One of the problems of high frequency traders (HFTs) is that they create an uneven playing field by producing a liquidity mirage. They can offer and then remove liquidity so fast that others simply can not keep up. Or they can push engage in the infamous ‘quote stuffing’ which many thought caused the ‘flash crash’ in May 2010. The result is not only a fractured marketplace but an unfair one where larger investors get nicked with a thousand paper cuts.
The traditional smart order routing methods break down an order and simultaneously send it off to multiple exchanges. That used to be a good solution. But the problem with this now is that because it takes slightly different times for each order to be transmitted to each exchange, HFT’s take advantage of these minuscule time differences to pounce on large orders.
A team of 80 people inside Canada’s RBC Capital have been working on a solution for two years. It is both simple and ingenious. RBC Capital’s solution is called THOR and it eliminates the time differential by synchronizing each smaller order so that all of them arrive at exactly the same time in each exchange or platform. This removes the time advantage of HFT’s and prevents them withdrawing or canceling orders when it isn’t to their advantage.
The game is no longer the same since HFT’s have to face the real risk that their ‘bluff’ orders will be called and they will have to honor them on the exchange. According to Greg Mills, head of RBC’s global equity division, THOR can synchronize orders within 350 millionths of a second. You can read more in this Globe and Mail article. And refer to RBC’s website for more information on THOR.
I don’t think that this is the ideal solution but it certainly is a game changer. Right now of course, there are very few market participants using RBC’s THOR order routing. But as the number of clients increases and as similar technologies come to be standard, the latency arbitrage will be wiped away completely. Personally, I’d prefer if this was removed through regulation but unfortunately, due to the regulatory capture of the US markets, that just isn’t realistic.
The backlash at HFT’s is gaining momentum. Another, even simpler, solution created by Credit Suisse is to simply ban HFT’s. Of course, HFT’s can’t be banned from an exchange unless it is the work of a regulatory agency. What Credit Suisse is proposing is the creation of a ‘light pool’ (in contrast to a ‘dark pool’) which ironically is based on their Crossfinder ATS technology. This is the same platform that has powered their dark pool since 2008 and enjoyed a stunning rise in volume thanks to HFTs. Based on current data, Crossfinder ATS is responsible for 2.8% of all US volume – almost as much as the next two competitors: Sigma-X and Getco.
CS’s light pool will be the first ATS in the US in 5 years and it will be the first of its kind. CS will exclude market participants if they don’t meet the criteria of ‘long term investors’. The new ATS is expected to go live in March 2011. For more details, see this Bloomberg article.
Here’s the trailer for the upcoming Thor film: