High frequency trading is becoming a controversial topic as exchange glitches and market mishaps become more and more frequent, so it is worth paying attention when Norway’s nearly $800 billion sovereign wealth fund discusses the pros and cons of the issue.
Norges Bank Investment Management, the division responsible for overseeing the pension fund, recently released a paper detailing how a large, long-term investor such as itself is affected by the evolution of markets and the rise of high frequency trading.
On many fronts they defer to the need for further studies to fully understand certain aspects of HFT and fragmented markets. However, they do highlight a few issues upon which they have seemingly taken a side, including quote spam and its corresponding phenomenon of phantom liquidity.
Buy-side traders face new challenges in assessing posted liquidity. This is driven by a number of factors including latency differences between venues, and rapidly changing order book dynamics given the high propensity for HFTs to post and cancel orders. This means available liquidity in an order book is really much lower than it would appear. As a result, institutional investors are concerned that greater HFT activity may have increased implicit trading costs…execution costs (as measured by effective spreads) did not fall after latency changes made by the London Stock Exchange…short-term quote volatility is higher for more liquid names with higher HFT activity.
As the Financial News points out, the paper is neither “a broadside against HFTs, nor a vindication of their activity,” but rather a plea from an organization managing nearly one trillion dollars for more academic research and more intelligent and targeted regulation.
On the topic of regulation, Norges is quick to mention that regulators must slow down and consider not only intended benefits and consequences of proposed legislation, but also those consequences that are unintended. Contained within the paper are the following tables dissecting regulatory measures that have been enacted on exchanges throughout the world.