From a 2008 paper written by Robert Barnes, managing director of equities at UBS, on MiFID and the growth of dark and light liquidity pools:
Smart order routing will arrive in Europe to pool, in a virtual manner, the multiple physical liquidity puddles resulting from the new venues. Order flow and new business will concentrate to those most capable in an increasingly fierce technological and commercial arms race. MiFID sets the regulatory framework encouraging competitive new entry and entrepreneurial opportunity. Realising this opportunity arises from understanding and embracing impending change to market structures.
High frequency and algorithmic trading: it’s the new global arms race.
He goes on:
According to the World Federation of Exchanges, the value of cash equities traded around the world in the most recent year 2007 was equivalent to USD100tr with approximately half (USD47.7tr) represented by Americas. The lower level of value traded in Europe (USD31.4tr) presents an interesting opportunity, as economists indicate that the American and European economies are similar in size. Reducing frictional costs of trading, i.e. reducing exchange and post-trade fees, may stimulate more liquidity in Europe.
This is worth bearing in mind considering Citadel Investment group just this week said it had taken a “significant majority stake” in cash equity trading venture Equiduct, a pan-European platform, to attract retail trading business in Europe.
Equiduct competes with other so-called multilateral trading facilities (MTFs) like Chi-X, Turquoise, BATS Europe and Nasdaq OMX Europe, all of which have been able to spring up in Europe post the implementation of MiFID.
Citadel, meanwhile, is among a vast majority of hedge funds and trading firms that are currently engaged in high frequency trading. While it does own stakes in other exchanges and platforms, this will be its first majority stake in such a platform.
As Sal L. Arnuk and Joseph Saluzzi of Themis Trading write in their paper on the effects of high frequency trading on global equity volumes and volatility, most of these clever blackboxes focus on alternative liquidity pools, exactly like those provided by Equiduct:
Volume has exploded, particularly in NYSE stocks. But you can’t look at NYSE volume on the NYSE. The NYSE only executes 25% of the volume in NYSE stocks. You’ve got to look at NYSE listed shares across all market centers, such as ECNs, like the NYSE’s own ARCA, or dark pools, like LiquidNet. Traders Magazine estimates high frequency traders may account for more than half the volume on all U.S. market centers.
A key point discussed is also how hedge funds and algorithm makers have tended to buy up server space close to exchanges even location sharing just to get the milli-second edge on orders placed by other less sophisticated algorithmic programmes, so they can position themselves accordingly to take advantage.
So the question to ask is how much of an advantage will a majority stake in Equiduct give Citadel in gathering a key position in the firm’s server location and also in acquiring potentially lucrative order information?
This is especially so given, as the FT writes:
Equiduct is already able to route incoming orders away to other MTFs if better prices are available there. It has also developed a system that automatically calculates where the best bid and offer spread is likely to be in a given share across Europe.
Of course, the MTFs have long targeted HFT traders as potential stakeholders in their businesses hoping ownership would help them commit liquidity to their operations. This has mostly, however, been done on a minority stakeholding-basis.
Meanwhile, the other interesting thing to note is that HFT-stacked heavy Equiduct is now positioning itself towards the retail sector. Which presents an interesting proposition: Unsophisticated investor versus machine. Who’s up for that?
Related links:
The Cold War in high frequency trading turns hot - FT Alphaville
The real story of trading software espionage - Tabb Group, in The Long Room
The Cold War in high frequency trading - FT Alphaville
