The May 6 flash crash has put high frequency
traders under a harsh spotlight. Many investors contend that
these traders, who use high-tech tools to buy and sell stocks
in microseconds, put long-term investors at a disadvantage by
front-running their orders and fueling market volatility.
Such activity merely increases the effective cost of trading
for pension funds and other institutional investors, critics
At a time when investors are struggling to eke out any
returns they can get, costs are as important as ever.
Fortunately, despite all the controversy about high frequency
trading, the evidence suggests that these high-speed,
high-volume players continue to put downward pressure on
equity transaction costs, not raise them, according to our 14th
annual survey of trading costs, conducted for Institutional
Investor by New Yorkbased Elkins/McSherry, a subsidiary
of Bostons State Street Corp.
[Click here to access the tables indicating Global
Execution Time and Market Impact
The average overall cost of equity trading in the U.S. edged
up during the 12 months ended June 30, but that increase
largely reflected lower trading volumes and higher volatility,
says James Bryson, president of Elkins/McSherry. The underlying
trend in costs is still headed lower, he adds. And costs fell
significantly in most international markets.
The concerns about high frequency trading are not
justified, because we have seen trading costs falling pretty
consistently, says Jamie Ritchie, director of capital
markets trading at Brockhouse & Cooper, a
Montreal-based global agency execution brokerage operating
in 39 countries, including the U.S. Some of that has to
do with the high frequency traders.
Average transaction costs for New York Stock
Exchangelisted stocks rose 10 percent in the latest
period, while costs on the Nasdaq Stock Market were up 16
percent, according to the survey. The U.S., with an overall
average cost of equity trading of 19.63 basis points in the
period, is no longer the worlds low-cost trading venue.
Japan and Sweden share that crown, with an average cost of
18.34 basis points in the period, followed closely by France,
at 18.49 basis points. Average transaction costs globally
declined 8.1 percent over the past year, to 38.02 basis
Concern about high frequency trading soared after May 6,
when the Dow Jones industrial average plunged nearly 600 points
in a matter of minutes and temporarily erased $862 billion in
equity value. A report on the incident by the Securities and
Exchange Commission and the Commodity Futures Trading
Commission attributed the collapse to a large automated sell
order placed by a mutual fund manager, but it added that
temporary withdrawals from the market by some high frequency
trading firms may have exacerbated the decline. Regulators are
weighing whether to impose some curbs on high frequency
trading, but with such activity accounting for as much as 70
percent of stock trading volume in the U.S., the prospects of a
crackdown appear remote.
Investors appreciate the liquidity that high frequency
traders bring to the market, but they worry about potentially
abusive practices such as pinging stocks, whereby traders
rapidly send and cancel successive orders to uncover valuable
information about an institutional investors position in
a bid to gain a trading edge. If you put in an order and
withdraw it immediately, and you have no intention of trading,
that is something that needs to be looked at, Ari
Burstein, senior counsel at the Investment Company Institute,
told a conference on market quality at New Yorks Baruch
College last month.
I think everyone cares about speed, says Phillip
Mackintosh, who heads Credit Suisses global
portfolio strategy team. What we dont want is
to put an order into a machine and then find out that the offer
you were going to hit is gone.
High frequency trading is less pervasive in Europe, but
industry executives expect volume there to continue to grow.
Such trading is likely to account for 45 percent of European
equity volume in 2012, up from 25 percent currently, according
to Aite Group, a financial services consulting firm.
The case against HFT is generally overstated, Reto
Francioni, CEO of Frankfurt-based Deutsche
Börse, told the Baruch College conference.
For brokers the key to interacting with high frequency
players is to take advantage of the liquidity that they provide
without revealing clients positions or trading
intentions, executives say.
The liquidity is important to the market, and we need
to interact with high frequency traders just like we interact
with any other liquidity providers, says Jonathan
Kellnar, president of the Americas business at Instinet in New
York. However, we always need to make sure we are acting
in our customers best interest. We need to make sure we
are not giving up clients information or leaving too big
a footprint. Instinet ranks No. 20 in global trading with
an average transaction cost, including commissions, fees and
market impact, of 4 basis points below volume-weighted
The controversy about high frequency trading has led some
institutional clients to demand more information about where
their trades are executed and the level of commissions and
rebates, which exchanges typically offer to high frequency
traders, that are paid, says George Sofianos, who heads up the
Equity Execution Strategies group at Goldman, Sachs & Co.
in New York. Their greatest concern seems to be about
more transparency on the choice of execution venues, he
says. Goldman ranks fourth among brokerage firms in global
trading and ninth among U.S. firms, with an average cost of
17.82 basis points and 8.15 basis points, respectively, below
VWAP. By a separate measure, execution relative to arrival
price, Goldman ranks No. 14 in global trading, with an average
cost of 4.48 basis points below the benchmark.
At Brockhouse & Cooper, Ritchie says his firm also
worries about information leakage, and the concern extends to
parties other than high frequency traders. You want to
use a broker who has no conflicts of interest with a
proprietary trading desk, he says. As for high frequency
trading, he says that although some customers had misgivings,
a lot of our investment manager clients think it is a
good thing. Brockhouse & Cooper ranks ninth in global
trading, with an average cost of 16.85 basis points below VWAP.
Relative to arrival price, Brockhouse & Cooper ranks No. 2
in U.S. trading and No. 3 globally, with an average execution
of 24.45 basis points and 27.23 basis points, respectively,
below the benchmark.
Both Goldman and Brockhouse & Cooper rank in the top
five in more than one cost category. Other firms that also
appear in the top five in more than one category include
Bloomberg Tradebook, Liquidnet and Fox River Execution
Technology. The Elkins/McSherry data are based on an analysis
of more than 11 million trades by 677 brokerages and nearly
3,000 managers on a universe of 19,669 individual stocks.
The challenge of preventing information leakage of
customers orders and of sourcing liquidity in
todays marketplace has helped fuel the growth of
Liquidnet, says New Yorkbased Alfred Eskandar, head of
U.S. equities at the firm. Liquidnet, a buy-side-only dark
pool, ranks No. 2 in both global and U.S. trading.
Notwithstanding all the fuss over todays market
structure and the role played by high frequency firms,
participants need to realize that the basics of trading
havent really changed, says Alan Hill, chief financial
officer of JonesTrading in Westlake Village, California.
Someone is always looking to reap short-term
profit, he says. The only difference today, he adds, is
that the players have changed, and its gotten a lot