HFT Being Investigated For Rebates

I am all for letting private companies price their own goods without government interference.  The CFTC is investigating commodity exchanges and their pricing strategy with high frequency trading firms.  The WSJ reports,

The Commodity Futures Trading Commission is investigating deals between large high-speed firms and the two futures-exchange operators, CME Group Inc. CME -0.46% andIntercontinentalExchange Group Inc., ICE -1.54% according to people familiar with the matter.

The probe is focused on complicated, often opaque incentive programs that give high-volume trading firms financial benefits such as discounts on fees the exchanges charge to execute trades, the people said.

On the other hand, I am all for horizontal, flat competitive marketplaces. Exchanges have given huge artificial edges to HFT firms with co-location, and rebates. At CME there is the other problem of B shares. They are guaranteed the lowest rate in their core rights, and this policy seems to violate that.

Here is another quote,

“There shouldn’t be secret deals,” said Mark Gorton, chief executive of Tower Research Capital, a U.S. high-frequency trading firm. “The big players shouldn’t have better rates than the little players.”

Yes and no. Members and Leasee’s always got better rates than retail. If firms buy seven seats, the CME lets them put as many prop traders as they want on the seventh seat at the lowest cost. Goldman and all the big banks have done this for years. I haven’t seen all of the big HFT players become clearing firms, but many have.

In the old days, when CME used to offer new products up to trade, all fees would be either not charged, or rebated. After taking my MBA at Chicago, I’d never do that ever. Nothing is free, and if a contract fills a need, traders will trade it.

Rebates are a different story if it’s on liquid contracts. Not only do rebates unbalance the playing field and make it less competitive, but rebates hurt the total top line revenue of an exchange, hurting the shareholders of the stock. If this pans out to be true, CME will have damaged their own shareholders, and disenfranchised their B shareholders.

Exchanges should be neutral. Today, exchanges are definitely not neutral and have played their hand in favor of activities they want to see happen. CME’s latest increase in fees on data have hurt the retail brokerage community-but they aren’t important.

Exchanges also should offer up highly liquid transparent competitive marketplaces. Compete on the bid/ask spread and price movement. Compete on cunning and figuring markets out. Competing on who gets the best fee schedule when it’s not transparent is wrong.

Most of the guys that I know running HFT firms are highly competitive and play it straight.  If you took away the rebates, and the co-location advantage they have, they would survive.  They are smart traders and know markets-and are willing to assume risk.

It’s muddy for sure, and we will have to see what comes out.

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