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The goal of any financial market structure and its
supporting rules should be to foster an environment of freedom and transparency
where informed market participants can make trading decisions that reflect pursuit
of their rational self-interest. Now truly
rational self-interest may be an ideal state that does not exist in the real
world as it presumes a trading participant is fully informed and fully rational
in their behavior. Recent economic
research (nicely covered in a recent Time Magazine article) suggests
entities are rarely fully rational in their actions. And in financial markets, the participating entities
are rarely fully informed because conditions change too quickly and the meaning
of the changes is often too opaque to achieve a fully informed state quickly
enough. So participants make educated
appraisals with their trade decisions and iteratively appraise and reappraise
those decisions as new data is received.
The goal of a regulator should be to try to ensure a
reasonably level playing, with emphasis on "reasonable." It is unrealistic to presume that markets can
be perfectly level. After all, the very
term “liquidity” implies movement and fluidity that belies the notion that a
perfectly level state can be achieved.
There must be some accommodation in regulatory actions to the natural
dynamics of the markets and their participants, much like a sailor must
accommodate the movement of the deck in even the calmest sea. Without such accommodation, we will
inevitably stifle the innovation and creativity that are the very foundation of
the financial markets. After all, a ship
in dry dock is perfectly stable, but of little use to the sailor.
Regulators should also strive to balance the needs of
individual trading entities with that of the trading population as a
whole. After all, one of the foundations
of algorithmic trading is the use of technology to minimize order impact. By mandating, per interpretation of Reg NMS,
that orders not avail themselves of a “flash” are we not circumventing the
interests of some traders (who wish to disguise their intent), by forcing their
trade to be routed to open markets? They
might rationally choose the risk of possible front running vs. the risk of not finding
liquidity or the transactions costs associated with that liquidity. Routing to public markets offers no guarantee
of best execution, since the Reg NMS best price standard does not necessarily
account for factors like transaction cost or depth of liquidity in these “lit”
markets. Dark pools exist for a
legitimate trading purpose.
As regulators look at flash trading and its impact, they
should recognize that technology is a tool, neither benevolent nor
malevolent. Those that wield technology in
the financial markets will do so in pursuit of their own interests. That is a good thing because the advantages they
seek are often transient and they prompt others to pursue similar advantages
with similar vigor. That vigor is the
thriving pulse that has propelled capitalism and made the markets what they are. The current markets are the better off
because of the technology advancements that are currently implemented. And those advancements were not the result of
regulatory demands, but the rational pursuit of self-interest by market
participants. Regulatory restrictions
are inherently a blunt tool, best wielded only after careful consideration.
Fair and open markets are a good thing, because they
encourage participation in those markets.
Regulators should focus on that goal, because it achievable and because
it is an area where the markets (exchanges, trading entities and regulators)
all have a common goal. But expectations
must be tempered. Fairness is not
synonymous with perfect equality. Regulators
cannot mandate equal intelligence, equal technology or equal information among
all participants. Some will be better
informed, more prescient in their views of the future, or just better
As David Byrne might say [or sing], “same as it ever was,
same as it ever was!”
And that is not a bad thing.
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