Spreads have been tightening throughout 2009, primarily due to contracting volatilities and increased competition from high frequency traders, vector market makers, but utilize their customers’ status to gain advantages over bona fide market makers.
These advantages include priority at the same price and not having to pay exchange fees. We may be seeing an end to this trend due to new rules implemented up to option exchanges that are designed to measure the activity of high frequency traders. As each of these exceed given volume levels, they are assigned professional traders as we mentioned, effectively removing the priority they currently receive.
The IFC rule went into effect in October and the CBOEs went into effect early this month. As of early January, these traders also have to pay exchange fees just as market makers do. We expect the CLECs to follow soon with similar rules. These actions will help to further level the playing field, giving us a better opportunity to recapture our market share.
The fact that exchanges must impose these rules in order to preserve their fee revenues gives us confidence that they will take the enforcement seriously. Another recent development that may result in reducing HFT competition is the SEC’s proposal to ban naked sponsored access, which currently account for a significant portion of market volume.
Under naked access, high speed traders can buy and sell stocks and options directly on an exchange using a Brokers access code with limited oversight. Often, these brokers are purposefully thinly capitalized, and due to the technological hiccup for just a misconceived strategy, a large loss to occur, they maybe unable to pay the loss. This makes all of us with substantial deposits at the trading houses nervous, and we are glad that the regulators are looking up measures to reduce the likelihood of such happening.
The broker would require an arrangement called sponsor of access, whereby these traders would have to route their orders through the systems over a distant broker and subject them to prepaid checks before routing onto an exchange. This is exactly what we have been interactive brokers do and have always done with all of our customer orders.
The concern among HFTs is that these prepaid checks would increase latency and affect the competitive edge that they previously enjoyed with unfettered access. Smaller firms may agree to the sponsored arrangement while the larger ones may apply to become regulated brokers themselves.
Some will ultimately drop out of the game altogether. All these developments taken together, the loss of priority, having to pay exchange fees, and sponsored access will put our HFT competitors on an even footing with us, which is a significant positive development for us going forward.
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