High frequency shopping
Imagine you are in Woolies doing the grocery shopping. You look at your Woolies IPhone App and it tells you need some Weet Bix, priced at $5.49, so you wander in the direction of the cereal aisle to grab a packet.
When you arrive at the shelf a funny thing has happened. The Weet Bix price ticket now says $5.51. 'Strange' you think to yourself, but you don't worry too much. It's only 2 cents after all.
What you don't know is that a clever bunch of computer geeks have developed a high performance computing system which enables them to track your IPhone usage, quickly buy them from Woolies at $5.49, and relist them for sale to you at $5.51.
'High frequency shopping' they call it. The geeks have invested a tonne in the computer system and are paying big bucks to Woolies for the license to operate it on their premises. Both parties insist that it is a 'free market' and that they are providing liquidity to the market for Weet Bix. Everyone's a winner!
As a customer, I'm not convinced. I heard the bit that went 'blah, blah, blah, free market, liquidity'. Maybe I'm a bit slow on the uptake and I don't really understand just how good liquidity is for me, but I'm pretty certain the result of all this is that I just paid 2 cents more for my Weet Bix than I needed to.
Fortunately Woolies won't be doing a deal with the computer geeks anytime soon. Why? Because if they do I'll be shopping at Coles and, in all likelihood, so will the rest of their customers. Whilst I appreciate the genius of the computer programming and respect the right of Woolies to operate their business in the way they see fit, I also respect my right to tell them to stick it.
This is the problem with the ASX continuing to allow high frequency trading, the sharemarket equivalent of clipping the ticket on our hypothetical Weet Bix purchase. Every trade put through the market is subject to being clipped by a 'speed of light' computer (owned by a hedge fund or investment bank) hooked into the ASX system that is able to 'front run' your real trade. You thought you could buy a share at $5.49 but, before your trade could make it to the end of the fibre-optic cable, the offer price has moved to $5.51.
There's good money to be made by both the participants and the ASX (which charges them juicy licensing fees for the best access) but the whole thing, whilst incredibly clever, is ridiculous. In any other context it would be laughable.
Advocates argue that it provides liquidity. It adds as much liquidity as our Weet Bix example. Liquidity comes from a participant bringing either stock or cash to the market - HFT brings neither. Hedge funds and investment banks can act as market makers without needing to do it at light speed. Market makers stand in the market as buyers or sellers, HFTers stand in the middle of a trade that would have occurred anyway. Market makers provide liquidity, HFT provides diddly squat.
The faux-libertarians (my pet name for those who only use free market arguments when it works in their favour) like to argue that it is the 'free market' in operation. 'Anyone can invest millions of dollars in a computer system and ASX fees' and join in is the argument. That's all well and good but the problem is that retail investors (and issuers) can't opt out of being on the other side of it.
Share trading is not a free market. It is heavily regulated and the ASX has a near-monopoly over it. You can't (morally, at least) regulate investors into having to act in a certain way and then argue the 'free market' as you put your hands in their pockets.
ASX, through its CEO Elmer Funke Kupper, warned in today's Australian of the 'dangers in changing the market structure'. The main danger, of course, would be to the profit of both ASX and HFT participants. 'Dark pools' (as non-ASX trading is called) threatens to keep money in the pockets of fund managers and their investors, at the expense of the HFTers and ASX.
There's been a huge amount of press on this issue recently. John Durie devoted most of a back page to it (again in today's Australian) where he curiously said that it was 'not front running in the traditional sense'. I assume what he actually meant was that it was front running done differently to how they did it in the good old days.
To me that would be the end of the matter. If we've accepted that front running is no good, the method for achieving it is somewhat irrelevant. Ban it. Move on.
But that runs the risk of the regulators getting bogged down in inquiries, submissions and a myriad of self-serving, bogus arguments. There is an easier way.
If we accept the proposition that the sharemarket is there to facilitate the flow of capital between issuers and investors, why don't we simply ask them? There's no need to get bogged down in the all arguments as to why it's right or wrong and no need to deal with a bunch of submissions by those trying to protect their patch.
One form to issuers and investors simply asking the question 'Do you want High Frequency Trading? YES or NO?' would suffice. Votes could be weighted according to average end of day balances over the course of the last year and that would be the end of the matter.
Unlike our shopping example, customers in this case don't have the opportunity to take their business elsewhere. The danger is that, instead of the HFT model being killed by the customers, they lose confidence in the entire industry and the overall sharemarket suffers as a result. Let's let the customers decide what they want on this issue and move on to more important things than the necessity for being able to trade shares by the nano-second.
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