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Wednesday, 21 May 2014

FD_BNR Newsroom presents: High Frequency Trading (HFT). Is it playing by the rules or actually breaking the rules?! Remco Lenterman of IMC Financial Markets speaks upon this topical subject!

Two days ago, on 19 May 2014, I had again the pleasure of being present at FD_BNR Newsroom, the semi-live talk radio show, presented by the savvy presenter and radiomaker Paul van Liempt.

The 'mike' of BNR Newsroom
Picture copyright of: Ernst Labruyère
Click to enlarge
The highlight in FD_BNR Newsroom was for me personally: ‘High Frequency Trading’ (HFT).  

I will publish a nearly integral coverage of the discussion (link in Dutch) at this blog, due to the importance of the subject; not only for interested private and corporate investors, that have a larger distance to the stock markets and want to know about the phenomenon High Frequency Trading. 

It is also interesting for people, who heard or read about recent rumours and accusations concerning HFT trade. Many of their questions and concerns were dealt with, last Monday, by the guests of the program.

The discussion about High Frequency Trading has become topical once again, due to the bestselling book about HFT, written by Michael Lewis: ‘Flash Boys: A Wall Street Revolt’.

Paul welcomed as guests: 
  • Remco Lenterman: CEO of IMC Financial Markets – A Dutch, globally operating HFT marketmaking company
  • Patrick FleurManager Trading & Execution at wealth manager PGGM Investments
  • Marco Groot: Column writer at Het Financieel Dagblad ( and former trader/investor
  • Corné van Zeijl: Fund Manager of SNS Dutch Stock Fund (i.e. SNS Nederlands Aandelenfonds)
  • Peter Paul de VriesCEO and owner of Value8 Investment Company 

The discussion started and ended with the meaning of the ‘flash trade’ – as HFT is called in The Netherlands – for private and corporate investors.

Paul van Liempt: Is the flashtrade a blessing or a burden?! What is its importance for private investors?

Paul van Liempt, presenter of BNR Newsroom
Picture copyright of: Ernst Labruyère
Click to enlarge
Remco Lenterman: We did not make up the expression Flash Trade. Our company started 25 years ago as a ‘marketmaker’. In those days all trade was executed by hand. Our company went through the evolution from ‘floor trade’ to fully electronic trade. A marketmaker deploys bid prices and offer prices at the stock exchanges (i.e. purchase prices and sales prices). Private investors and traders can trade, using these prices.

People should understand that modern stock exchanges have turned into large trading computer systems. Ten years ago a phenomenon emerged, which became known as High Frequency Trading or HFTHFT is the generic term for a number of stock activities, for which sheer speed is of the utmost importance.

Actually, we still do the same as 25 years ago: we supply the market with liquidity, by setting bid and offer prices through a screen at the stock exchanges. Flash trade is the Dutch moniker for HFT. A better name would be ‘Computerized Trade’.

Stock exchanges have turned into large computers. Everybody who is trading at the stock exchanges, does so via a fully automatic computer system. Few people realize that. Brokers use algorithms to execute their orders for their investing customers. Traders use algorithms to supply the market with liquidity.

Paul: What have been the consequences of this paradigm shift?!

Remco: One of the undeniable results is that the expenses for stock transactions have been spectacularly reduced. This is the consequence of the radically increased efficiency: in earlier times when orders were executed through telephone calls, one's stock order went through the hands of four to five people, before the transaction was completed. 

Nowadays, an investor enters his order in an online trading screen of f.i. Dutch online broker Binck Bank. After this person has finished it, this order is immediately forwarded to the trading system at the stock exchange. With just one or two mouseclicks. The efficiency gains have been enormous.

We got rid of the high commissions for stock brokers and other intermediary people. As a consequence, the spreads between the bid and the offer price have never been so narrow. For a < €10 stock, the spread is only one tenth of an euro cent. This is spectacular!

Ernst: I remember hearing in a documentary about so-called ‘priority orders’, coming from certain HFT market parties. These priority orders would be executed with precedence upon normal orders from common private and corporate investors.

This order kind seemingly enabled HFT traders to act as a ‘hidden intermediary’ between the stock exchange and the private / corporate customer that wanted a certain stock. 

Their trade was akin to a ticket office, which bought all tickets for a U2 concert in advance and resold them to the normal concert visitors with a certain margin upon the price. Does this kind of business also exist in The Netherlands?!

Remco: I am definitely aware of the discussion. We are also really active in the United States. I object against the accusations that Haim Bodek made in that documentary. All existing order types have been published on the websites of exchange supervisors. Ergo: there are no hidden or secret order types in the system. 

However, the American stock system is extremely complex. Many of its complications do not exist in Europe. The regulations for HFT trading in the United States have been written ten years ago. Within one-and-a-half year, new regulations for HFT trading will be deployed in Europe. The process of legislation is in full motion, due to the continuous changes within the stock market. 

It was originally a floor market with brokers and traders, in which many people were physically dealing with stock orders. Nowadays, the stock market is fully electronic; the legislation and regulation must be adjusted to that change, in order to let the business work as good as it did in the past.

Paul: Speed has always been paramount, right?!

Remco: Oh yeah! Speed has definitely been paramount: now and in the past. The market maker who called the bid and offer price first, was the one to execute the transaction. I am competing with large option brokers and market makers, like Optiver, Flowtraders and many others. 

That is the reason that I want to call the bid and offer price as soon as possible, as I know that I will get the transaction then.

This speed enables me to let the spread between bid and offer price be extremely narrow these days. Never in history, this spread has been so narrow as today. Speed allows this process.

“We” – aka the Dutch – have been very progressive and innovative with respect to fully computerized HFT, as we realized that this operation required radically different skills and competences than the floor trade did.

Ernst: Would the European transaction tax mean the end for the HFT trade in continental Europe, due to the fact that the whole HFT industry would move to the London City?!

Remco: Politicians represent High Frequency Trade as something negative, which it is not: “HFT is bad and unfair”, they state.

The transaction tax is used as a means to target HFT traders. The eleven EU countries, participating in the transaction tax proposal, want to collect €35 billion with this tax. This is a multiple of the amount that people and companies actually earn within the HFT market.

In the end there will be only one party, which is footing the bill: that are the savers. The Netherlands has the largest pool of savers in Europe, so for our country this is about the worst development possible!  

Paul: Really, Patrick Fleur?!

Patrick Fleur: When this transaction tax will be declared applicable to all varieties within the generic term HFT, I am indeed afraid that a substantial part of my liquidity will vanish. This would widen the spread between the bid and offer price, causing that the participants have to foot the bill for the additional expenses.

F.l.t.r: Patrick Fleur of  PGGM Investments 
and Remco Lenterman of IMC Financial Markets
Picture copyright of: Ernst Labruyère
Click to enlarge
Paul: Is it correct what Michael Lewis states in his book "Flash Boys: a Wall Street Revolt", that the HFT flash trade is a legal kind of frontrunning?!

Remco: For me, this is almost a scandalous accusation. This accusation has actually been denied by the regulators. Michael Lewis states that some traders can see the stock orders of investors before they actually enter the stock market. I don’t know a single stock exchange anywhere in the world, where this is possible. There is no frontrunning (i.e. prescience) here.

I will explain the phenomena of colocation: the stock exchange computer is stashed in a datacenter near the stock exchange. In the early years of electronic trading, we noticed one day that our company was structurally lagging to the London and Paris marketmakers, who had their computers very close to the ‘floor’ of the stock exchange. Due to the physical distance, we had a disadvantage.

Since that moment, the stock exchanges offer colocation: this enables us and other marketmakers to put our computers next to the computers of the stock exchange itself. This means that every party sees the stock data at the same moment again. This colocation offers a level playing field to every trader and stock broker. As a matter of fact, all brokers have their computers in the same datacenter nowadays.

Marco Groot: Even today, I have spoken to people in the business, who are stating the contrary. 

As soon as they place their orders, the liquidity vanishes… I actually went through it myself: one enters an order and notices that the liquidity has vanished in the meantime. 

I cannot prove that the things that Michael Lewis states are actually true. However, when you are able to check somebody else’s stock order in advance or even when you have just a few milliseconds in advance, the level playing field is gone. Besides that, a market maker enjoys favourable expense rates and also some HFT traders enjoy those favourable rates.

Marco Groot, former investor and column-writer at
Het Financieele Dagblad
Picture copyright of: Ernst Labruyère
Click to enlarge
Remco: The latter is not true. We almost always pay equal prices. 

I have only an advance when I have a market making obligation: for instance in the case of options and ETF’s (i.e. exchange traded funds). For 99% of the time, I am obliged to set bid and offer prices. Our achievements and performance in this matter are assessed. 

With normal stock packages, we pay exactly the same amount in expenses as common, large stockbrokers. It could even be true that these brokers pay lower prices, due to their larger trade volumes.

‘Fake liquidity’ is a problem on a fragmented market. 

In the US, as a matter of fact, there are 14 stock exchanges at which we [IMC Financial Markets – EL] are setting the prices. We set the same price everywhere. 

When – for instance – we set a price of 21 bid and 22 offer for Intel stock and we set this price on stock exchange ‘A’, then it can happen that somebody else sets a price of 22 bid and 23 offer on stock exchange ‘C’ in the meantime. 

In this case I am obliged to change my quote again. This modus operandi enables that the stock quotation has only a spread of one cent.

Every now and then somebody tries to take all offers on a certain stock from all exchanges at the same time. When he goes to exchange C first and this offer has gone in the meantime, then I will adjust my prices. Then this person can be too late [at another exchange - EL].

Corné: It also happens in Europe. 

During the execution of an order, the liquidity is gone at the exact moment that I want to hit. You state, for instance, that you want to buy for 22 and I say I want to sell for the same price. 

When I subsequently want to make a deal, you state “I am sorry, but I’m gone in the meantime”. That is when you get fake liquidity and that makes me angry.

Corné van Zeijl, Fund manager of SNS Dutch Stock Fund
Picture copyright of: Ernst Labruyère
Click to enlarge
Remco: When I have placed a bid of 22 at Euronext and you want to sell your stock for that price, then there is no way that I can strike that bid.

Corné: Yet, it happens!

Remco: In that case, I really don’t know what happened with that order and if perhaps somebody has seen it in advance?!

Peter Paul de Vries: In case that such excesses would indeed be possible with HFT trading, would you think that people, who had discovered these anomalies, would work at the supervisor's office?! Or with a firm like yours or like your competition?!

Peter Paul de Vries, CEO / Founder
of Value8 Investments
Picture copyright of: Ernst Labruyère
Click to enlarge
Patrick: Fortunately, more and more smart people do start to work at the Dutch supervisors DNB (i.e. Dutch national bank) or AFM (Authority Financial Markets). 

By the way, I know for sure that there is fake liquidity in the market. I don’t state, however, that this happens at companies specialized in market making: such actions would kill their own business. On the other hand: I do think that there are other firms active, who do use fake liquidity in an inappropriate way.

Remco: We are trading at 100 stock exchanges worldwide. Every stock exchange where we trade, is maintaining its own supervision. On top of that, there are 10 globally operating supervisors, who are supervising our actions. 

No market is as transparant as this market. Every transaction that we make can be found at Yahoo Finance the next day!

Marco: I am convinced that there are scoundrels walking around in the world, who can check out other people’s orders through a backdoor operation and who can create this fake liquidity. Otherwise I can’t explain that when I enter an order, the liquidity has suddenly vanished without a trace.

Undisclosed journalist in the audience: How does this fake liquidity work? How can orders be entered initially and subsequently been withdrawn?!

Remco: Not one single stock exchange offers this facility.

However, it can be – as a consequence of the fragmented stock trade – that a broker offers his shares at all stock exchanges. When he initially goes to "Tri-ex" [I don’t know the exact name of this stock exchange – EL], as this offers the lowest trading prices, and subsequently enters Euronext, it could happen that a market maker has changed the quotes in the meantime. 

However, when some parties, active in the HFT market, could structurally look into somebody else’s orders before these orders enter the stock markets, this would be something that we would notice too.

Corné: These days, it happens on occasions that you can’t do any business at all. At no single stock exchange!

Remco: I have noticed that phenomenon. Sometimes it happens that a certain investor is asking a quote for a certain fund. While we are setting the price, we notice then that the fund quotation is suddenly rising. This could mean that the investor is buying himself or that he asked another market maker for a quote. This process can’t be suppressed or stopped.

The added value of HFT is the following: when we would take a rain check and put our computers off line for one day, then every investor would get a worse quotation, as a consequence of much larger spreads. 

In other words: it is a no-brainer that we have a lot of added value for general stock trade.

This discussion was the absolute highlight of this week's BNR Newsroom. If you speak or understand Dutch, don’t hesitate to listen to the integral broadcast of BNR Newsroom on the site of BNR Newsradio. 

Paul van Liempt and his guests are always a good listen and this episode was no exception.

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