Bid-ask spreads have narrowed and transaction costs have decreased. But there are hardly any measures or data to determine if things have changed with respect to market fairness.
It’s important to note here that Indian exchanges have some safeguards in place. Pre-trade risk management ensures that a member’s position limits aren’t breached; a predetermined throttle rate ensures that an algorithm that is faulty or is designed with mala-fide intent isn’t able to pump in excessive quotes in a short period of time.
Even so, the regulator must pull up its socks and get a better grip on the changes in market structure. Some firms that help trading firms develop algorithms using technology such as complex event processing also offer regulators equal capability to monitor and safeguard markets. Giles Nelson, deputy chief technology officer at US-based Progress Software Corp., writes in his blog, “The same technological advances that led to the evolution of HFT can be used to ensure that the markets work safely, by ensuring that limits are not exceeded, that an algorithm ”going crazy” can’t bring down an exchange, that a drunken trader can’t move the oil price and that traders are dissuaded from intentionally trying to abuse the markets.” Sebi is already using a market compliance offering by The Nasdaq OMX Group. It needs to now beef up real-time market monitoring and surveillance.
JR Varma of the Indian Institute of Management-Ahmedabad, chairman of Sebi’s own risk committee, has suggested in the past that a stress test of the market structure should be conducted by building a so-called stock market simulator. All of these solutions require processing large amounts of data and will entail large investments in technology. Sebi must state its intent and plans on these measures, rather than spooking the markets with statements that it doesn’t have the capacity to monitor the fast-evolving marketplace.
Your comments are welcome at inthemoney@livemint.com
Comment E-mail Print Share
First Published: Mon, Mar 12 2012. 09 36 PM IST
blog comments powered by Disqus
  • Wed, Jul 30 2014. 05 04 PM
  • Wed, Jul 23 2014. 06 06 PM
ALSO READ close

High frequency trading: To let be or to not let be

Subscribe |  Contact Us  |  mint Code  |  Privacy policy  |  Terms of Use  |  Advertising  |  Mint Apps  |  About HT Media  |  Jobs
Contact Us
Copyright © 2014 HT Media All Rights Reserved