SPECIAL REPORT-Globally, the flash crash is no flash in the pan

BATTLE LINES

Whatever the flash crash’s ultimate impact, it has the
potential to revamp the way tens of trillions of dollars
circulate through the world’s stock markets. It could also
spell significant changes to the business models of banks,
brokers, exchanges, funds, and the increasingly dominant
proprietary trading firms that all interact daily.

The biggest battles in coming years will likely center on
so-called high-frequency trading, or HFT, in which firms use
computer codes called algorithms to submit rapid-fire bids and
offers, making short-term markets and earning tiny profits on
price imbalances.

Having effectively replaced the trading floor specialists
of years past — and often based in offices nowhere near Wall
Street or the City of London — these operations remained quite
profitable through the volatile market drop two years ago this
month. HFT is now involved in an estimated 60 percent of U.S.
stock trading, and 40 percent of that in Europe.

The battle lines are now being drawn.

In a July draft report, British EU lawmaker Kay Swinburne
called for a full examination of HFT’s costs and benefits, as
well as “stress tests” to determine how exchanges would handle
a European version of the flash crash. Top European Commission
member Michel Barnier went a step further on Tuesday, declaring
that HFT needs new governing rules given the inherent risks it
poses. [ID:nN12159642] [ID:nLDE66K0QZ]

“I think a number of us are coming to the view that this
high-frequency trading has negative social value, and that it’s
not information discovery,” Nobel Prize winning economist
Joseph Stiglitz, a member of the joint CFTC-SEC advisory panel
studying the flash crash’s implications, said on Sept. 30.

“They’re playing games. They’re trying to extract
information from informed traders, people who are doing the
research,” Stiglitz added at a reception hosted by Thomson
Reuters in New York.

SEC Chairman Mary Schapiro has said HFT strategies need a
closer examination, and the agency is considering saddling such
traders with market-making obligations and privileges so that
they provide liquidity when it is most needed. Such a move
would put U.S. markets at sharp odds with Europe, which has
done away with market makers.

All this tough talk has spooked high-frequency traders and
the exchanges that rely on their liquidity and volumes. They
note that HFT was not blamed outright in the SEC-CFTC flash
crash report, and argue that its short-term strategies have
made trading cheaper and easier for all investors.

Richard Balarkas, CEO of Instinet Europe, the Nomura
Holdings Inc-owned (8604.T: ) agency brokerage and alternative
venue operator, said winding back the clock is a mistake.

“I don’t think investors on the whole want to go back to a
market where they all pay a tax, usually in the form of a wider
spread, to a firm making monopoly profits that will in any case
wave a white flag as soon as a stock has a liquidity shock,” he
said in an interview.

“It’s crystal clear why the flash crash happened: a lack of
buyers, and unthinking selling. It was pure, simple supply and
demand within a regulatory regime that the SEC had created.”

AFTERSHOCKS

The soul searching in the United States and Europe has
spawned some anxiety elsewhere. Exchanges in Asia and Latin
America invested heavily in recent years to install electronic
matching engines and order routing systems to attract the very
kind of trading now under the microscope.

Executives said that while there are lessons to be learned
from the flash crash, there is a danger in overreacting.

“It’s unfortunate for places like India, that the
confidence among the global regulators was shaken in exchanges
in the developed countries,” James Shapiro, head of market
development at Bombay Stock Exchange (.BO: ), said on the
sidelines of the Paris conference. “India is basically now
where it needs more deregulation to some degree. This has
introduced an element of caution.”

Atsushi Saito, CEO of the Tokyo Stock Exchange (.TOPX: ),
which launched a $140-million super-fast “Arrowhead” stock
trading system in January, told the conference: “We are
carefully watching the report from the United States on this
May 6 event… But we are very uncomfortable about the
demonization of high-frequency trading.”

When so-called MiFID II takes effect in 2012, it could set
the tone for any possible cross-border marketplace in East
Asia, where, as in Australia and Brazil, exchanges face the
prospect of new competition and a race to ever-faster
electronic trading in the near future.

It is here that the most severe aftershocks of the U.S.
flash crash could hit, said Joseph Gawronski, president at New
York-based institutional broker Rosenblatt Securities.

“Certainly the incumbents don’t want to see fragmentation,”
he said. “But at the same time they do want to see
high-frequency trading come to increase their velocity. And
that’s a very fine line.”
(Reporting by Jonathan Spicer; editing by Jim Impoco and
Claudia Parsons)

SPECIAL REPORT-Globally, the flash crash is no flash in the pan