(Bloomberg) — Regulators are testing the limits of science in their drive to stop high-frequency traders from manipulating European securities markets.
The European Securities and Markets Authority wants high- frequency trading venues to synchronize their clocks to within a nanosecond, or one-billionth of a second, to help supervisors better track potential market manipulation.
Such precision isnt yet possible, according to Leon Lobo, business development manager for time and frequency at the U.K.s National Physical Laboratory, which built the worlds first cesium atomic clock 60 years ago. Scientists calculations may not even be able to keep clocks consistent to one-millionth of a second across the 28-nation European Union, he said.
At the microsecond level you need to understand how you are implementing the standard, Lobo said by telephone. At the millisecond level its no problem; at the nanosecond level its impossible.
ESMA wants to introduce more detailed time-stamps to allow regulators to better distinguish the order in which trades are executed. At their peak, algorithms shot out about 323,000 stock-trading messages every second in the U.S. in 2013, compared with fewer than 50,000 for the busiest period in 2007, according to the Financial Information Forum in New York.
The Paris-based regulator is in the process of implementing financial-market legislation that covers everything from broker research fees to high-frequency trading, which has grown rapidly since the 2008 financial crisis. The rules will come into effect in early 2017.
Granularity and Accuracy
ESMA has proposed linking the time standard to the speed at which trading venues acknowledge an order after receiving a trade request, known as the gateway-to-gateway latency time. This means that clocks must become more accurate as trading speeds up.
At present it may not currently be feasible to expect trading venues to synchronize their clocks or time-stamp events to a granularity which is less than nanoseconds, ESMA said in in a consultation paper published on Dec. 19. As a result, ESMA has proposed capping the granularity and accuracy requirements at the nanosecond level.
Laboratories can provide time data to large numbers of users with an uncertainty on the order of 100 nanoseconds, the National Physical Laboratory said in a response to ESMAs proposal. The NPL, based in Teddington, Middlesex, is home to Britains atomic time scale and is the focus for time and frequency measurements in the U.K., according to its website.
Future Changes
Computer-driven trades can be executed in about 300 microseconds, according to one study. A microsecond is one- millionth of a second. At that speed, more than 1,000 trades can be made in the blink of an eye.
ESMA said in its response that nanosecond-level accuracy is needed to allow the rules to adapt to future changes in the evolution in the speed of trading. David Cliffe, an ESMA spokesman, declined to comment immediately on the laboratorys response.
Trades are happening in the millions per second, Lobo said. I can see where the regulators are coming from. You need microsecond and below for that.
At the sub-microsecond level, the biggest problem is that if everyone uses different methods of time calculation, its going to be very unlikely that someone else has exactly the same time, Lobo said.
The ability of high-frequency traders to process orders quicker than rivals, using technology such as microwave towers, has led to accusations that some detect and trade ahead of large stock-market orders, front-running them without regulators knowledge.
Faster Networks
Michael Lewis, in his book Flash Boys, portrayed the market as unfair because the more advanced traders could use powerful computers and faster networks to take advantage of other investors, changing the prices of the securities they trade. Warren Buffett, the worlds second-richest person, has also criticized firms that can trade in fractions of a second.
I think of the high-frequency traders as just basically exploiting a system thats got these glitches in it, Lewis said in an interview on CNBC last year.
Synchronizing trading clocks to a microsecond is theoretically achievable, the Association for Financial Markets in Europe said in its response to ESMA.
It is however far from easy, and is subject to many external influences that mean that ensuring that the proscribed accuracy is maintained in all circumstances is extremely hard, according to AFME, which represents financial firms including Deutsche Bank AG, HSBC Holdings Plc and Barclays Plc. AFME proposed an accuracy requirement of 100 microseconds.
