* Super-fast data feeds, algorithmic programs jar hedgers
* CME, ICE say markets are evolving as screens displace pits
* Grain handlers seek exchange, CFTC review of impacts
By Christine Stebbins and Peter Bohan
CHICAGO, Nov 19 (Reuters) – The U.S. grain industry says
high speed computerized traders are disrupting their markets,
but grain exchanges and regulators have no quick fix for the
concerns, according to grain industry officials and traders.
The dispute, which pits grain companies at the Chicago Board
of Trade against speculators armed with algorithms and superfast
data feeds, echoes protests seen in world stock markets in
recent years as old-fashioned arm-waving traders have been
replaced by electronic matching of bids and offers on screens.
Grain hedgers are sounding the same alarms as other
traditional “buy and hold” investors against the new “high
frequency traders” (HFT), who dart in and out of markets at
lightning speed, narrowing bid-ask spreads and providing
“liquidity” but creating, critics say, dangerous and unnecessary
swings in prices.
“There are a lot of people on the commercial side who say
that we’ve gone astray,” said Diana Klemme, vice president at
Atlanta-based Grain Service Corp, which advises grain hedgers.
“We don’t want to get markets so erratic and potentially
irrational that people say ‘I can’t be in this.'”
From the “flash crash” of Wall Street stocks in May 2010 to
the sudden loss of $460 million in a software glitch at Wall
Street market maker Knight Capital in August 2012, the role of
high speed traders has drawn greater scrutiny.
Canadian regulators have proposed curbs and EU regulators
are weighing similar new rules. U.S. regulators have been seen
as slower to take action.
But after a sharp drop in oil futures prices in a few
minutes on Sept. 17, Commodity Futures Trading Commission
chairman Gary Gensler said last month that he will soon issue a
“concept release” of new rules for HFT in commodity markets.
That is meant to invite public comment and start down the road
to possible new regulations.
Grain traders are eager to have their say.
“Our members would pose the question: what is the purpose of
agricultural futures markets?” said Todd Kemp, vice president at
the National Grain and Feed Association, which represents more
than 1,000 grain handlers and processors. “Is it to allow
high-frequency traders to make a quick buck by betting which way
markets will move immediately following report releases? Or is
it to facilitate price discovery for agricultural commodities
and to help commercial hedgers manage their risk?”
CBOT’s parent, CME Group, and its rival, the
all-electronic Intercontinental Exchange, say grain
markets are evolving and HFT is a healthy part of the growth.
“HFT traders are present in all electronic markets and are
an important source of liquidity and market continuity. They
provide price discovery where other traders may be reluctant to
do so,” said ICE spokeswoman Brookly McLaughlin.
CAUGHT IN THE MIDDLE
ICE introduced grain futures in May to compete with CME’s,
with little effect so far on CME’s dominant grain market share.
But it is CME which is the focus of HFT’s grain critics.
On the one hand, CME says it must compete with ICE for the
HFT traders who bring greater trading volume – and fees for CME
profits.
On the other hand, grain hedgers like ADM or Cargill
, or ethanol plants, also bring great volume. But price
spikes from HFT buying, for instance, can mean costly margin
calls for such “short” hedgers. Volatility in thin nighttime
markets can also trigger stop-loss orders that hit hedger
positions.
Bryan Durkin, CME Group chief operating officer, said in an
interview that the exchange will address NGFA concerns. But he
also emphasized that higher volume is a virtue.
“Liquidity is the best defense against disruptive markets.
We want to make sure that people understand that algorithmic and
high frequency traders provide liquidity to these markets,”
Durkin told Reuters. “Our markets have never been deeper, more
liquid, tighter and more cost effective.”
Grain trader complaints about HFT center on two issues:
speed of market access and order execution. They say HFT traders
disrupt price discovery by flooding CBOT corn or soybeans or
wheat markets with bids and offers, often canceling orders as
quickly as they are made – in the blink of an eye.
“The high frequency trader is constantly putting orders in
and canceling it without the intent to trade,” said grain
analyst Roy Huckabay at Linn Group in Chicago. “It’s not unusual
for him to put in an order to buy 5,000 December corn and cancel
as soon as one is filled.”
Grain traders say such erratic trading – referred to as
“banging the beehive,” “quote stuffing” or “gunning for stops” –
prevents farmers and hedgers from filling orders at desired
prices and slows transactions at more than 7,000 grain elevators
across the United States.
But Durkin defended CME’s oversight of suspect trading.
“We have surveillance mechanisms in place to look for that
kind of activity,” he told Reuters. “If we identify it, we
pursue it.”
James Overdahl, a former SEC and CFTC economist and an
adviser to the Futures Industry Association’s Principal Traders
Group, said HFT is a “natural evolution of the market” and
electronic audit trails of trades strengthen accountability and
transparency, both winning arguments for regulators.
“Many of these people are performing a market-making
function and they are looking to go where the spreads are the
widest. Apparently they are seeing those opportunities in the
grain market,” Overdahl said.
One trader at a Chicago-based HFT trading firm who declined
to be named said the lightning speed of HFT was so mind-bending
that grain firms simply need time to evolve new routines.
Headlines now take anywhere from a 10th to a quarter of a
second (100 to 250 milliseconds) to hit screens of a news agency
like Reuters or Dow Jones. But superfast “low latency” data
feeds move at speeds of 10 milliseconds or less, triggering
immediate machine matching of trades — even before a headline
can be read.
“It is giving a perception of a problem when there probably
isn’t a problem,” the trader said.
A PAUSE THAT REFRESHES?
Despite such arguments, HFT critics say the new players must
have better oversight. Gensler last month suggested, without
elaborating, that more “pre-trade filters” and testing and
registration of HFT trading programs might be considered.
Grain firms like Cargill also want the collateral amounts
put up by HFT firms to trade derivatives evaluated. Hedgers say
many of the high-speed traders avoid holding overnight positions
and thus face minimal CME margin requirements compared to grain
firms who need to stay hedged to secure bank lines of credit.
In addition, grain firms want CME to suspend trading for a
“pause” during monthly U.S. Agriculture Department crop reports,
citing erratic CBOT prices during releases of USDA data during
market hours since June.
On Sept. 28 at 8:30:01 ET – one second after USDA quarterly
corn stocks data – a total of 931 CBOT December corn contracts
(4.66 million bushels) traded, moving prices up 7-1/2 cents
($7.12 to $7.19-1/2) compared with the last trade of $7.11 at
8:29:57, just before the USDA data.
On Oct. 11, a total of 863 Dec corn futures traded three
seconds before the USDA’s monthly crop estimates, triggering
suspicions that HFT traders had obtained leaked USDA data. USDA
officials denied any leaks occurred from its “lockup” room,
where journalists write stories ahead of each report under
strict surveillance by guards.
CME refuses to suspend trading, citing ICE’s refusal to do
the same. NGFA is expected to keep arguing for such a pause. But
many grain industry veterans expect no change unless CFTC orders
it.
“CME and ICE that run these contracts are interested in one
thing: volume,” said Joe Christopher, a long-time grain merchant
at Crossroads Co-op in Sidney, Nebraska. “They have a bottom
line and stockholders to answer to. It’s not the same climate
that you had when the members owned the exchange and ran it
basically to suit their commercial customers’ interest. It’s the
funds and traders. They are the new commercials on the block.”
(Graphics by Gavin Maguire; editing by Jim Marshall)
