BEVERLY HILLS, Calif. - Advances in information technology and new regulations are leading to greater transparency and the democratization of the financial markets, according to speakers on a Monday panel at the 2013 Milken Institute Global Conference.
A revolution is underway in how transactions are executed, information is processed and disseminated, and capital is allocated, bringing changes across the financial spectrum from commodities to derivatives to equities and debt, speakers said.
“We feel very strongly that automation has resulted in much better liquidity and transparency for individual investors,” said Jamil Nazarali, head of Citadel Execution Services, Citadel Securities.
Ten years ago, Nazarali said the intermediary role was done by specialists and market makers and there were literally thousands of humans sitting on the trading floors that have since been replaced by computers.
“Today computers do that – and it has been good for individual investors,” Nazarali said. The changes make it possible for a retail investor to make an online purchase with as little as $10, he said.
The speed of technology also brings a dark side, felt last Tuesday when a fake tweet reporting a bomb at the White House caused the Dow Jones Industrial Average to plummet.
Last week’s market scare generated by the fake tweet is an example of how quickly technology can have an impact on the market, said Bart Chilton, a commissioner for the Commodity Futures Trading Commission.
“Regulators need to have better view of what is around the corner,” Chilton said.
Chilton said there are two kinds of traders; and the ones that have the most potential to damage the market are high frequency traders, who he calls “cheetahs.”
“I’m talking about those who are at it 24-7, 365,” he said. “They don’t like it, but we call them cheetahs in reference to the fastest animal in the animal kingdom.”
There is nothing wrong with the cheetah, unless their activity is causing market tremors, he said.
“We have the automated trading business, which Bart calls cheetah,” Nazarali said. “We feel very strongly that automation has resulted in much better liquidity and transparency for individual investors.”
Firms like Ares and Citadel execute trades for retail investors, which levels the trading field for retail investors, Nazarali said.
“They are able to do a $10 trade and have millions of dollars of technology at their disposal,” he said.
Chilton said the so-called cheetahs are different from Citadel.
“They are doing proprietary trading for just their own book,” Chilton said.
“We don’t know everything about how this gee whiz-bang technology is affecting the markets,” he said.
“I’m just saying let’s take a step back,” Chilton said. “The hack attack is a good example of why we should take a step back.”
Terry Duffy, executive chairman and president of CME Group, said the impact of the tweet saying the president was hurt didn’t cause the NASDAQ to drop by even 1% at any time. He said the impact was overstated.
The contrarian on the panel, Duffy doesn’t think the futures market -- where his company operates -- needs regulation like other markets such as credit swaps.
The futures market doesn’t tend to have the swings that the securities markets do; so it isn’t as obvious that regulation is needed, he said.
“In the futures market, high frequency traders have built up such a huge pool of liquidity with the farmers and the ranchers that they are seeing a big decrease in high frequency trading, unlike in the securities market,” he said.
Nazarali said the members of his firm are more concerned with the increased level of trading that occurs off-exchange.
“In the equity markets, 40% of trading happens off exchange,” he said.
Moderator Chris Brummer, senior fellow with the Milken Institute and a member of the Financial Industry Regulatory Authority, Inc.’s National Adjudicatory Council, asked the speakers if they were concerned about the potential for market manipulation.
Lou Salkind, managing director and executive committee member, The D.E. Shaw Group, said everyone should consider the data when considering the impact of technology.
“Trading costs have been an order magnitude less and trading volumes are an order of magnitude more; costs are lower,” Salkind said.
He added that market manipulations occurred before computer trading came into vogue.
“Look at what happened in 1987,” he said, referring to the “Black Monday” stock market crash.
“It is probably heresy to say this,” Salkind said, “but I think a lot of regulatory changes that have occurred over the past decade have been good.”
Today, no one exchange has more than 20% of order flow; and there is much deeper liquidity and a pretty fragmented market, Salkind said.
“If you think about where we were a decade ago, there was a duopoly in the equity market -- The New York Stock Exchange and NASDAQ controlled all the markets,” he said.
Chilton advocated for registering the so-called cheetahs, because he wants to know they are testing their programs.
“My thing is let’s be a little skeptical,” Chilton said. “If we get all the research and it says everything is fine, than fine.”
The best thing Dodd-Frank did was to require greater capital and margin, Chilton said.
“When Lehman Bros. went down in 2008, they had all these credit swaps,” he said. “They were leveraged 30-to-1 – and we saw the result in the economy.”
The legislation also brings unregulated over-the-counter derivatives such as swaps that do not go through an exchange into the light of day, Chilton said.
“It is important to create a risk protocol to avoid having one player do something that can bring the whole system down,” Nazarali said.
