U.S. regulators are about to take a big step toward reining in high-frequency trading: defining what it is.
On Wednesday, a Commodity Futures Trading Commission subcommittee is expected to propose a roughly 60-word definition of high-frequency trading that would define it broadly, a bad sign for traders who had hoped for narrower language. The announcement follows three months of sometimes contentious meetings by an industry group that was formed by the CFTC to help the agency wrestle with the impact of rapid-fire trading on financial markets.
Such trades now generate more than half of all U.S. stock- and futures-trading volume, and critics claim the surge in high-frequency trading has left Wall Street more vulnerable to computer-driven failures that sap investor confidence.
In response, officials at the CFTC and Securities and Exchange Commission have been exploring ways to track the orders and trades of high-speed firms, which use powerful computers to jump in and out of markets, trying to exploit fleeting price moves.
Much as the proposed "Volcker rule" has spurred sweeping changes on trading desks, the official definition of high-frequency trading likely will guide regulators as they seek to crack down on trading that allegedly is manipulative or undermines investor trust. The Volcker rule would restrict bets banks could make with their own money.
In a sign of the effort's importance, the process of crafting a definition is being overseen by the CFTC's enforcement division. The subcommittee that meets Wednesday is part of the CFTC's Technology Advisory Committee, led by Scott O'Malia, a Republican commissioner who has spearheaded the effort to increase oversight of computer-driven trading at the agency.
According to a draft version reviewed by The Wall Street Journal, a subcommittee working group is proposing to define high-frequency trading as a form of trading that uses sophisticated computer programs to make automated decisions in the markets, with no human decision-making involved in individual transactions. The draft also defines such trading as using technology to amplify the speeds at which firms send orders to exchanges and other trading venues, and generating large volumes of messages, orders and cancellations compared with other, slower types of trading.
The subcommittee still could make changes before Wednesday's meeting. The definition, which isn't subject to approval by the full commission, eventually could help guide the CFTC's rule-making process as it ramps of regulation of high-speed trading. The subcommittee faces a tough balancing act between writing a definition narrow enough to apply to specific trading activities and broad enough to rope in a wide swath of firms. The wording in the draft version is potentially wide-ranging enough to include the algorithmic-trading desks at big Wall Street firms that help clients buy and sell securities, as well as smaller firms specializing in high-frequency trading.
But the definition also may be so broad that it could be difficult to enforce and might face challenges in court, according to a person involved in the discussions about the definition.
High-frequency trading firms and others, including members of the CFTC's advisory groups, have argued that it is fruitless to try to define a group of market participants before identifying what exact behaviors should concern regulators. Doing so could mean tagging certain players while others slip through the cracks or potentially change their behaviors to elude scrutiny. Some involved in discussing the definition wanted it to be "toothless" to ward off what they view as potentially harmful regulation, according to two people involved in the discussions. The definition-writing group includes representatives of high-frequency trading firms Virtu Financial and Getco LLC, Deutsche Bank AG, research firm Tabb Group LLC, and Themis Trading LLC, a New Jersey broker and critic of some high-frequency trading practices, as well as NYSE Euronext.
The rise of high-frequency trading also will get attention Wednesday at a hearing of the House Financial Services Committee's subcommittee on capital markets. The hearing is focused on the health of the financial markets for investors and companies seeking to raise capital by selling stock. Likely to dominate at least part of the hearing: Facebook Inc.'s glitch-riddled initial public offering on the Nasdaq Stock Market last month.
Last week, officials from Nasdaq OMX Group Inc. and NYSE Euronext told House subcommittee members in a joint presentation that the proliferation of trading venues such as dark pools, in which orders are posted by firms away from public exchanges, has hurt the quality of the market and investor confidence.
The two exchange operators claimed that such trading operations helped trigger the May 6, 2010, flash crash, when stocks plunged sharply in a short period. "Liquidity evaporates quickly when it is spread too thinly" across the market, the presentation said.
In testimony for Wednesday's hearing, Dan Mathisson, head of U.S. stock trading at Credit Suisse Group, compared the Facebook offering to the flash crash, saying the bungled stock sale caused "significant chaos in the markets."
NYSE Euronext Chief Executive Duncan Niederauer is scheduled to testify at the hearing, as well as executives of high-frequency trading firms and securities firms. Mr. Niederauer will urge regulators for measures that would bring trading back onto public exchanges, according to prepared testimony. "We should not wait for another May 6 to address" questions such as why "the volume of securities trading in dark pools tripled" in recent years.
Nasdaq CEO Robert Greifeld declined an invitation to appear at the hearing, according to a subcommittee spokeswoman. A Nasdaq spokesman declined to comment on Mr. Greifeld's decision not to attend the hearing.
