The Knight Capital incident has cast a shadow on this topic that has attracted more and more attention from financial institutions and financial regulatory authorities nowadays - particularly on high frequency trading and financial innovation; however, it is not the first company that has faced this kind of problem. As early as 1998, a company called Long-Term Capital Management (LTCM) faced a similar dangerous situation due to high-tech bond trading strategies, though the impact was eventually neutralized through the US government's efforts. High-frequency trading (HFT), or high-speed trading, is a trading strategy that involves trade stocks or options utilizing sophisticated technical software to earn profits in an extremely short time period. A trading order may be issued by an automatic trading system every single minute based on some pre-set computer program, if not in a shorter time frame. However, the gain or loss of such highly frequent trading strategy significantly relies on the processing speed and the complementary actions of the trading system. While traders and investors are enjoying the returns and advantages from the highly developed and seemingly invincible computer science, the existence of "bugs" make these systems vulnerable and even the slightest error, not matter how small, in the software may lead to countless losses or even lead to the whole brokerage giant's collapse.
As revealed by the dot com bubble, the high-tech trading technology is a two-edged sword, and whether it is beneficial or not depends on how the people use it, and high frequency development is just an outrageous example. The turnover of a stock being traded will soar if the high frequency trading is applied and the stock exchanges' income will also increase if all these transactions take place inside the exchanges. However, in recent years, there has emerged an under-the-table transaction facility called the "dark pool", which has taken away a considerable portion of the accreted income from the exchanges. The dark pools provide a platform for some leading institutional investors to trade behind the scene using the high frequency trading systems.
Seeing the obvious benefits from the dark pool transactions, Hong Kong investors and financial institutions began to consider introducing this kind of facility, hoping that they too can also gain from the booming high frequency trading. However, the Hong Kong stock market has its own unique characteristics which may be a reason for the local authority's conservative perspective of this issue. There are three kinds of related fees involved in a transaction: commission, transaction levy and stamp duty. The brokerage firm will get the commission while the other two fees go to the Hong Kong Stock Exchange and the Hong Kong government accordingly. If the stocks transactions flow into those dark pools, then the corresponding transaction levies will not be collected by the Hong Kong Stock Exchange. On the other hand, the Hong Kong Government insists on keeping a relatively high stamp duty on stock transactions, which cannot be avoided even in the case of dark pool trading, thus setting a hurdle preventing those institutional investors from introducing high frequency trading mechanism. The Knight Capital incident however, shows that even the highly developed technology may have flaws and negative impacts, which to some extent, relieves Hong Kong investors from the regret of missing revenue from high frequency trading.
The author is Associate Professor at Department of Finance & Decision Sciences of Hong Kong Baptist University. The views expressed here are entirely his own.
Source : www.chinadaily.com.cn
