Loyola University of Chicago School of Law, JD 2022
With the rapid innovation of technology penetrating our lives comes the need for increased regulation on the industries that are being impacted, and the stock market is no different. In the late nineties, the Securities and Exchange Commission (SEC) approved the use of an electronic stock exchange system and by 1998, they authorized the use of High- Frequency Trading (HFT). HFT is a method of electronic stock trading where the trader uses high powered technology to complete automated trading at a large volume and speed. Because these trades are not made by people, but instead computers, they can be executed within millionths of a second. As the speed that HFTs have allowed for stocks to be traded at has decreased over time, their popularity has increased. By 2012, it was estimated that HFT accounted for almost 50 percent of all U.S. equity trades. Their popularity is contributed to HFT’s ability to allow traders to ensure they have the most up to date information on the market and ensure that they get the lowest price. This gives traders the power to buy and sell at high speeds, increasing liquidity in the market.
The need for high-frequency trading regulation
Despite their growing prominence in the market, there is speculation over the need for increased regulation of these trades. Senator Dean Kaufman has been a vocal proponent of the increased need for regulation of HFTs. In a letter to SEC Chairman, Mary Shapiro, Senator Kaufman stated that “the proliferation of exchanged and other market centers that has increased fragmentation, the substantial rise in volume executed internally by broker-dealers or in dark pools, excessive messaging traffic, the dissemination of proprietary market data catering to high-frequency traders, and order-routing inducements all may be combining in ways that cast doubts on the depth of liquidity, stability, transparency and fairness of our equity market. These areas deserve further review and possible rule making by the Commission.” Not only do HFTs favor large corporations over smaller investors, but they also risk allowing the exaggeration of stock prices because they move large sums at instantaneous speeds. Because HFTs are automated they respond to any sudden change in the market.The Flash Crash of 2010 that caused the Dow Jones to plunge almost 1,000 points in one day was attributed to high-frequency trading. Navinder Sarao, a London based day trader manipulated the market to trigger HFT programs to buy large quantities of stocks at a higher price than anticipated. While Sarao was responsible for instigating the crash, HFTs were guilty of perpetuating the fluctuation of stock prices and demonstrated how volatile they make the market. The market quickly recovered from this disaster, but this was proof of the dangers that HFTs present.
Subsequently, the SEC attempted to implement precautions to safeguard against this type of fluctuation. Additional systematic circuit breakers, or trading curbs as they are otherwise known, were added to prevent additional trading of specific stocks if the price moves ten percent or more in five minutes. The new threshold of trading curbs has only been triggered once since their implementation, on March 9th, 2020, due to Coronavirus concern. However, there is still worry, from Senator Kaufman and others, that this threshold is too wide to protect against another HFT induced crash.
Cboe’s proposal for an increase in regulation
Recently, Cboe Global Markets (Cboe), the owner of the Chicago Board Operations Exchange, has sought to create a method of limiting the advantage of HFTs over other market participants. Cboe proposes a launch of periodic auctions, where stocks will be aggregated into batches and their sale will be executed during interval periods. This is in contrast to the continuous sale of stocks that the market currently supports. The proposal was created in an effort to even the playing field for traders who are not operating HFT programs. This will make the competition focused on price as opposed to speed. If this proposal by Cboe is approved by the SEC, they would be the first host of periodic auctions in the U.S. stock exchange. While Cboe is the third-largest U.S. stock-exchange operator, the proposal for periodic launches is for their platform BYX, which only handles about two percent of the U.S. trades. This may seem minuscule, but approval by the SEC of this type of mechanism could be indicative of whether they agree with speculations that HFT needs increased regulation or if the measures they have already implemented are sufficient.
The U.S. is not the only country attempting to answer this question. Other countries have attempted solutions to deter and regulate the use of HFT. For example, in September of 2013, Italy implemented a tax on HFT at a two percent rate for any trade that occurs every half second or faster. This made Italy the second country after France to make this decision. During her 2016 presidential campaign, Hillary Clinton advocated for a tax on HFTs here in the U.S. following this precedent, claiming that it would be the most effective way to slow ‘abusive trading strategies’. It is currently unclear if any of these proposals for regulation will be put into effect in the near future, but with attention increasingly being drawn to these advantageous practices in the market it is becoming increasingly expected by experts.