Obama's bank plan could level high-frequency field

NEW YORK (Reuters) - President Barack Obama’s plan to crack down on proprietary trading at big U.S. banks could spark a new rush of start ups, putting them on equal footing with the established independent trading firms that don’t enjoy the backing of large financial institutions.

The plan, unveiled Thursday, would fragment the so-called high-frequency trading that provides much of the buying and selling in U.S. markets. But that liquidity would likely remain at healthy levels, say traders, analysts, and investors.

Besides the independent trading shops -- some of which have come to dominate equities and futures volumes in recent years -- hedge funds and private equity could also benefit if Obama successfully bars Wall Street banks from proprietary trading operations, unrelated to serving customers, for their own profit.

“It shifts the profits from the banks to the prop trading independent firms, but I don’t think it has a tremendous impact on liquidity,” said Larry Tabb, chief executive of research and consultancy firm TABB Group. “In equity markets, if one player goes away there are twelve others to step up to the plate.”

Independent high-frequency trading firms emerged in force in recent years to take on banks in the world of proprietary trading, where bets on capital markets are made with the firms’ own money, rather than executing trades on behalf of clients.

Independent proprietary firms, including heavyweights Getco and Tradebot, represent about 46 percent of all high-frequency trading in U.S. equities, compared to 30 percent by broker-dealers, according to a December report by Boston consultancy Aite Group.

The 15 largest independent firms alone account for 31 percent of overall high-frequency trading.

In the months before and throughout the financial crisis, a flurry of independents launched to take advantage of the volatile markets, a lucrative rush that died down in the second half of 2009. The firms use rapid-fire trading programs to make markets and take advantage of tiny buy and sell imbalances.

Obama’s proposal would likely force banks to sell or spin off their high-frequency proprietary operations into stand-alone entities.

That could spur traders to launch their own shops and help to level the playing field for today’s independents.

“It will definitely help the independent shops. It will create a more level playing field for everyone,” said Louis Liu, founder and managing partner at Lotus Capital Management LP, a New York-based quantitative trading firm that uses high-frequency strategies.

“Players will no longer have cheaper capital to make risky moves, some of which may not be warranted,” said Liu, adding independent proprietary traders are more likely than those backed by banks to make less risky bets in the market.


Obama’s plan is intended to limit the risk posed by massive financial institutions, but faces an uncertain political fate and would take years to come into effect.

It also raises questions over how to differentiate proprietary trading from exchange-based market making at the targeted banks, which include Goldman Sachs Group Inc, Morgan Stanley, and JPMorgan Chase & Co.

Still, it has the potential to reshape electronic trading in the United States -- where regulators last week launched a probe of equities markets to determine whether high-frequency traders, which account for more than half of all volumes, have undue advantages.

“If the plan goes through, I think you’ll actually see more shops being opened up,” said a partner at an independent high-frequency trading shop who requested anonymity.

“I don’t think the competition at banks will go away, but the talent in (the banks) will go into different places, or start their own firms,” he said.

James Ellman, president at San Francisco-based hedge fund Seacliff Capital, said it was unlikely a profitable bank proprietary desk will simply shut down under Obama’s plan.

“Either someone will want to buy that unit, or just as likely the guys that run that unit -- who know they’ve got a machine they just turn on every day and money spits out of it -- are going to want to (buy out) the thing,” he said.

Reporting by Jonathan Spicer; Editing by Tim Dobbyn