If ever a collection of people had an interest in bringing the facts to light, it is those in the business of computer-based trading (CBT). Populist anti-banking sentiment is running high and politicians, particularly in continental Europe, appear happy to fan the flames. The debate over how to regulate the industry rages and many see high-frequency traders as an easy mark.
That's where the British government's Foresight project team comes in. Their multi-discipline research project is tapping experts around the world and mixing academic rigour with real-world experience - all in the interest of giving decision-makers a clearer picture - to create a comprehensive report on the effects and implications of computer-based trading. First announced almost two years ago, the project is nearing its conclusion and will publish its final report in the autumn.
Automated Trader has been talking to people involved with the project, as well as those potentially affected by its findings, ahead of the report's release. And contrary to conventional wisdom, the CBT community is not necessarily uniformly hoping the project will lend its weight to demands for less regulation - just more sensible regulation.
"The first thing which I liked about the project was that it wasn't just a microscopic look at anything to do with high-frequency trading, because that's not useful at the moment," Dr. Rami Habib, chief executive of Algo Technologies, told Automated Trader.
"They tried to look at systematic trading. Systematic trading includes a whole array, a whole spectrum of participants in the financial community, from large hedge funds, mutual funds to some pension funds that use algorithms," Habib said. "So it covers more than just the proprietary algorithmic trading world, which is such a small fraction of the overall trading activity."
For Habib, the question of how to regulate algorithmic trading starts with definition, and here the Foresight project begins to help.
"If you step back a couple of years to around when there was the Flash Crash, there seemed to be a bit of a witch hunt for high frequency trading. But no one cared to define 'what is high frequency trading', no one cared to put a bracket around 'what does high frequency trading look like?'
"And in my eyes, being a trading technology service provider, I think that high frequency trading or algorithmic trading should be used, and are being used, by anybody in the financial markets who cares about good quality execution, which actually pretty much covers anyone - anyone from mutual funds to pension funds to long-short equity funds to brokers. Anyone who cares about execution should be running some form of algorithm, some form of efficient execution to get good prices in the market and ultimately enhance trading profitability."
Dr. Rami Habib
That can mean smart-routing or using algorithms to break up large orders into smaller ones, or to provide liquidity or go for rebates to avoid paying large spreads. "It's all about efficient execution," Habib said.
He took part in one of the project's workshops, sitting together with market participants and senior figures from technology firms and other providers. The Foresight project, because of the way it's structured and the definition of its mission, is able to bring together a wide array of people into one virtual room - or occasionally into one physical room.
The project has brought together experts from 20 countries. It includes a high-level stakeholder group that reads like a "Who's Who" for the financial community. For instance, one of the founding partners of Bloomberg LP, Tom Secunda, sits on the stakeholder group. Led by the UK Treasury's Financial Secretary Mark Hoban, the stakeholder group also includes top figures from the Bank of England, the IMF, exchanges, banks, financial services, technology firms and information groups.
One of its members, European Parliament member Dr. Kay Swinburne, is hopeful that the report's findings will be heard loud and clear among European lawmakers and the European Commission.
"We hope that they (the Foresight team) are going to come to the Parliament and to the Commission to deliver the findings directly so that they're not done by a governmental route," Swinburne said at a recent industry event.
Swinburne acknowledged the risk that a report commissioned by the British government, which on financial affairs has often not been of one mind with the Continent, could be seen as tainted for its Anglo-Saxon origins. But she believes that the way Foresight has been set up and structured will leave politicians little choice but to treat its findings seriously.
For instance, the experts doing the research will not show the initial findings to the stakeholder group until they have been peer reviewed.
"So that for me, as somebody who believes in scientific rigour, is the best test they can have. If it stands up to scientific community scrutiny then I can tell the politicians will stand up and take notice," Swinburne said, in response to a question from Automated Trader.
The Foresight team has not announced a release date for the report, although Swinburne spoke of publication in September. "The evidence may be late, but it won't be too late," she said, referring to the tight timetable as regulators rush to make decisions to get a raft of legislation done this year as mandated by the Group of 20.
A spokesman for the project said more than 400 experts from industry and academia were involved.
"The diversity of views we gather means that debate is not skewed in one direction," the spokesman said. "The guidance we have received from a group of leading experts, as well as from a high level stakeholder group has also ensured that discussions remain balanced, and takes account of all of the findings that have emerged from the evidence-based research we have commissioned."
But even with a cast of 400, there are challenges.
The spokesman noted that CBT is a relatively new phenomenon in markets. "The nature and complexity of the technology attached to this field is evolving at a rapid pace. All of this implies that empirically based research on specific topics of relevance within the field may not always exist. In such cases, the project findings will make clear where uncertainties remain."
Dr. Kay Swinburne
For many in the algo world, the report could not come soon enough.
"There is clearly a misunderstanding, at least in public opinion, about what algorithmic trading is," said Nicolas Vitale, chief executive and founder of Alpha Novae, a solutions provider for automated trading. "Generally, people are quite frightened about things they don't understand."
Indeed, the British novelist Thomas Hardy once said, "Fear is the mother of foresight," and it's hard to find a more fitting phrase given both the name and the nature of this project.
When the project was first announced, in November 2010, only a few months had passed since the Flash Crash on Wall Street. So the CBT community had much to worry about in terms of becoming chief scapegoats for the various ills plaguing markets.
The initial Foresight press notice on CBT struck an ominous note, with project leader Sir John Beddington, the government's chief scientific adviser, saying: "It's essential to develop a better understanding of how computer trading in financial markets might evolve, in order to help protect the UK and other economies against technology-led economic instabilities."
Words like "protect" and phrases like "technology-led economic instabilities" were probably not what algo traders wanted to hear. But skip ahead a year and the very first finding by the Foresight experts could not have been more welcome for the CBT world.
"Economic research thus far provides no direct evidence that high frequency computer based trading has increased volatility," read the lead bullet point an interim report issued last September.
The Foresight research so far has included a three-part working paper provided in English, French and German, as well as 17 supporting documents and a survey, all of which can be found on the website www.bis.gov.uk/foresight/our-work/projects/current-projects/computer-trading .
The Foresight team says the interim report only summarised the available evidence at that time and the final report will include work that has since been commissioned. This includes workshops, surveys, regulatory impact assessments and other pieces of research.
They expect the final report to attract "substantial interest in the stakeholder community" and to inform international regulators.
For Vitale, it's important that the message gets out there that automated trading is actually helping the market place. "It's really lowered the barriers for everyone, everyone now can trade quite easily," he said.
The issue that many in the market place are most concerned about is regulation. Vitale said there is a real risk that politicians will focus more on what they think the general public wants to hear rather than the evidence. "So this report will help, I'm sure," he said.
Vitale said he did not see a problem in having a regulatory body that specialised in automatic trading or high-frequency trading. "I think that we need to have regulation but also not put everything in the bin and say, 'Okay, forget the computers, we'll go back to the phone.'
Turn-back-the-clock thinking rears its head whenever technology and traditional business practices clash. That's why he worries when people talk about introducing cancellation fees for traders - one of the ideas mooted to limit high-frequency trading. "We need market makers. We need people who take risk, who put a firm offer in the market. We cannot tell them, 'Well, you don't have the right to cancel your orders.' "
Habib at Algo Technologies said one common view in the workshop he participated in was the need for better post-trade surveillance. Regulators and exchanges needed to devise better ways to prevent computer-based abuses such as quote stuffing to clog up an exchange or market-makers who send orders they clearly have no intention of trading.
"It's that side of the regulation," he said. "There should be a lot more pressure on that side of it."
Like Vitale, Habib sees the question of fees for cancelled trades as a potential mistake that would do more harm than good. And his hope is that work such as the Foresight project can help decision-makers understand this.
"I just think they could do with some policing around (post-trade). And I don't think the solution is charging for cancels. Because if you start charging for cancels, then you will still start to bring back the prices from the people who are actually providing good prices and have good intention of trading."
The Foresight project seeks to look 10 to 20 years ahead to understand challenges, risks and opportunities. Habib said that when his group was asked to look ahead 10 years, it drew a direct linkage between better surveillance and a stronger market-place.
"One of the ways to bring confidence back to the trading community would be for there to be sufficient regulation, or sufficient surveillance to ensure there is no harm being done, or there's no abuse in the markets by these algos," he said.
In other words, more sunshine, please.
Yet perhaps it is a little ironic that it was Brandeis who coined the phrase that the algorithmic community should now be embracing. The man who would one day become a Supreme Court justice made a career of fighting powerful forces and it's not a stretch to say he probably would not have been all that impressed by the algo community. One of his earliest and biggest targets for scorn? The banking industry.