The 'slow frequency' shift from FX to stock markets

Efforts to curb the advantage of high frequency traders - who use computers churning out numerous transactions at lightning speed - face resistance on stock markets, although technology is already starting to level the playing field in currency dealing.

Critics of high frequency trading (HFT) say it distorts prices, causes "flash crashes" when markets dive in an instant, and fuels an expensive arms race to shave milliseconds off trading times.

However, high speed trading firms argue that they provide essential liquidity in markets which narrows the gap between buying and selling prices, cutting costs for investors.

While regulators are still discussing possible restrictions on HFT in equities markets, operators of commercial foreign exchange trading systems are already taking action.

Banks grouped together in April to launch their own currency trading platform, ParFX, which features technology to level the playing field between slower and faster clients.

EBS, one of the largest currency dealing platforms, unveiled initial steps in August to curb high speed trading with a similar method to ParFX. This uses a randomizing technique in which the first order to join the queue in the system is not necessarily the first to be executed.

"I'm pretty sure we're (ParFX) the first platform in the world to use this randomized pause. Now we've seen one other venue follow our lead," said David Fotheringhame, head of electronic FX spot trading at Barclays, who helped develop the ParFX concept. "We know a lot of other exchanges are looking at it."

Introducing such a system in equities, however, will be tough due to tighter regulations and the large revenues high speed trading firms generate for stock exchanges, said Larry Tabb, founder of the TABB Group financial consultancy firm in New York.

"In the equities market, it's going to be pretty tough for an exchange to introduce randomization because the regulations have been interpreted to be very time-price specific," he said.

National securities regulators would have to approve any change in the way stocks are traded whereas this would not be necessary in the $US5 trillion a day currency market, which crosses borders and has little regulatory oversight.

Scare off clients? 

The size of high frequency trading in equities is another barrier to change. "High frequency trading firms are very significant clients of the exchanges... (High speed curbs) will act as a significant deterrent to their client base and so that becomes problematic," said Tabb.

HFT volumes have fallen over the last few years due to lower volatility and higher correlations between asset classes, but the sector remains a major force on financial markets.

High speed trading accounted for 49 per cent of total volumes on the US equities markets last year, down from a peak of 61 per cent in 2009. In Europe it was 28 per cent, down from 38 per cent, according to the TABB Group.

On the regulatory front, the European Union is holding final negotiations on revising trading rules, known as the Markets in Financial Instruments Directive (MiFID).

The European Parliament has approved in committee a half second minimum resting period for equities trading, but this is widely regarded as a negotiating tactic that will be weakened in the final version of the law, or absent altogether.

In the United States, the derivatives watchdog Commodity Futures Trading Commission (CFTC) asked last month for industry input about speed trading in what could be the first step to rein in the sector.

PARFX ramps up

The technology used by ParFX to curb speed trading is working smoothly and could be used in other sectors, said Daniel Marcus, global head of strategy and business development at inter-dealer broker Tradition.

Tradition developed the infrastructure and operates the ParFX platform on behalf of a consortium of 11 founder banks, which include Barclays, BNP Paribas, Deutsche Bank, Bank of Tokyo Mitsubishi and Morgan Stanley.

"I think spot FX is one of best examples in the market to use the randomizer, but it could equally apply across other markets - anything that's affected by HFT," Marcus said.

At the moment, Tradition has no plans to use the technology in other asset classes as it focuses on expanding ParFX.

The ParFX system assigns a randomized pause of 20 to 80 milliseconds to all order elements before matching the buyer and seller. This is much longer than a pause on EBS of between one and three milliseconds for trades in the Australian dollar/US dollar currency pair. One millisecond equals one thousandth of a second.

ParFX is adding 10 more banks to the system and plans to expand to non-banking members early next year, Marcus said.