WASHINGTON Dec 4 High-speed traders make money off the back of small investors without taking much risk themselves, a top U.S. government researcher found, potentially posing a setback for the sector as regulators consider tighter rules.
High-frequency trading firms (HFTs) earn large and persistent profits, according to a study by the chief economist at the Commodity Futures Trading Commission (CFTC), the powerful U.S. derivatives regulator.
"HFTs derive their profits from fundamental and small investors," Andrei Kirilenko said in slides he first presented at a conference on Friday. "HFT profits increase in aggressiveness."
The study, which Kirilenko had written together with two academics outside the CFTC, presented the views of the trio of authors and not necessarily those of the CFTC, its commissioners, or its staff.
The CFTC said the study is still under peer review, a common process for academic papers in which other researchers critique a publication before it goes to print.
Critics of high-speed trading say it can exacerbate market crashes because traders need to turn over large volumes to make enough money from the tiny price differences they seek out, reaping a small margin on each trade.
Europe is discussing tighter rules, such as forcing the traders to post orders for at least half a second, far longer than the fractions of a second they currently stay in the market, in which each micro-second counts.
In the United States, the issue is on the radar of the over-arching Financial Stability Oversight Council (FSOC), which called for "policy responses when appropriate" from the CFTC and the Securities Exchange Commission in its 2012 annual report.
The body has also said that monitoring the sector in real-time is hard because it is opaque.
The sector, which accounts for about half of all stock exchange trading, has been blamed for playing a role in the May 2010 "flash crash," when the U.S. stock market plummeted nearly 10 percent in a matter of minutes.
A panel of outside experts in 2011 recommended that the SEC and CFTC rein in computerized trading and suggested charging HFTs for their disproportionately high buy and sell orders.
The SEC and CFTC have not yet issued their own framework of potential reforms for the industry.
CFTC Commissioner Bart Chilton, a Democrat who has long been critical of the high-speed trading sector, welcomed the study from Kirilenko and others.
"What this paper shows is that this type of speed trading can often be parasitical and have far less value to markets and price discovery than many contend," he said.
Britain is more attuned to the industry. In a government-sponsored paper released in October, it rejected most of the recent plans hatched by Brussels.
Out of nine proposals, the paper found two were effective, while seven were problematic, including a plan to force HFTs to post prices to buy and sell at all times, to stop them from pulling out when markets get choppy.