Fragmented markets gave HFT rationale, says Rolet

Algorithmic and high-frequency trading’s main purpose is not to provide liquidity to markets but to trade between fragmented markets, according to the chief executive of the London Stock Exchange.

The comments, by Xavier Rolet, came the same day that the LSE revealed that a new trading system installed for its Turquoise trading platform – partly to attract high-frequency traders – was the fastest trading system in the world, at 124 microseconds for a trade to be done.

They come as regulators are scrutinising the role of computer programmes known as algorithms to drive trading automatically in markets, as well as the role of high-frequency trading, which refers to certain trading startegies that often use algorithms to get trades done at high speed.

Mr Rolet told an annual meeting of the World Federation of Exchanges that high-frequency trading had ultimately been a creation of regulators, who encouraged the development of competition betwen market venues through regulations such as Reg NMS in the US and the Markets in Financial Instruments Directive (Mifid) in Europe.

In the US, that has led to a proliferation of trading across 11 exchanges, 37 alternative platforms and 200 broker networks, according to the Securities and Exchange Commission. The need to navigate through this number of venues has prompted the development of sophisticated trading technology, including algorithms, some of which seek out automatically where orders are best done.

Algorithms are used by asset managers and brokers, as well as high-frequency traders. High-frequency trading accounts for over half of US share trading, while around a quarter of trading volume on the LSE is done by what Mr Rolet caleld “specialist” automated traders, including high-frequency traders.

Mr Rolet said: “Liquidity provision is not its primary purpose. It is design is fundamentally proprietary profit-driven, but is a required activity given regulators have decided to introduce competition and fragmentation.”

His comments came as other exchanges criticised the scale of fragmentation in equity markets. Exchanges have long felt uneasy about the emergence of competition, but have seized on the “flash crash” as evidence that market structures have become needlessly complex amid a proliferation of trading venues.

Mr Rolet said that regulators had decided to introduce competition in equity trading as “a central dogma of efficiency”, but there had been “unintended consequences of fragmentation”.

Duncan Niedererauer, chief executive of NYSE Euronext, said the problem was that fragmentation has resulted in fragmentation of “regulatory data” as well. He cited the difficulty that exchanges and trading platforms had in the hours after the “flash crash” explaining what had happened across venues as whole, as many had different types of trading systems, some including circuit breakers and some not.

“What I think was less obvious to regulators is that there was a knock-on-effect in fragmentation of regulatory data,” he said.

Mr Niederauer added that so much trading had moved into “dark pools” and other alternative venues that “if we are not careful where this takes us is that the attractiveness of quoting in the public markets will dissipate”.

Thomas Peterffy, chief executive of Interactive Brokers, one of the largest US-based brokers, said the number and variety of types of trading venue made the US markets “a complete mess”.

“Some amount of competition between exchanges is a good thing. It keeps costs down, technology up to date and services improved. But having too many exchanges creates difficulties for brokers and regulators and undermines the very purpose of an exchange.”