[ by Melanie Gretchen ]

High-frequency traders face speed limits on a major trading platform for the very first time that threaten their domination of the markets.  The proposed limitations seem so effective in leveling the playing field that  many market professionals tout the proposals as a template for a regulatory clampdown on computer-driven activity. 

EBS, one of the two dominant trading platforms in the foreign exchange, or forex, markets, introduced the proposal that may soon replace the current principals of "first in, first out" trading - which EBS says gives unfair advantage to the fastest computers, and has led to an arms race of spending on technology.

How the Current System Unfairly Benefits HFTs.   HFTs employ algorithms instantly transmit orders from the point of origin to the trading records maintained by an exchange.  Those who can shave off the most microseconds in their transmissions are the ones who get to the top of the trading book.  HFTs further reduce transmission times by locating their computer servers as close as possible to the trading platforms' own servers. 

This prompts many large and sophisticated traders to complain that the actions by HFTs are simply increasing the complexity of doing business.  Proponents, however, counter that HFTs improve the efficiency of markets and narrow transaction costs by providing sorely needed liquidity.

How the Proposed Plan Would Work.   EBS would scrap the FIFO methodology and replace it with a system that batches incoming orders, where the batches are dealt with in random order. This minimizes, if not eliminates, the importance of speed, which makes sense to EBS Chief Executive Gil Mandelzis  who says:

"Speed has little to do with why many participants come to our markets. These are serious players who come to the market to exchange risk; they do not come to race."  

Mr. Mandelzis adds:  "It is a technology arms race to the bottom, and a huge tax on the industry, since people are having to make significant investments in speed without any connection to their trading strategy."

EBS, a division of ICAP, the UK-listed interdealer broker, and Thomson Reuters each operate the most popular electronic trading platforms in the $4 trillion forex market.  A third platform, ParFX, launched this month, uses a similar system to impose randomized pauses on incoming orders, saying it will ensure "a fair trading system for all".  ParFX was created 2 years ago by large banks - including Deutsche Bank and Barclays which, at the time said that EBS favored HFT firms.

The direction these market innovations are taking prompt Larry Harris, former chief economist of the SEC and now a professor of finance at the USC Marshall School of Business, to express hope that their adoption in the forex markets will spur regulators to act more prominently, saying:  "Wherever you see high-frequency trading, requiring a delay is a sensible thing to do.  We are talking about delays of one-thirteenth of the time it takes to bat your eye. It hardly slows down the market at all, but it ensures that a smaller trader has a better chance of getting first in line."

For further details, go to [Financial Times via CNBC, 4/29/13].