In a market obsessed with technology, it seems incongruous to discuss the merits of introducing artificial pauses into the order process.
That continues to be the view of those who describe randomization as a gimmick that creates the illusion of a level playing field while masking a platform’s technological deficiencies.
| These preventative solutions, combined with market surveillance, address the underlying issues that can lead to disruptive behaviour|
David Mercer, CEO of LMAX Exchange, says none of his customers has ever requested random execution.
“We don't use randomization," he says. "Just like on an exchange, all orders are matched on price/time priority, which enables transparency of execution and ensures that our market participants are treated equally, irrespective of the order size or activity levels.”
Mercer describes randomization – as well as the introduction of latency floors – as examples of how some venues are trying to introduce systems designed to even out the speed disparity between market participants.
He suggests the concept has gained limited traction due to concerns about its ability to improve trading transparency and the removal of certainty and precision in order execution.
Randomization of execution cannot reduce latency arbitrage because different clients have different latencies, suggests FastMatch CEO Dmitri Galinov. “In addition, since the randomization decreases certainty of execution, that has to be compensated in wider spreads.”
However, Roger Rutherford, chief operating officer at ParFX, suggests that in a global market such as spot FX, where thousands of trades are executed every minute, spreads are constantly changing and it is difficult to attribute wider spreads to any one particular factor.
“Spreads are impacted by a wide range of issues including market volatility, the size and value of a trade, use of last look, etc," he says.
"We believe randomization makes it easier to manage risk, not harder. The introduction of a randomized pause and other features on ParFX has firmed liquidity, increased fill rates and improved efficiency of execution.”
In a non-randomization trading environment, during periods of market dislocation makers will try to cancel their quote, whilst the taker attempts to hit, observes Mark Bruce, head of product at EBS BrokerTec Markets.
“Once there is an element of order batching, a window opens for additional takers to arbitrage the maker, with the odds of the maker successfully removing their quote significantly diminishing,” he continues.
“It is for this reason that we are in the process of prioritizing cancellation messages within our latency floor, as it will protect market makers to avoid such scenarios, which in turn should result in tighter, more liquid markets.”
Bruce reckons that neutralizing technology or infrastructure differentials is a positive development for the market, while ParFX's Rutherford suggests that "first in, first out" trading has led to an arms race of spending on technology for the fastest execution strategy to maintain a millisecond advantage rather than focusing on trading strategy.
“The randomized pause is meaningful enough to nullify disruptive traders whose strategy relies solely on speed, but meaningless to those that have a genuine trading need, who seek firm, executable liquidity and compete on strategy,” says Rutherford.
Yaacov Heidingsfeld, chief executive of liquidity aggregation technology vendor TraderTools, has previously suggested that better market surveillance might be a more effective way to tackle latency arbitrage.
|Dmitri Galinov, FastMatch|
However, FastMatch's Galinov observes that market surveillance requires the establishment of a consolidated tape, a process whereby real-time data of a given security’s trading across all dealers and venues is aggregated.
“Without this, it would be impossible to undertake surveillance of a global and dispersed FX market,” he suggests.
According to EBS BrokerTec's Bruce, while market surveillance is effective at highlighting flashing or spoofing, it cannot identify a cross-region arbitrage executed over microwave and high-speed networks.
“A markets operator with both market surveillance and a randomization feature will be in a beneficial position to effectively manage their market ecology,” he adds.
When it comes to tackling trading misbehaviour, surveillance in itself will not be effective because it is only reactive – it has to be combined with a proactive solution that stops the misdemeanour occurring in the first place, says Rutherford.
“For example, participants trading on ParFX cannot predict the timing of orders or game the platform,” he concludes. “In addition, the randomizer prevents abusive practices such as rapid-order submission and cancellation prior to execution with the sole purpose of moving the market.
"It also nullifies speed advantages like dark fibre, cross connect and low latency systems and models. These are all preventative solutions that, combined with market surveillance, address the underlying issues that can lead to disruptive behaviour.”