It’s only an idea now, but there is widespread discussion in the equities markets about instituting a rule to require exchanges to freeze quotes or orders for a minimum amount of time, also known as "time-in-force."
Time-in-force first surfaced in the Security and Exchange Commission’s Concept Release in January. The idea has since gained traction because high-frequency traders’speed in executing trades and canceling orders might have contributed to the May 6 "flash crash."
But implementation of any such notion into a rule seems a long way off and faces many hurdles. In short, a TIF rule would mandate a minimum amount of time an order or quote could remain active before it is executed or is canceled. The thinking goes that a TIF requirement would slow trading down and maintain an orderly market in times of market stress.
The likely minimum duration for a quote under such a proposal could be 50 milliseconds, suggested several sources. Quotes can currently be updated in the low-millisecond range.
The problem, as opponents of such a rule see it, is liquidity providers would be less likely to trade and post limit orders. That would ultimately hurt liquidity and widen spreads, making trading more expensive for all investors.
The topic of a minimum time for quotes came up during this summer’s joint meetings on the flash crash between the SEC and Commodity Futures Trading Commission. In September at the Economic Club of New York, SEC Chairman Mary Schapiro said the SEC is considering introducing a minimum "time in force" for orders to offset the frenetic cancellation of orders by high-frequency traders. During her speech, Schapiro asked whether high-frequency firms should be prohibited from withdrawing liquidity out of the market during times of volatile price movements or be treated as market makers and have an obligation to provide liquidity at all times.
"We know that, in the ordinary course, many high-frequency trading firms cancel 90 percent or more of the orders they submit to the markets," Schapiro said. "There may, of course, be justifiable explanations for many canceled orders to reflect changing market conditions."
According to data distribution firm Nanex, on an average trading day 15 to 20 of the most actively traded stocks receive more than 5,000 quotes a second that never result in a trade.
Congress is weighing in on the matter, as well, in an effort to pushing for constraints on high-frequency trading. Sen. Charles Schumer, D-N.Y., has expressed concern over the speed of trading and whether some sort of restriction, such as a minimum time requirement, is in order. In a Sept. 7 letter to the SEC, Schumer said he was "increasingly convinced that the costs of reducing execution speeds by an extra microsecond here or there outweigh the benefits in terms of allocating capital efficiently."
Schumer cited studies that claimed less than 1 percent of all orders posted are actually executed, while the rest are canceled. However, regulating the amount of time a quote must be posted is seen as limiting high-frequency traders’ ability to trade and could prohibit them from contributing liquidity to the markets. High-frequency traders make their profits by buying and selling in fractions of a second – by posting thousands of quotes per second.
If a TIF does come to pass, it would be part of exchanges’ rule books. So far, the exchanges are wary of any requirement that would slow down quotes, which in their opinion would hamper price discovery. Chris Isaacson, chief operating officer at BATS Global Markets, said that while there isn?t one yet from the SEC, anything that might resemble time-in-force could ultimately result in wider spreads and higher costs.
"Forcing people to display liquidity for a certain amount of time will cause them to be less aggressive in doing so and lead to a widening of spreads, in the end costing investors more," Isaacson said.
Aside from liquidity, another key issue is which venues would be affected. Given that 30 percent of total trading volume occurs off-board, exchanges like BATS want alternative trading systems and dark pools to be subject to TIF provisions. If not, exchanges could be at a disadvantage, as trading flows would move to venues not affected by a minimum quote requirement — namely, the broker-dealers.
"I definitely think there is a risk of pushing trading off-board and into the dark with this type of proposal," Isaacson said. "Especially if passive orders that are entered into a dark venue are not subject to the same requirements as what is displayed in the lit markets."
For their part, HFTs told Traders Magazine that not only would their trading strategies be affected, but also non-HFT firms employing index-arbitrage, which requires very short-lived price discrepancies between an index and the underlying stocks. Thus, having to leave a quote posted for a set amount of time could undermine any arbitrage strategy.
HFTs added that they do not clog up the system with excess quotes and other message traffic and that their trading activities contribute liquidity and promote price discovery. According to industry estimates, HFTs constitute between 50 to 60 percent of total equity trading volume.
"It would almost certainly increase spreads to compensate liquidity providers for additional risk and probably decrease volume," said Chris Bartlett, director at Nobilis Capital, a high-frequency firm in New York.
He said that TIF presents problems because it would force anyone sending in a limit order to keep it in the market for a set amount of time. That would result in him getting picked off as his quotes are no longer reflective of the market.
For example, Bartlett said, if there is a sudden drop in a related future to the underlying stock, the end result is that an equity order has been turned into a "free option" order.
He also pointed out that requiring a minimum time requirement could open up a wide new range of trading strategies to take advantage of the requirement.
"Anytime there is a limitation on the market pricing mechanism, it creates trading opportunities," Bartlett said. "It does not matter what the time-in-force is — whether it’s one minute, one millisecond or one microsecond — there will always be someone fast enough to get inside it."
Tom Peterffy, chief executive of Interactive Brokers and a pioneer in automating trading, said he is not in favor of any proposal that would mandate any type of time constraint on quotes. "I’m not in favor of this at all, posting quotes for a time or for holding back of messages," he said.
Peterffy added that if a minimum time requirement for quotes were enforced, it would be difficult to post accurate pricing when markets move fast. This is especially true, he added, for those who have to make markets in multiple stocks and then must keep track of when each quote was posted and move them when the market changes.
"If [the regulators] slow down the movement of quotes, that will hurt the market, plain and simple," Peterffy said.
