I came across an interesting paper the other day

published by GETCO:

href="http://www.getcollc.com/images/uploads/Final_EU_Paper.pdf "

target="_blank">A Modern Market Maker's Perspective

on the European Financial Markets Regulatory

Agenda.

The HFT community

has come in for quite a bit of stick recently and so it was

refreshing to see an intelligent and well argued explanation of

its role in today's financial markets.

One of

the key points

href="http://www.getcollc.com/"

target="_blank">GETCO makes is that high frequency

trading is not a trading strategy in its own right. Instead,

trading with high frequency (or with high speed and volume) can

reflect a number of different trading strategies. Where it is

supporting electronic market making then speed is crucial as the

market maker needs to minimise his 'exposure

time', i.e. that period when he cannot modify a quote

in response to changing market conditions. At least for market

making, then, high speed is actually a way of reducing risk

rather than increasing it.

The paper goes on

to say that electronic liquidity providers like title="GETCO" href="http://www.getcollc.com/"

target="_blank">GETCO actually increase overall

liquidity and reduce volatility by buying when others want to

sell, and vice versa. The real debate, though, stems from exactly

how obliged the 'modern day market maker' is

to maintain these two-sided quotes especially when markets are

volatile.

target="_blank">GETCO rightly argues, however, that

its role as designated market maker (DMM) or Lead Market Maker

(LMM) on many venues and stocks means that it is subject to very

specific obligations in this regard. And so, ironically, the

faster

target="_blank">GETCO can access markets the safer

they would appear to be.

The other issue is

how such firms are rewarded for their provision of this liquidity

to markets. In the old days market makers earned the bid/ask

spread between the quotes that they provided but this has changed

since the introduction of MiFID. First, the maker taker pricing

models operated by many alternative venues provide extra reward

(in terms of rebates) to those firms that lodge passive liquidity

on their platforms. Second, the increased competition between the

venues has led to an overall reduction in tick sizes which

favours electronic liquidity providers over the more traditional

market maker.

I guess the problem comes with

the high frequency players that simply siphon liquidity between

venues in order to take advantage of maker taker rebates without

any real obligation to consistently make two-sided

markets.

Anyway, read

href="http://www.getcollc.com/images/uploads/Final_EU_Paper.pdf "

target="_blank">the paper and have your own say in

our readers' poll.

Note: There is a poll embedded

within this post, please visit the site to participate in this

post's poll.