The high frequency trading market is a “shocking” and “disgusting” invention, powered by computer-driven investment strategies that take advantage of genuine, individual investors, says Eric Sprott, the outspoken chief investment officer and senior portfolio manager at Sprott Asset Management LP.
Sprott told the Investment Industry Association of Canada’s (IIAC) annual conference in October that high frequency trading (HFT) has caused a major problem for the securities industry and is scaring away investors.
“Where’s the real investor? He keeps pulling away because he knows he’s not going to be treated well. We must create a level playing field.”
HFT emphasizes high transaction volumes and very short duration holding positions along with rapid automated buying and selling. The goal of HFT is to generate short-term profits using pre-set computer algorithms.
Sprott cited one estimate that “90 per cent of all orders rest for less than a minute and 50 per cent of all orders rest for less than a second. I don’t want you to believe that that is the investment industry. That is a shocking, disgusting data point and I wish this industry would take it to heart. That is not a market. That is people taking advantage of the bona fide investor.”
He said he hopes the industry supports a suggestion by Aequitas Innovations Inc., the rival stock market to the TMX, led by Royal Bank of Canada and backed by a number of big-name players in financial services. It is expected to launch late next year. Aequitas CEO Jos Schmitt has said that while HFT trading practices can contribute to the efficient pricing of securities across various asset classes, Aequitas believes that certain predatory HFT strategies have created an unlevel playing field that it seeks to address.
The death knell
“You must know in your heart that HFT is the death knell of financial markets,” Sprott added.
Ian Russell, IIAC’s president and chief executive officer, said IIAC is eagerly awaiting the results of a study by the Investment Industry Regulatory Organization of Canada (IIROC) on HFT trading and its impact on domestic markets. Late last year, IIROC announced it was conducting the study and asked for opinions. It also noted one of the questions it would like answered is whether investor confidence is affected by any specific types of trading behaviour.
“Whether that impact is assessed as being positive or negative, HFT in the market does have a negative impact on investor and issuer confidence in the market,” Russell said.
However, a recent study by the C.D. Howe Institute says HFT actually enhances market quality. “For example, it lowers bid/ask spreads, reduces volatility, improves short-term price discovery, and creates competitive pressures that reduce broker commissions,” states the report. “Despite being at a pronounced speed disadvantage, retail traders have realized a net gain from the presence of HF traders in the world’s capital market.”
Meanwhile, Sprott also said the markets have been tainted by the number of seemingly endless scandals in the securities industry internationally, including ongoing investigations on foreign exchange trading, gold fixes and the LIBOR scandal. “This is not something that we should be proud of. In fact, the antithesis is true. It must be eradicated.”
He predicted average investors will come back to the market if they can make some money and not be taken advantage of by in-and-out players.
On top of everything else, he said governments have become enmeshed in the markets through tax credits, bailouts and various rounds of quantitative easing. A number of countries have stepped in to avoid failures that would have otherwise happened to undercapitalized major banks. Instead they have bailed them out – not just at home but also around the world.
Sprott echoed the comments of a friend of his who told him that “there are no markets, just interventions.” He gave the example of governments intervening in the marketplace through their “manipulations” of interest rates.
“It is a 100 per cent intervention market. Rates are not determined by the market, they are determined by the Fed. The Fed feels it’s its mandate to make sure that markets somehow represent that everything is OK.”
Despite the number of scandals that have hit the securities industry over the past few years, IIAC’s Russell said a U.S. study suggests investors are very satisfied with their advisors.
The study, called The Economics of Loyalty, was conducted by Advisor Impact with 1,000 U.S. investors.
When asked to measure the level of satisfaction with their own investment advisor on a scale of 1 to 10, 86 per cent of respondents rated their satisfaction at 7 or higher and 72 per cent rated 8 or higher.
“That’s quite an accomplishment and a credit to the investment advisors in our industry,” said Russell. “The value, trust and confidence that investors and clients have with advisors and member firms need to be underscored.”
He said his organization has made suggestions to government that will help raise capital for Canadian businesses and help the Canadian economy. Specifically, IIAC has proposed various ways of encouraging capital formation and promoting fairer tax treatment for individual Canadians, including asking the government to undertake a cost-benefits study on the impact of a lower capital gains tax rate for small businesses.
IIAC has been a strong proponent of a single, national securities regulator and will continue to push for that in the coming year, said Russell.
Meanwhile, Kenneth Bentsen, president of the Securities Industry and Financial Markets Association (SIFMA) in Washington, D.C., said different jurisdictions have to work together and co-ordinate their regulatory frameworks, especially when it comes to derivatives and fixed-income products.
There are a number of organizations looking into various aspects of cross-jurisdictional issues, said Bentsen, including the G20 and the International Organization of Securities Commissions (IOSCO), the worldwide association of national securities regulatory commissions.
As of yet, no one has figured out the cumulative impact of all these rules but it’s up to the industry to implement them and in the end, pass the cost along to customers. “It’s important for regulators across the globe to look at the totality of those rules, look at how they interact, what the cost is going to be and how efficient they will be going forward.”
Charles Spiring, chair of IIAC and vice-chairman and director of National Bank Financial in Winnipeg, said that the Canadian and global market places still have a long way to go when it comes to recuperating from the economy and the battered stock markets.
Some securities companies are shutting down, while others are merging to maintain some identity, said Spiring.
At the same time, he said the pace of regulatory change around the world continues on, but the timing is off.
“A tsunami of regulatory change is upon us and it could not come at a more ill-advised time.”