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CME’s Speed

Tuesday, February 13, 2018 11:09
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You might have seen this article in the WSJ yesterday about how trades are confirmed by CME.  Some traders get confirmation before the rest of the market.  They are able to exploit that information advantage to create a profit for themselves.

CME isn’t the only exchange where this happens.  Everyone has a similar issue that is an electronic exchange.  CME is the biggest kid on the block, so they get the headlines.

There doesn’t seem to be a clear pattern in the amount of time some traders get confirmations earlier than others.  Might be 500 milliseconds or it could be a different amount of milliseconds.  In CME’s defense, that makes the technological problem tougher to fix.

In addition, CME sells co-location to traders that pay for it.  They will automatically get faster information and order entry.

I can only speak for myself and nobody else.   Here is what I assumed when I was on the board and in strategic planning back then.

When we demutualized 18 years ago, members like me knew they were giving up some edge to the rest of the market.  We had bought memberships, and some of the value embedded in that membership was the opportunity to transact on the trading floor.  Clearly, we had an edge but it was auctioned off to anyone that wanted it.  Of course, then you had to physically compete for space in the pit next to the best order flow.  That wasn’t exactly a free or fair market either.

You can see how co-location is similar.  Some HFT firms buy real estate next to data centers to preserve an edge.  Some invest in satellites and other technology to preserve an edge.

Electronic trading was supposed to change that and make the playing field level.  It was supposed to create a virtual top step where everyone had the same access to the order flow.   As I tell everyone that fears robots or technology putting them out of a job, I know exactly how it feels.

There is no quick technological patch any exchange can do to “fix it”.  The real fix is in how quickly they match trades.  Slowing down the market would even the playing field.  I recall that Alvin Roth wrote a chapter about this in his book, Who Gets What When and Why.  Some studies I have seen have shown that the faster the market goes, the more there are discrepancies in the information that flows out of the exchange and through pipes that firms can exploit.

This is not the fault of the HFT firms.  If I were them, I’d be doing the same thing.  It would be suicide for them not to take advantage.

The problem lies with the exchanges.  Not fixing it or ignoring it opens them up to criticism by people like Michael Lewis who slant how they report it.  Flash Boys was entertaining, but not the full story on electronic marketplaces.  Not fixing it allows people to think markets are rigged.  It increases the cynicism of people around markets.  That breeds a lack of confidence in public markets which begins to erode confidence in capitalism.

That’s why I really want to see them fix it.  I am very worried about America’s confidence in the free market system.  The HFT firms are still going to make the lion’s share of the money.  They have the best talent.  Who makes the money isn’t the issue.


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