I don’t normally write posts like this, but this deserves our attention.
I won’t completely recap the article in the WSJ this morning about the AXA fine, but here are the highlights and some points to consider.
A unit of French insurer AXA SA, AXA Rosenberg Group LLC, runs one of the largest quant programs out there, with $60+ billion under management as of last year. After a coding problem disabled risk controls on some of their accounts (oops?) and those accounts suffered sizable losses, investors pulled about half of that, leaving the unit with “only” $30B under management. Obviously, still a very significant pool of money. After the event, senior management at AXA took steps to cover up the error.
And here is the important part… the SEC charged AXA with a significant fine and demanded they repay losses to the investors’ portfolios. This is the first judgment of its kind against a quant firm, and could be the beginning of something interesting. I don’t fall into the camp of people who think that all HFT and algo trading is evil. In reality, many of the HFT advances have resulted in a net positive to the individual investor who benefits from narrower spreads and better execution in orders done via algos. However, the field is full of abuses (for instance, much of the apparent liquidity in the book is not real liquidity, but what I think of as “predatory” liquidity. This is something that needs to be addressed.) and the arms race of faster execution with less human may have unintended consequences.
In general, I tend to think less regulation and more free markets is better. “Let the market itself work it out” is usually my attitude, and, in terms of economics, I tend to fall squarely in the Austrian camp. The issue in this case is not competition or normal evolution of markets and technology, it is potentially abusive and quasi-criminal practices that may well have an overall negative net impact on the market. At any rate, better regulatory oversight from regulators that have deep insight into market structure and quant trading is needed, and quant shops need to be held accountable for errors that hurt investors. It is possible that yesterday’s AXA settlement may represent a new direction and commitment from the SEC to deal with some of these abuses.
http://online.wsj.com/article/SB10001424052748704376104576122642878858736.html
(if you are unable to read the whole article, Google “wsj axa fine” and click on the article from that link. Online WSJ articles are available through Google links.)
3 Comments on “The wind of change is blowing…”
Thought there would be many comments here, given you strike a more sympathetic tone than most on the subject. I have to agree and would say that the market itself is an excellent regulator. In that vein, there are market-based solutions to HFT latency arbitrage emerging: http://www.theglobeandmail.com/globe-investor/putting-the-hammer-to-high-frequency-traders/article1871294/
I’m afraid if the regulators get in the business of putting a “Good Housekeeping Seal of Approval” (CFTC’s words, not mine) on algorithms, costs and barriers to entry will increase without “solving” anything.
Sometimes I imagine what it must have been like for a pit trader a decade ago, realizing that his greatest edge would soon be gone. Some transitioned to the screen, many did not, but there was no stopping electronic trading.
Similarly, the HFT world is dominated by what seem to be very simple strategies designed to capitalize on speed. But the algos are getting smarter, and Moore’s law all but guarantees they will be come more so, exponentially. Who will make the transition? Do we even know what the transition is? Probably not, but it’s not unreasonable to venture that even the very best very short term day traders will be getting a run for their money in a few years.
why are stock markets so boring -are no one tradng anymore!?? Low volatility bs..
Hi Adam. Every investor must accept responsibility for their own investments. If you invest in a fund returns are not guaranteed (in fact low performance of funds is what steered me to trading for myself). However, investors are entitled to not be misled by management as was the case here with the cover up and that the fund management will have adequate risk control to prevent rogue traders blowing it all.
Should the fund use HFT and have adequate risk control there is no issue here. HFT is nothing more than the latest technique in a market that has always had different players using different edges. Good luck to them.
I must say however that self regulation (aka free markets) is a joke. In todays age ethics *unfortunately* count for absolutely nothing. Goldman sacs selling garbage to the market while actively shorting it themselves is a prime example. Toyota’s efforts to avoid a recall of knowingly unsafe vehicles is another – both within the last 12 months.
Living in a country (Australia) where regulation exists well in many industries I fully support it. Regulation saw our banks face barely a blip in the GFC while continuing to make super profits. Most would argue they are still not regulated enough. The same has happened for public transport, tolls, airlines (thus leading to Qantas’s exceptional safety record), and other things although many are slowly eroding away.
What’s the point: Regulation is a good thing when done properly with motives to protect consumers, not political motives. Lack of regulation is exactly why we faced a GFC and will do so again and unfortunately given America’s size, it doesn’t just affect American consumers, it affects the world. If we are all unable to operate profitably under the exact same regulations faced by all and operate outside of these – why not just rob a bank, what’s the difference? Ironically the fund manager who loses half a billion in consumers funds through fraud will face less jail time and better jail conditions than the liqueur store robber who stole $2K – go figure!
Anyway rambling now – just my opinion 🙂