If high-frequency traders felt under siege this month on both sides of the North American border, they could look to a single place for the root of their problems: Royal Bank of Canada.
RBC, Canada’s biggest bank, is a key shareholder in Aequitas Innovations Inc., which was blessed by regulators on Nov. 13 with a “recognition order” approving the creation of a new trading platform and exchange.
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A key plank in the Aequitas plan to is to provide a “safe haven” from “predatory” high-frequency electronic traders that use their lightning-fast speed to squeeze profits from tiny price differences between exchanges.
Critics say HFT strategies disrupt normal trading and drive up the costs for ordinary retail investors. And there is no critic as devout as former RBC trader Brad Katsuyama.
Mr. Katsuyama, who was hired at RBC by an executive who is now the bank’s point man on the Aequitas project, just took his latest venture — an anti-HFT dark pool called IEX Inc. — to a landmark threshold of 1% market share of U.S. equity trading.
Mr. Katsuyama’s anti-HFT crusade exploded into public consciousness with the publication of Flash Boys, Michael Lewis’s best-selling takedown of Wall Street.
The book, which was published in March, has contributed to his venture’s success since its launch just over a year ago, he told the Financial Post in an interview this month.
“Our first day we could very well have traded nothing. We had no idea,” the Canadian-born Mr. Katsuyama said.
The market share milestone this month gave his team “a tremendous amount of optimism…. It’s all moving in the right direction,” he said.
Whether high-frequency traders are the disruptive force portrayed in Flash Boys remains a subject of fierce debate on Wall Street and Bay Street, but Canadian regulators kept the anti-HFT momentum going this month by granting approval to Aequitas Innovations Inc.
The company — which is backed by a consortium of Canadian money managers, pension funds, and banks — was formed to create a new trading platform and stock exchange that will go head-to-head with Toronto Stock Exchange owner TMX Group beginning next year.
Aequitas and IEX are not working together to challenge the incumbents. But both come at their business from the perspective that lightning-fast high-frequency strategies can put other traders at a disadvantage.
Both alternative trading platforms will use speed bumps to slow traders down, and both companies are also planning to launch full-on securities exchanges to compete with the industry’s biggest players.
The parallel developments are not surprising given that Mr. Katsuyama formed his views on high-frequency trading when he was a cash trader at Royal Bank, which is now a key investor in Aequitas. Greg Mills, RBC’s lead player on Aequitas, was Mr. Katsuyama’s boss when he first joined RBC.
Around 2009, when Mr. Katsuyama was at RBC’s New York office, he worked on a project aimed at thwarting HFT strategies that were hurting the bank’s clients. The technology he helped develop, dubbed THOR, is still at work within RBC and has been patented in the United States.
While that technology has been well received, both Aequitas and IEX are now going beyond a single product that is limited to a particular broker’s market share.
They are aiming to solve issues that affect an entire marketplace.
As Mr. Katsuyama puts it: “THOR was a guide through the jungle, IEX is about creating an entirely different jungle.”
Aequitas, too, is looking beyond THOR with plans to offer market-wide access. The upstart says its combination of technology and routing strategies are designed to “protect” traders from “parties leveraging speed in today’s fragmented market landscape.”
In addition to speed bumps, the plan is to discourage high-frequency trading on certain platforms through financial disincentives such as higher fees for execution.
Mr. Mills, who is head of the global equities division at Aequitas shareholder RBC Capital Markets, says the numbers posted this month by his former trader’s dark pool in the United States are encouraging.
The IEX market share “shows there’s strong support by the industry for a market that protects the interests of long-term investors from predatory HFT strategies,” Mr. Mills told the Financial Post shortly before regulators approved Aequitas.
There are other numbers Mr. Katsuyama’s IEX can boast about. It has become the fourth-ranked alternative trading system south of the border by volume for tier-1 stocks listed on the S&P 500 and/or Russell 1000, according to FINRA, and last month traded a record 88 million shares in a day.
IEX now boasts 130 subscribers, up from 19 when it went live just over a year ago. On opening day, it traded just 568,000 shares.
This style of trading probably contributes positively to market quality
Despite the growth, Mr. Katsuyama says he still battles a “state of inertia where people don’t want to do things differently.”
Still, he knows he is trying to persuade them to “make fundamentally different choices” when it comes to trading, and recognizes that when fighting the status quo “it’s hard to predict how well you can do that.”
Aequitas, too, plans to shake up the status quo. And it seems to be working.
Already, the incumbent TMX Group has unveiled a plan to implement its own short order processing delay – or speed bump – on a trading platform called Alpha.
The challenge from Aequitas will be one of the top challenges facing new TMX chief executive Lou Eccleston. He has a background in technology, which could help, and industry watchers say strength in the area would have been one of the key reasons Mr. Eccleston was hired.
Not everyone, however, is convinced IEX and Aequitas have staying power, or represent the new world order.
Connor Clark & Lunn Investment Management Ltd., for example, which manages $33-billion in assets, takes issue with the premise that high-frequency trading is a demon that must be defused or pushed out of the marketplace.
“While we agree there are certain HFT strategies that lead to higher investor transaction costs, we do not agree that HFT, as a whole, is bad,” the money manager wrote in a letter sent to the Ontario Securities Commission in September.
“In fact, on net, this style of trading probably contributes positively to market quality.”
Connor Clark’s letter criticized the Aequitas proposal, saying it will add “considerable complexity” to the marketplace and also takes aim at too broad a swathe of traders.
“Unfortunately the Aequitas Proposal casts a wide net … one that includes beneficial forms of HFT as well,” the money manager wrote.
Richard Nesbitt, who ran the parent company of the Toronto Stock Exchange from 2004 until 2008, says he isn’t convinced HFT is all bad either. But neither is he willing to criticize the upstart rival to his former exchange.
“Having that alternative out there is great, and I think it’s healthy to see the TMX reacting in a competitive way,” said Mr. Nesbitt, who retired this year from his job as chief operating officer of Canadian Imperial Bank of Commerce.
“My view is markets should be about choice and the more alternative structures there are the better.”
He said it “shouldn’t be a surprise” if TMX loses market share to Aequitas, adding that market innovation should be embraced, so long as it doesn’t put particular dealers or clients at a disadvantage.
Still, he expects there will be an evolution in the market, rather than a revolution, with some products and ideas falling by the wayside if they don’t work.
“To put artificial constraints on something like speed is only going to last for a short period of time,” predicted Mr. Nesbitt, whose former employer CIBC gained trading market share by embracing high-frequency traders.
“There’s generally a better way to do it than slowing the whole race down and throwing [only] slow horses into the Kentucky Derby.”
