Royal Bank of Canada has become the standard-bearer for a revolt among investors against so-called predatory high- frequency trading practices on both Wall Street and Canadas Bay Street.
The technology, ideas and personnel behind the upstart IEX Group Inc. alternative stock market in the U.S. and the proposed Aequitas Innovations Inc. exchange in Canada can be traced to Royal Bank, portrayed as an outsider on Wall Street in Flash Boys, Michael Lewiss book exposing the U.S. markets obsession with trading speed.
Certainly our clients, as I look at our electronic trading numbers, are doing more business with us, said Greg Mills, head of global equities at Royal Bank. We have more requests for meetings, we have more people coming to us and saying Help us understand this problem again.
Read About RBC’s Answer to HFT
Royal Banks RBC Capital Markets unit spent years supporting Brad Katsuyamas quest to understand the effects of high-frequency trading on Wall Street, ultimately developing software designed to protect against traders using speed as an advantage. Katsuyama, the protagonist of Flash Boys, left RBC to found IEX, which began trading in October, and Royal Bank has since publicly supported it.
RBC Nice
Royal Bank has emerged as a leader against predatory high- frequency trading at a time of increasing scrutiny from both regulators and the public after the release of Lewiss book, which claims the stock market is rigged against investors. The bank is described by Lewis as fostering an RBC nice culture with its no asshole rule on hiring.
High-frequency trading isnt inherently good or bad, Mills said. The problem arises when certain market players use technology to take advantage of others.
Thats what we need as an industry, to see regulation mature to the point where it can begin to eliminate those predatory practices, and thats where well level the playing field, Mills said in a telephone interview yesterday.
Royal Bank, along with seven partners, owns a stake in and helped found Aequitas, a market with similar goals to IEX. The Toronto-based bank is Canadas second-largest lender by assets.
One thing thats clear is that RBC is the common denominator between IEX and Aequitas, said Jos Schmitt, chief executive officer at Toronto-based Aequitas, in an April 1 interview at the companys headquarters in Royal Bank Plaza. It tells you something about where they come from, what they stand for and what they seek to achieve. They translated that to being the spark in a change on Wall Street and on Bay Street.
DarkPools
High-frequency trading firms have been accused of ripping off investors in the $22 trillion U.S. stock market by using tactics including paying for the right to trade indarkpools and placing their servers as close to the exchange as possible to speed up trading.
Royal Bank saw what its competitors were doing and decided to go in a different direction, Mills said.
We were going to stay on the side of being an advocate as opposed to an adversary for our clients, he said. Thats not an easy thing to do, because theres no playbook when you zag and everybody else is zigging.
Royal Bank has taken several steps to counter the advantages enjoyed by high-frequency traders. The lender developed the THOR software; refused to create its owndark pool, and supported the creation of IEX by sending the first order on the exchange last October. The bank also hired Schmitt to run Aequitas after approaching him to investigate problems in the market in late 2012.
Builds Business
Being associated in the public eye as a champion for hard- luck human investors against robots helps the bottom line for Royal Bank, said Som Seif, chief executive officer of Toronto- based Purpose Investments Inc.
This is good business for RBC, Seif said. His firm manages about C$400 million. I dont want to overplay the Canadian perspective, that Canadians want to save the world. If theyre identified as a player that cares, it will build business.
According to Lewis book, Royal Bank surged up the Wall Street rankings after it developed THOR and demonstrated the software to other firms. Royal Bank, which placed No. 19 in Greenwich Associates 2009 internal stock market rankings, jumped to No. 1 by the end of 2010, the book said. Greenwich Associates ranks the banks annually based on surveys of fund managers, analysts and traders.
Joan Weber, a spokeswoman at Greenwich Associates, declined to comment and said the rankings are private data owned by the company.
Police Probe
New York Attorney General Eric Schneiderman has begun a probe of equity markets, and the Federal Bureau of Investigation is reviewing high-frequency trading firms practices to see whether they break the law.
Most of the large brokers in the U.S. in the last five years have put their bets down on not slowing things down, Sang Lee, a partner with Aite Group LLC, a research firm, said in a phone interview from Boston. RBC came in late to the marketplace. They couldve spent a gazillion dollars to get up to speed, or find another way to deal with the problem. They chose the path less traveled.
Katsuyama, the founder and CEO of IEX, had his start as a trader in Royal Banks New York offices and first alerted the bank to what he thought was odd behavior on his trading screens, including disappearing bids and prices that jumped right after he placed his orders.
THOR Platform
His subsequent attempts to resolve the problem led to the creation of THOR, software designed to normalize the amount of time it takes for data to travel to an exchange, removing the speed advantage of high-frequency firms. Eventually, Katsuyama and his team left Royal Bank to form investor-owned IEX. The market, open for about five months, delays reports of order executions by 350 millionths of a second, enough to take out the advantage of the fastest firms.
Traders’ Take on THOR
The bones of the THOR software, patented by Royal Bank, can be found in the smart order routing system of Aequitas, Schmitt said. Along with that technology, Aequitas will use speed bumps and fees to discourage high-speed trading. Both firms reject the maker-taker model, which pays rebates to market makers for providing bids and offers.
Thought Leader
Aequitas revised the rules of its planned exchange after an initial proposal was rejected by regulators in January due to concerns about equal access to orders, and is still on track to roll out its services in the first half of next year, Schmitt said.
Royal Banks involvement and perception as a thought leader makes sense as Canadians have been innovators for decades, thanks to the markets smaller size, said Doug Clark, managing director at ITG Canada. The Toronto Stock Exchange listed the worlds first exchange-traded fund, the Toronto 35 Index Participation Units, in 1990.
If this is driven by our thought leadership, vision and conversations that came out of Canada, as Canadians we should be proud, Aequitas Schmitt said. Weve developed a unique culture here of saying that not everything that happens in the U.S. is right.
Money Managers Also Drive High-Speed Trading, SECs Berman Says
(Bloomberg) — The speed and complexity of modern stock markets is partly driven by long-term investors who have adopted strategies pioneered by high-frequency traders, according to a top U.S. securities regulator.
Trading patterns analyzed by the Securities and Exchange Commission found that money managers use sophisticated computer programs to fill their orders on a variety of private trading venues, including dark pools and over-the-counter markets. Their goals require an unavoidable increase in the complexity of our markets, and in a very real sense is also driving the need for more and faster technologies, said Gregg Berman, one of the SECs top authorities on high-frequency trading.
High-speed trading is facing unprecedented scrutiny following the publication of Michael Lewiss book, Flash Boys, which argues that the practice has helped rig the U.S. stock market. In a speech yesterday in New York, Berman didnt mention Lewiss book directly but said the current debate is too narrowly focused and myopic.
If there are things we want to change about our market structure we must look at both sides of this equation, including why and how market participants on both sides interact with the markets, Berman told the North American Trading Architecture Summit in New York. Focusing separately on just one or the other misses the entire point of how buyers and sellers are brought together.
Berman is one of the SECs policy advisers on rules that affect high-frequency traders, dark pools, and other elements of computerized trading that evolved after years of regulatory changes and advances in technology. TheSECis facing pressure to respond to Lewiss claims as regulators insist they are studying all aspects of market behavior, not just practices of high-speed traders.
Data Feed
Bermans office is drawing on data from a more robust market-data feed, known as Midas, as it conducts its review. In his speech yesterday, Berman said the market may not be moving too fast because data shows investors are able to access even the most short-lived quotes.
While 23 percent of orders are canceled within one- twentieth of a second, approximately 19 percent of all trades happen during the same time window, Berman said.
Solutions that simply attempt to address the speed of cancellations are likely missing half of the speed story, he said.
BlackRock Inc., the worlds largest money manager, said in an April 8 policy report that predatory high-frequency trading activity mostly affects institutional, not retail, investors.
High frequency trading encompasses a wide variety of trading strategies and care must be taken to differentiate predatory practices from practices that benefit end- investors, BlackRock said in the paper.