Ted Kaufman - United States Senator for Delaware

High-Frequency Traders Seen Exonerated In Flash Crash Report

Source: Dow Jones

By Jacob Bunge

October 4, 2010

Members of the high-frequency trading community said Friday that the official report on the May 6 flash crash would help restore some of its tarnished reputation, while also highlighting the need for regulators to improve their own technology.

Computer-driven trading firms have borne criticism for intensifying that day's rapid market plunge after several of the biggest traders exited the market as volatility neared its peak, prompting lawmakers to seek tighter oversight.

"Factually, I believe that the report makes it pretty clear that [high-frequency trading] did not 'cause' the flash crash," said Manoj Narang, president of Tradeworx, a New Jersey-based firm that runs a high-frequency trading fund.

What the report does show, according to Aite Group Senior Analyst Paul Zubulake, is that regulators need better technology and a firmer understanding of electronic trading.

The 104-page report released jointly by the Securities and Exchange Commission and Commodity Futures Trading Commission Friday, showed that high-frequency traders did not broadly shut down transactions on May 6.

Six of the 12 biggest such firms scaled back trading activity during that afternoon's plunge; two of these left the market altogether, while four others curtailed trading for period of time between one and 21 minutes.

The regulators' report indicated some of the key drivers, notably large, bearish trades in the stock-index futures market that fueled a growing wave of selling in securities, jamming some exchanges' systems.

A slowdown in price data coming from exchanges prompted some firms to suspend trading activity, hesitant to continue doing business based on information that could have been faulty.

"These are all rational reasons to step out--they were worried about their systems and trade cancellations," said James Overdahl, vice president with NERA Economic Consulting and an advisor to the Futures Industry Association's Principal Traders Group, which represents proprietary trading firms.

Lawmakers, including Sens. Charles Schumer (D., N.Y.) and Edward KAUFMAN (D., Del.), have called upon regulators to ramp up trading requirements for high-frequency trading firms, to ensure there is enough liquidity to go around when markets turn turbulent.

The Securities and Exchange Commission is weighing a range of potential rules for such firms, including a broadened definition of "bona fide market maker," though some trading firm executives have argued that creating new obligations and benefits will raise costs for investors.

"They were doing what traders do, which is buy and sell, and I don't know how you can have rules forcing that in a free market," said Leo Melamed, chairman emeritus of futures exchange operator CME Group Inc. (CME). "What the regulators need to be doing is making sure exchanges have technological capabilities that can handle that [volatility]."

Additional detail on how many firms ceased trading amid the flash crash and why they did so is unlikely to end all debate over private, electronic traders' role in U.S. markets.

"I'm not going to fly in a plane without a pilot, and I'm not going to trade in a market without human beings," said Charles Trzcinka, finance professor at Indiana University.

Even if high-frequency trading has reduced costs for investors, Trzcinka said, the slower human factor is "a safety margin we ought to be willing to pay for."

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