October 17, 2009 / 12:02 PM / 10 years ago

RPT-Critic of high-frequency trading rattles conference

(Repeats story sent Oct. 16)

By Jonathan Spicer

SCOTTSDALE, Arizona, Oct 16 (Reuters) - Seth Merrin, the outspoken head of block-trading platform Liquidnet, shook up a trading industry conference — and conjured up the U.S. Revolutionary War — on Friday when he said high-frequency traders harm traditional market players.

Merrin, whose private market caters mostly to buyside institutions, told an audience here that the world’s fastest traders fail to provide liquidity in a broad array of stocks, and when they do, the resulting smaller bid-ask spreads end up costing institutions that trade larger blocks of stock.

“The institutions are the British Army in the Revolutionary War walking down the field in lock-step, proud and in red — you couldn’t get a brighter color. The high-frequency shops are the Americans hiding in the woods in their camouflage, picking them off one by one,” Merrin said.

“We all know who won the war ... we kicked their asses,” he told a Security Traders Association conference, to laughter.

High-frequency trading — where banks, hedge funds and independent proprietary shops use lightning-quick algorithms to make markets and earn thin profits from inefficiencies in the myriad marketplaces — has come under fire this year after politicians and others raised concerns about unfair markets.

The U.S. Securities and Exchange Commission is looking into the practice, which is estimated to account for more than half of overall U.S. equity volume, and is spreading quickly into other regions and asset classes.

Speaker after speaker over two days at the STA conference had defended high-frequency trading, arguing it reduces costs, curbs market volatility, and adds liquidity so that traders can move stocks even in a crisis such as last year’s sell-off. The ultra-fast practice is generally seen by the industry as the natural evolution of increasingly electronic markets.

Merrin, whose market has relatively little high-frequency flow, said the practice has a “virtually unlimited capacity” to grow because every institutional buy or sell order creates a supply-demand imbalance from which the traders can profit.

“For every buyside algorithm that is created out there today — whose sole purpose is take this large order, slice it into tiny pieces to mask it going into the market — there are now thousands of computers on the other side that are sniffing that out,” he said. “And those computers are ... more sophisticated than whatever algorithm you guys are applying.”

This type of trading does not represent true market making, Merrin said, because it focuses primarily on the most liquid, large-cap stocks, such as Citigroup Inc (C.N), American International Group (AIG.N), and Bank of America (BAC.N) — and far less on others.

“Yes, they’re reducing the spreads, but it costs the institutions” because they’re beating the institutions to the profits to be made on market imbalances, he said, adding he does not want to see this type of trading banned.

Rebuttal was quick.

Jamil Nazarali, managing director of electronic trading at a unit of Knight Capital NITE.O, later told the conference the facts aren’t there to back Merrin’s claims.

Joseph Rizzello, CEO of the small National Stock Exchange, said high-frequency traders played a key role in smoothing out the crisis a year ago, adding that banning the practice would halve trading volumes.

On Thursday, Dave Franasiak, principal at law firm Williams & Jensen PLLC, who represents the STA in Washington, said Senators Charles Schumer and Ted Kaufman and other lawmakers raising concerns over high-frequency trading have encouraged “a sense of perceived inequality, where somehow the little guys are getting hurt.”

Kaufman wrote in the Financial Times newspaper on Friday that, left unchecked, “high frequency trading could develop into a systemic risk, becoming simply too big and too fast to regulate.” The SEC, playing a big part in the Obama administration’s financial reform plan, aims to issue a concept release on high-frequency trading by year end.

Merrin, who admitted there was yet little data to back his claims, stressed that institutions need to become more familiar with the fast traders interacting with their orders.

“If the British didn’t change their fighting stance, their tactic, and they didn’t choose a different battlefield, they would have lost every war since then,” he said. (Reporting by Jonathan Spicer; Editing by Gary Hill)

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