NEWS UPDATE
EQUITIES
FCA study estimates HFT
‘sniping’ costs investors globally
$5 billion a year
Analysing billions of message data points from the LSE, the FCA claims eliminating
latency arbitrage would reduce the cost of liquidity for institutional investors by 17%.
H
igh-frequency trading (HFT) firms are gaining
almost $5 billion in profits globally each year by
exploiting tiny speed advantages in equities markets,
which the UK’s watchdog has labelled a ‘latency arbi-
trage tax’ on investors.
The Financial Conduct Authority (FCA) said that as
part of an in-depth study it analysed message data,
including attempts or failed to trade messages, from
the London Stock Exchange for all stocks in the FTSE
350 index over a nine-week period in 2015 to quantify
latency arbitrage.
Referred to by the market as ‘sniping’, latency arbi-
trage is defined as the practice whereby HFTs make
very small profits by taking advantage of a brief gap,
a matter of microseconds, before stock prices realign
following a correlated instrument price shift.
According to the FCA’s research, ‘sniping races’
are very frequent with the average FTSE 100 stock
subjected to around 537 latency arbitrage races each
day, or one every minute, and the races account for a
significant 22% of average daily trading volume.
The winners typically beat others by 5-10 microsec-
onds, and the activity is concentrated with just a hand-
ful of firms winning the majority of the sniping races.
Just six firms account for more than 80% of winners
and losers of the races in its study. The firms were not
named in the study.
The study concluded that the small profits gained by
HFTs, the ‘latency arbitrage tax’, calculated as the ratio
of daily race profits to daily trading volumes, is 0.42
basis points, equating to £60 million per year in the UK
equity market, and $4.8 billion annually across global
equity markets.
“As is often the case in regulatory settings, the det-
6 // TheTRADE // Spring 2020
riment per transaction is quite small and a 0.42 basis
points tax on trading volume certainly does not sound
alarming. But it all adds up,” authors of the report from
the FCA wrote in an overview. “And remember, we are
talking here only about equities. The same phenom-
enon extends to other asset classes that trade on
electronic limit order books such as futures, currencies,
US treasuries and more.”
Furthermore, the activity negatively impacts institu-
tional investors more than retail investors who have
savings or pensions. The FCA said that sniping races
and the ‘flawed market design’ has increased the costs
of trading, but eliminating latency arbitrage would
reduce the cost of liquidity by 17%.
HFT has been an issue of controversy following the
publication of Michael Lewis’ best-seller ‘Flash Boys’,
which suggested that the US stock market is rigged to
benefit high-speed traders. Proposals have been made
to deal with the HFT arms race, including implement-
ing speed bumps on exchanges to slow down firms.
Others have suggested continuous trading be eliminat-
ed in favour of frequent batch auctions to remove the
incentive to trade faster and level the playing field.
The FCA has urged researchers and regulators to
replicate its analysis of exchange message data on
other markets to gain more insight, but most authori-
ties do not capture the data and exchanges preserve it
inconsistently.
“The limit order book is viewed as the official record
of what happened, but we argue that the message
data, and especially the ‘error messages’ that indicate
that a particular participant has failed in their request,
are key to understanding speed-sensitive trading,” the
study concluded.