With Sanjay Rewal, CEO Open Futures
Another area of regulatory concern is that there should be no preferential access to Indian markets. An additional issue is whether there are added benefits for the markets, given that algorithmic trading is prevalent. The Indian regulator wishes to discuss these points with the marketplace. It will be an interesting consultative process because, depending on the proposals, they may or may not be conducive to helping market micro-structure.
From recent interviews, we understand that the regulator is looking at a two-tier system or a minimum resting period: for example, mini-auctions for very short periods of time. Once the consultation is published, trading participants will be able to comment on whether the proposals make sense from an Indian and a global perspective. We understand that the Chairman of the regulator is looking towards IOSCO for guidance and best practice. Hopefully, the consultation process will take a reasonable length of time because the longer they take to discuss this with the general public and market participants, the wider the range of perspectives they will have to analyse.
For example, a retail broker’s perspective might actually contain a misunderstanding of what HFT or algorithmic trading is. There needs to be a legitimate, broad marketplace that allows people to articulate their points of view whether they are retail traders, a mutual fund, an HFT group or a proprietary trading group. If the marketplace is transparent and functions on that basis, then we should get a better market for all types of investors.
Ideal market structure
At Open Futures we believe in transparency. Creating more restrictions only benefits the trader with the wrong type of edge. From the point of view of a high frequency trader – how do they make money?
They make money because they have access to great technology and successful models. They are not going to make money if their models are not profitable no matter how fast they can trade.
Transparency and access should be highlighted and promoted rather than increasing the number of hurdles in the way. Having said that, if there is a legitimate concern that somebody is getting hurt because a firm did something wrong, then of course, they need to create the right hurdles. But if a retail customer is being hurt because someone is doing trading of a particular nature, then there needs to be evidence to support that.
There are at least 80 research papers released in favour of algorithmic/HFT and there will be plenty with the counter view. In general, the reason why regulators worldwide have chosen not to interfere with the market micro-structure beyond a point is precisely because of the way it functions as a whole. Look at the current market – first the lot size increased which forced the volume to shrink, then the Securities Transaction Tax was increased on options which meant that option volumes started to come down.
Now, if the changes to options trading are being done because the regulator doesn’t want retail to be speculating in the option market, at least there is a definite argument for it. We may well disagree, but at least there is a sensible discussion to be had. But, insofar as algorithmic trading goes, the evidence suggests that it has not led to any inefficiency in the Indian market nor overseas. It has not led to traders becoming disenfranchised because other traders use an algorithm. This is an age of progress. We ought not restrict those who are trying new technologies, new algorithms and innovative ways of trading.
If there is a legitimate concern about protecting retail traders, then the articulation of that concern should not necessarily be via preventing algorithmic trading or HFT in the form we see today. If there is specific abuse, then the market and the regulator can work together to find that person and proceed against them. However, we very much hope that the consultation process finds evidence to suggest that retail is not getting hurt.
The role of an exchange
The role of an exchange ought to be to create a transparent, fair, ‘equal to all’ market place. In all seriousness, at Open Futures we believe that co-location (co-lo) is actually one of the biggest levellers. Co-lo means that everyone is dependent on their own brains and their own ability to leverage technology and mathematics. In the past there were differential access mechanisms, so if a firm were connecting to an exchange which didn’t have co-lo, and they were connected using exchange lines, it meant that someone sitting five kilometres from the exchange would benefit more than someone sitting 5,000 kilometres away. Differential access was built into the system. Co-lo ensures that differential access does not happen.
We have discussed this issue with the exchanges and have suggested that they give subsidised access to co-lo to every broker they can. The reason for this is simple. Let’s say a small broker indicates that they are suffering because they don’t have co-lo access. If the exchange put in servers at a lower cost than that of leasing lines to the exchange, it becomes impossible for a retail broker to say they don’t have access. There should be no question of a differential level of access. However, we don’t agree that if a firm can pay, then they should be able to access data faster. Everyone should be allowed to pay for data at a certain rate. With co-lo, access to data is much faster because we are sitting next to the exchange compared to someone sitting 1,000 kilometres away.
Once the exchange indicates that everyone is free to access it, then there will be open access to the same data. The point is that the exchanges need to understand this and maintain a fair, transparent and equal marketplace.
This is the most important role of the exchange.
It is our hope that the exchanges and the regulators will deliberate at length over the discussion papers when they are released. It should not be the case that they have decided what they are going to do already. After considered discussion, people will begin to realise that algorithmic trading does provide liquidity and that it allows the markets to trade even more volume.
Trading more is not necessarily wrong. This is a marketplace and it is supposed to have all the constituent elements of a marketplace. It is very unlikely that the regulators will choose to do anything that is not backed by extensive research by renowned trading experts both in India and overseas.
For example, if there is a two-queue system, then the first fundamental rule of an exchange, which is price/time priority, would be broken. When an order is received which is of a higher or lower price, then it gets priority. If an order is received at the same price which, for example, is sent at time T and another is sent at time T+10 seconds, then T should get priority.
It is vital that the regulators go into the marketplace and find out what market participants actually think. The marketplace will certainly respond with proof that algorithmic trading doesn’t affect the market in the manner that they think. Anyone who works with a large amount of data and looks at the market data from that angle will find the same evidence that we have found.
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With Sanjay Rewal, CEO Open Futures