Cut the pipes on trading robots
ASX chief executive Elmer Funke Kupper believes that Australia can lead the world in eliminating the evils of high frequency traders who are creaming money from retail investors and those who manage retail money.
On close questioning by the KGB, Funke Kupper agreed that if this move fails, the ASX will have to consider cutting the pipes that give the high-frequency traders the chance to jump in front of orders to make retail buyers pay more and sellers get less.
Of course the high frequency traders pay large sums for this right to manipulate the market.
I have never known such a chaotic situation in the Australian Stock Exchange. Readers are now coming to me with examples of peculiar trading events – but more of that later.
In fairness to Australia, in New York the situation is worse. Both markets have been enticed into what Star Wars fans would call the ‘dark side'. The victims are smaller investors or fund mangers acting on behalf of smaller investors.
In New York, most fund managers have been forced to abandon the New York exchanges because of the bad practices. In Australia the same thing is happening. Full marks to the institutions. The exchange regulators in Australia and around the world should hang their head in shame for allowing this to happen.
Because it is so serious the KGB Interview with Funke Kupper is longer than usual and I was more aggressive than normal.
To the credit of Funke Kupper he admitted that mistakes had been made. He believes with a passion that the technology that high-frequency trading uses has aspects that are very good for markets.
The regulator needs to introduce measures that will make it too costly for the high-frequency traders to rip money off small traders and fund managers but will preserve the good parts of the technology.
I fear that the Australian regulators will not protect smaller investors but Elmer Funke Kupper says I am wrong and that the regulators are on top of it. I genuinely hope he is right and my fears are unfounded.
Let's therefore give the regulator the chance to do the right thing in the interests of retail investors and those managing the savings of smaller investors. Meanwhile, in the next few months it is important that fund mangers continue to develop what are called "dark pools” where they trade among themselves because although these pools have many bad features they are the only mechanism we have to make sure the regulator gets on top of the bad features of high frequency trading.
Towards the end of the interview we really get to the nub of the question and I put to Funke Kupper that if his solution of tightening rules does not work and the fund mangers are still not happy with the way the ASX is being conducted, then the only solution is to cut the high frequency trading pipes.
Funke Kupper: Well, my... Yeah, maybe it is. I think it's a hard decision to make”.
And then I put to the ASX chief this proposition: "If you can fix it and the fund managers believe it's a fair market, then that's fine. But if you can't, then I tell you what to do” (I will be telling the ASX to cut the pipes)
Funke Kupper: "And so you should. But remember if we cut the pipes, we're back to your solution which is there one exchange in this country. I mean it's a consequence of doing it and so that will be a very deliberate space trade-off by regulators to, say...
Kohler: Oh, are you saying that CHI-X can't exist without high frequency trading?
Funke Kupper: I suspect that model is more dependent on it than our model. In fact multiple exchanges really to some degree depend on that kind of model. The next stop in this...
Kohler: So, that's an interesting statement. I mean so are you saying that the stock exchange competition actually relies on high frequency trading in order to have competition?
Funke Kupper: It's a circular argument ….
You can follow the debate from there in the transcript. As far as I am concerned, if the regulators can't make the trading fair then the pipes should be cut. The ASX is very close to agreeing. That's a big step forward.
Meanwhile when you have a market being manipulated by high frequency traders ordinary people get very upset. Here are two examples that have crossed my desk. Just over a week ago BCI Iron was trading at $2.65 and then in about two minutes it was boosted to $ 3.50; then there was a sale (later cancelled) at $4.64 and then half an hour later the stock was back to $2.65 - blatant market manipulation.
Last week NKWE Platinum was trading at 5 cents and three minutes later fell to 4.5 cents in trades which had a total value of less than $5. And then back to 5 cents. That market manipulation represented a $3 million market capitalisation move. In fairness the stock was later suspended because the major shareholder was being forced to sell its shares.
There is a lot of work to be done to ensure fairness on the ASX.
The good news is that the ASX chief executive does understand there is a problem that must be fixed.
Footnote: Just to be clear cutting the pipes is a dramatic expression for ending the deals that give the legalised insiders preferential access to the market.
Previous articles on the subject include: Getting the jump on high-frequency trading (July 18) and Time to control the trading machines (August 6).