The item (‘Regulation Threat to CME Dominance’) on the front page of the ‘Companies and Markets’ Section of the January 27 Financial Times could easily have been missed if one didn’t scan the page carefully. Basically, it noted the increasing aberrations to do with “automatic trading”- especially “flash orders” - which now dominate 70% of equities and derivatives transactions,
The trades are instantly implemented as computers (on trading floors) have been matched to the peculiar structure of the very derivatives that drive most equity trades, both purchases and sales. In one case, CME Group – associated with the Chicago Futures Exchange is to investigate a trader who – within seconds- made both 200,000 buys and sales on a “mini” futures exchange subsidiary. This has raised eyebrows, especially as it means large trades could easily be manipulated if no watchman is at the gate.
The truth is with automatic trading there is no “gate” or gatekeeper”. By the time most of these automated flash transactions are completed (in about two microseconds) a massive gain or loss can be effected – with the latter often coming at the expense of ordinary Joes and Janes still operating by telephone: calling in their action to their broker, or mutual fund company. The sad fact is that in nearly all such transactions these folks will be a day late and a literal dollar short.
What we need, pronto, is the regulation of flash trades as part and parcel of any broader financial regulation reform – which is much more desperately needed than just imposing a 0.15% fee on banks (which I understand, comes under an obscure loophole that they can use to claw back the money under a tax write-off).
As I stated in several earlier posts, this reform needs to encompass limits on derivatives, especially credit derivatives, and any other arcane instruments or entities designed by the "quants" subsequent to the 2008 credit meltdown. As for credit default swaps themselves, I believe the optimal control is to place them in separate exchanges and not mix them up with normal derivative-bearing securities. (Especially as they represent "bets" on trading conduct and outcomes, not merely traditional securities)
Those of us sincerely worried about the formation of a new asset bubble, because of the flood of cheap money engendered by the Fed’s ongoing low interest rates, really hope Mr. Obama will take this issue on tonight in his State of the Union address. His most urgent populist maneuver is, indeed, to take on the epicenter of capitalism run amuck - in Wall Street – but to do so in an intelligent and direct way, not by appeal to hocus pocus or diversions.