The new era of the stock exchange manipulation
The case of Sergey Aleynikov
Last July 3rd, the principal international press agencies diffused the news of the arrest, at the Newark (New Jersey) Airport, by the United States FBI, of an immigrant of Russian origin, Sergey Aleynikov, when he was returning from Chicago. He was accused of having robbed 32 Megabytes of source codes (1) from the automatic trading system of the U.S. Investment Bank Goldman Sachs.
The anomaly of the affair has caused a considerably increased level of attention from the Control Authorities of the Stock Exchanges of the principal Countries (the United States, in particular), and from international opinion, specialized and unspecialized.
In fact, Aleynikov, 39 years old, double nationality, Russian and U.S., is a former programmer of Goldman Sachs, resigned from Teza Technologies LLC, with headquarters in Springfield, Illinois. The secret codes, found in his possession, allow access to the platform used by Goldman Sachs for trading operations on stock markets and commodities. Furthermore, Aleynikov, before being arrested was able to upload the codes on a German server (2) .
But who is Sergey Aleynikov? His profile on the Internet site ‘Linked In’ (3) is disturbing.
In fact, in Goldman Sachs, Sergey (or Serge) Aleynikov held the position of Vice-President for the equity strategy sector with the responsibility, in terms of development, for:
- high frequency trading platforms (namely trade in microseconds made on United States electronic markets, such as the NASDAQ (4) , the NYSE and the CME – Chicago Mercantile Exchange;
- computer solutions for the monitoring in real time of trading decisions through combinations of technologies (SNMP, Erlang/OTP, Boost, ACE, TibcoRV, RDRD – Real-time Distributed Replicated Database).
Not easily understandable skills, but extremely sophisticated and of great importance in the world of stock market trading.
The case of financial computer-espionage reached its height when, after the theft of the codes and the consequent arrest, Goldman Sachs was forced – to justify the gravity of the complaint filed against Aleynikov – to declare the hazard of the stolen codes. Towards this end, an investigation of Bloomberg has reported the statements of the Attorney General, Joseph Facciponti (“…the bank has suggested the possibility that there is danger that someone who knew this programme has been able to use it to manipulate the markets…”)
Essentially, Goldman Sachs has publicly stated that they consider the codes for operations of high frequency trading, a dangerous weapon “in the hands of the wrong people”.
But who says that the “hands” of the traders of the investment bank in question (or, however, of the entire community of financial traders) are the correct “hands” for the good of transparency and of the free and regular market?
Goldman Sachs (just like the principal societies operating in the computer trading, such as Renaissance Technologies, Citadel Investment Group, Jane Street Capital, Hudson River Trading, Wolverine Trading, Jump Trading and Getco) have always refused to accept the interpretation that the utilization of these software items can be understood as disloyal behaviour towards the market. The same U.S. bank, could not, however, deny the significant impact of the high frequency trading operations on their accounts.
The facts are unequivocal. At the end of last July, one of the major U.S. stock indexes, the S&P500 (5) , recorded a growth of 44% compared to the previous low point in March. The increase is extremely significant and has enjoyed record profits (compared to those announced for the second quarter of 2009) of Goldman Sachs and JP Morgan, two of the most important U.S. financial institutions. The operative results, which well surpassed the expectation of the analysts, were determined by an increase of the proceeds of 65% and 39% respectively, compared to the same trimester of 2008, generated for the most part by the activities of investment banking (6) rather than by the increase of the bank lending (loans to companies, mortgages to the family sector).
The singularity of the volume of growth of the economic accounts of the two U.S. banks, generated mostly by the compartment relative to the trading of securities, has raised questions as to the matrix of such earnings, obtained in the moment immediately following the lowest point of the world financial crisis which hit the very sector of banking investment. Because of this, the hypothesis has taken shape that the expansion of the revenues of these banks could be due, more to computer technology systems applied to finance, than to a real state of health determined by solid fundamentals of budget of these same banks.
High Frequency Trading:
manipulation of the market or evolution of operations?
In light of the incident, it becomes important to understand how much this trading methodology should take precedence over other ‘more human’ modalities, and where the same can lead those, in the future, who possess the technology and the knowledge. In practice, it is necessary to understand the “competitive advantage” that high frequency trading is giving, and will give, to its users.
The operational methodology based on the commonly named “high frequency trading system allows the instant and automated carrying out of millions of sale orders, simultaneously, on the different financial markets (shares, bonds, derivatives and commodities. The algorithms used allow the software to creep into (before other operators with inferior computer systems) the book (7) of offer and purchase of stock, to gather information seeking profit occasions and to generate high frequency trading.
These “infiltrations” occur in a matter of fractions of a second (namely in “high frequency” or in “low latency” (8) , rendering them, in fact, almost invisible to the majority of the operators.
High-frequency trading was introduced in 1998, when the Securities and Exchange Commission (SEC), the U.S. Control Authority authorized the introduction of the electronic commerce, with the objective of opening the markets to the on-line trading and, thereby, guaranteeing greater liquidity to trade. Thanks to the progress of the technology, the number of the transactions per second has
increased to a million operations, making it possible, through increasingly specialized software to “intercept” trends of exchange (buying or selling) before others and change strategy much more rapidly than in the past.
In fact, the simultaneous scanning of more markets (market skimming) allows the identification of market behaviour much sooner than the “normal” investors. Such “privileged” information offers the automated operator the opportunity of changing, within microseconds, (if necessary) his own trading strategies, on the basis of how the “normal” (and slower) investors are conducting their trading.
This “predatory” game is realized, mostly, to the detriment of operators who use the more traditional (and less reactive) trading software, and it can determine unjustified increases, both in the prices of the traded securities and in the volatility of the markets, (and less reactive) providing distorted signals to the economy.
The “high-frequency” finance, therefore, exploits the “grey zones” of the regulations, realizing behaviour which is intentionally false and impossible to trace, and determining the conditions for altering the “normal” conditions of the market.
The amount of automated trade generated by these programmes is extremely high. Their expansion is the consequence of three trends in stock trading:
1) the introduction of trading platforms which are completely electronic (such as NASDAQ-OMX and NYSE-Euronext);
2) the growth of the computer networks of negotiation, managed by providers like Direct Edge and BATS;
3) the increase of dark pools (9) distinguished by trading outside of the regulated market.
The electronic trading has, on the one side, reduced the costs of transactions for the securities operations, but, on the other side, has allowed the trading desk of the principal investment banks, owners of advanced trading technologies, to become market makers. In other words, principal providers of liquidity for the entire U.S. capital market, substituting traditional subjects (the banks, to a great extent). In general, the market maker is an authorized party who proposes – on regulated markets and multilateral trading systems – as available on a continuous basis, to negotiate (by buying and selling) financial instruments, at prices set by himself (10) . The market maker is, therefore, a financial intermediary who guarantees the “negotiability” of securities traded on the market, a function that continuously carries out the exposition of proposals of purchase and sale, (depending on market trend) (11) .
His profit is made by making money on the spread between bid price (12) (price at which he is disposed to buy) and ask price (13) price at which he is disposed to sell). The market maker, for his institutional function, is bound to guarantee the possibility of exchanging certain quantities (even small) of the security (or securities) on which he is committed, without interruption (14) .
The existence of high-frequency trading systems allows an “automated” market maker (15) to exploit the institutional position of garrison of the prices to the detriment of the other investors. In fact, the market maker, by analyzing the purchase or sales orders, can trace the trading strategy of the investor, “appropriating” hidden information relative to his purchase intentions.
The dimension of the high
frequency finance market
According to the details furnished by the New York Stock Exchange (NYSE), the average daily volume of high frequency trading has grown from 2005, by 164%. Of the orders performed on the NYSE, only 25% are managed by the society which regulates that market. A consultant society on the subject, Tabb Group, has recently estimated, in fact, that the traders at high frequency negotiate, at the present time, around 75% of the volume of daily share trading in the United States (compared to the 30% of 2005 (16) , although representing only 2% of the approximately 20 thousand trading societies operating in the U.S. markets.
The largest portion of the trading occurs through electronic trading system (17) alternative to the Stock Exchange, such as, for example, the dark pools. This growth in the United States has been able to benefit from two important aspects:
the privileges offered to the traders operative in high frequency on the completely electronic markets, like NASDAQ, where they can see, at 30 milliseconds (0.03 seconds), the transactions before the others. In the graph below, it is possible to make a practical example of how the so-named “advantage of 30 milliseconds” operates.
Let us suppose that at 9:31 one morning, a mutual investment fund (defined human trader A) has submitted an ‘at best’ purchase order (18) of 10.000 shares of the X society (X securities). On the market in that moment, the
price of the X security is equal to 21 dollars (19) . The high-frequency trading software, in the space of 30 milliseconds, intercepts the order of A and analyzes it before it is made public. Gained information:
1) buys all the available lots of X securities on the market at the price of 21 dollars. In this way, removing the possibility for the investor to find securities at the price which he has previously observed as quoted;
2) seeks a seller B who has issued a purchase order for the same X securities, but at a price superior to 21 dollars;
3) sells the X securities at 21.01, realizing a profit of 1%.
Meanwhile, the inundation of initial automated orders, has influenced the mechanism of the price formation of X, making it rise to 21.02. This obliges investor A to pay the X securities at 21.02 with a premium of 0.02 (2%).
So, against the order of sale issued by the “human” trader A, the software trader enters immediately after the order has gone out, placing his own “autonomous” transaction, completing it before the answer reaches the human trader, thereby obtaining a profit. The aforementioned profit multiplied by millions of dollars, is equivalent to billions of profit obtained from hundreds of billions of operations based on a thousandth of a second.
The inundation of purchase orders (above mention in Point (1) automatically generated by the high-frequency trading software and simultaneously cancelled (so-named “flash order”) is useful to confuse the institutional investors, and alter the prices and confuse any programme that observes the movements of the principal actors of the market (for example, the Monitoring Authorities. This is not science fiction. This is advanced technology of the Stock Exchange.
The hegemony (not evident, but known to a few) of the high-frequency trading in the negotiations of the world stock exchanges, has sparked off heavy criticism, to the point of inducing the U.S. Securities and Exchange Commission to heighten attention on the stock exchange practices. Charles Schumer, Democratic Senator of New York, asked SEC, on the 24th July last, to prohibit the above mentioned practice of the “advantage of the thirty millisecond”. In the SEC meeting of 17th September, a favourable opinion was expressed towards the block, but the road to its definitive introduction is still very long and thwart with many obstacles.
In short, it is better to continue considering it a problem, rather than nurse expectations, also since the “voluntary” ban on the “flash” practices that certain electronic platforms are publicizing (as a gesture of transparency and good will), in reality, is useless insomuch as through cross trade involving platforms where the practice is still permitted, the identical effect is obtained. For a ban on the “flash” orders to be authentic, it should be common to all electronic trading.
Sal Arnuk and Joseph Saluzzi of Themis Trading (20) have accused the high-frequency trading of increasing the volatility of the markets. In effect, the present volatility on the markets has touched the highest level ever, passing from a daily average of 1% in 2008 to 4% of this year. According to Goldman Sachs, in the month of October 2008 alone, the volatility of S&P500 has doubled, if compared to the same date of the beginning of 2008.
The Themis Trading Studio denounced the multiple risks of improper use of the high-frequency trading, such as the low quality liquidity (in that it could suddenly vanish, causing sudden downfalls of the Stock Exchange; the multiplying of false signals on the market; the presence of servers in the stock exchange itself, for the principle of “co-localization” and, therefore, more “informed” – for the principle of the “low latency” – so as to “beat” institutional investors). In particular, Arnuk and Saluzzi show certain stock exchange mechanisms in which the normal functioning is endangered by the presence of automated trading software, such as:
1) the concession of a “rebate of liquidity” conceded for a stock trade.
With the purpose of attracting volume, the stock exchanges offer rebates of circa 0.25 cent to the broker who has effected the order (21) . Given their role in guaranteeing the liquidity (22) of the market, the societies that manage the stock exchanges assume the costs of transaction and their remuneration. This makes it advantageous for the high-frequency trader to buy and sell a security at the same price, insofar as they earn a commission of 0.25 on each operation.
The more a market attracts investors and huge volumes of trading, the more the demand will be for financial information relative to that market for the suppliers of data (Bloomberg for the professional investors and Yahoo Finance for the retail investors). The high-frequency traders tend, therefore, to “capture” enormous quantities of such commissions which change from being insignificant, to become an important source of income, transferring a higher cost onto “normal” investors;
2) the practice of the “flash order” made possible through the providers on stock trading platform (BATS, Direct Edge and NASDAQ-OMX). The high-frequency trader may place orders to trade for the sole purpose of identifying the “investment rules” underlying the order issued by the investor. The high-frequency trader puts out, from a few hundred thousand to a million orders, for every 100 transactions they actually achieve;
3) the co-localization of the servers of the market makers in the same buildings responsible to the markets of the NASDAQ and to the New York Stock Exchange (NYSE).
The stock exchanges allow their location to be close to the official servers used to trade on these platforms. The advantageous logistical position allows the servers of the market makers to react with more speed because they are characterized by “low latency”. Also the co-localization renders generous commissions to the stock exchanges, paid by the market makers for positioning their own servers in this way. According to the Traders Magazine, in 2008, the number of enterprises that have co-localized their own servers at the NASDAQ has doubled.
The star of High Frequency Trading: Getco
One of the principal operators on high-frequency trading is also one of the least known. Getco (23) LLC, a private society with less than 250 employees, which represents 10% to 20% of the daily trading volume in the United States. Since its constitution (some 10 years ago), the society has become one of the five principal traders measured in volume of electronically negotiated stock on the Stock Market, probably the principal market maker in the United States.
For the analysis of the volume of trading, Getco bases its entire success on the development and ownership of extremely complex and sophisticated algorithms. Unlike the traditional trading companies of Wall Street, the characteristic of Getco is its flexibility, that is, the holding of few securities in portfolio, for a period not exceeding the day, low leverage, with the sole intent of speeding up a sudden need of incoming or outgoing trading by the markets.
To make a practical example, regarding Microsoft stock (24) negotiated in a range between 24.09 dollars/share and 24.12 dollars/share, the Getco traders might have “captured” a sales order for not less than 24.10 dollars/share. Getco will place, therefore, purchase orders of Microsoft shares at 24.10 dollars/share, seeking sale orders at higher prices, and gaining decimal differentials (of the kind 0.01-0.02 dollars/share).
Gathering large quantities of Microsoft shares at 24.10, Getco will continue on transactions, in spaces of millesimal time, until a market limit at 24.10, gaining thousands of dollars only on an operation transacted in a space of a few minutes.
In its role of market maker, in terms of availability of electronic liquidity, Getco operates in three computer stock exchanges, CHI-X (25) , BATS and ELX.
Its activity benefits from the advice of important figures in the world financial panorama, such as Arthur Levitt (former President of the U.S. SEC, Richard Lindsey and the society, General Atlantic.
In general, to protect its own interests, Getco maintains constant relations with the SEC and with the other monitoring Authorities, so as to be able to influence, when necessary, the regulatory decisions in trading matters.
The market of infrastructures
for the High-Frequency Trading
Today, in the electronic trading environment, speed represents one of the principal factors of “competitive advantage”. The adoption of new systems applicative to trading, in which algorithms programmed by the computer react automatically to the fluctuations of the market, make the “low latency” a strategic aspect. A delay in the network of only a millisecond can influence, in a very significant way, the margins of action of the financial institutes that are operating and, in consequence, can influence also the profit obtained.
The network latency and the proximity to the trading infrastructures constitute the base on which are supported strategic activities like the management of the orders, the elaboration of transactions and the management of the liquidity. The nearer one is to the centres in which the trading activities are carried out, the greater is the possibility of increasing one’s own competitive advantage.
In the present environment of the world financial stock market, the technology of electronic trading at high velocity allows the operators to place and effect thousands of orders relative to more societies (defined in “symbols”) in less than a second. To make an example, last 29th May, the symbol JPM (corresponding to JP Morgan) was traded 203 times in a fraction of 500 milliseconds (that is 0.5 seconds). In this fraction of a second, the price of JP Morgan changed 48 times on the NASDAQ.
This explains why the London Stock Exchange announced on the 15th September last, the purchase of 30 million dollars of Millennium IT, a society of technological services, based in Sri Lanka. The technology of Millennium
will allow the LSE group (of which the Italian Stock Exchange is also part) (26) to be able to benefit from “latency reduced” systems (which allow the increase of the capacity of the system to absorb from 20 thousand to a million trading orders per second (27) with a reduction of operative costs estimated at 10 million £ sterling a year, at least, starting from 2011-2012.
In the supplying of solutions for financial trading systems, on 12th June last, Colt, leader operator in Europe for the telecommunication corporations (28) and KVH Co. Ltd., with headquarters at Minato-ku, Tokyo (29) , announced a partnership agreement to support the applications of electronic trading in the global financial sector. This is a partnership of great importance in the high-frequency trading compartment. KVH and Colt are already leaders in the respective markets of proximity hosting and in the connectivity at very high performance.
The partnership intends to increase the quality of the management services in hosting the servers of the clientele in a co-localized environment, that is, situated close to the financial markets where the so-called proximity hosting operates, allowing, in this way, the maximum possible speed of transmission. Solutions of proximity hosting allow, in fact, a drastic decrease of the latency levels, which renders a much higher performance of the network.
The Colt and KVH solutions of proximity hosting intend to offer the physical presence in proximity of the principal stock markets in Europe, the United States and Asia, thereby allowing the clients to have access, at low latency, to the principal financial markets, i.e. London, New York, Tokyo, Frankfurt, Chicago, Paris and Zurich.
The situation in Europe and Italy
In Europe, platforms such as CHI-X Europe, Turquoise and a European branch of BATS have favoured the expansion of high-frequency trading. BATS Europe, in
particular, starting from last August, launched, in Europe, the first service to offer trading on a multilateral platform of negotiations of the dark pool type. The multilateral platforms of negotiation – Multilateral Trading Facility, MTF - represents market alternatives (to the traditional Stock Exchange) for the negotiation of financial instruments. They were introduced with the 2004/39/CE Directive (namely, Market in Financial Instruments Directive – MiFID), acknowledged in Italy with Legislative Decree N° 1644 of 17th September, 2007. The MTFs are negotiation circuits, managed by investment enterprises that allow the purchase and sale – through the meeting of trading interests coming from a plurality of subjects – of financial instruments already quoted on one or more national stock markets. In practice, the largest banks and financial intermediaries had the idea of becoming a consortium and creating between themselves an “alternative Stock Exchange”, in which the clients’ orders, before being transmitted to the Italian Stock Exchange are offset within the MTF. Examples in Italy are represented by TLX of Unicredit, HI-TLX of Centrsim and AIM Italia and EXTRAMOT of the Italian Stock Exchange (30) .
The concern over the practice of high-frequency trading has found an institutional voice in the interpellation to the Minister of Economy and Finance, presented the 31st June last, by Senator Elio Lannutti (31) .
The Judicial Inspection Act poses a dilemma on the opportunity-cost between volumes – the opportunity to provide space to this technology with the purpose of increasing the trading, transaction gains, and the levels of liquidity present on the market – and efficiency (possible alterations of the market mechanisms). The Judicial Inspection Act requests an urgent intervention by the Government with the purpose of banning, also in Italy, the use of the high-frequency trading systems.
Reasoning in terms of the Italian Unified Code of Finance, if through the flash orders, the traders in high-frequency can “worm out” beforehand, the purchase/sale intentions of the investor, one can deduce – in a clear and unequivocal way – the case of misuse of privileged information (insider trading) (32) inherent in the high-frequency negotiation systems, even though realized through absolutely lawful means. Furthermore, emitting a large quantity of “sham” orders (with the sole purpose of intercepting the purchase intentions of the investors and not for a real interest in offering authentic trading alternatives) due to the “signals” sent through the subsequently cancelled orders (in the moment immediately following the emission of the order itself), the market becomes distorted also from the viewpoint of the correct dynamics of formation of the prices. This is a further case of crime known as “rigging” of financial instruments (33) .
It is very unlikely,(also because it would represent a technological involution) that the practice of high-frequency trading will ever be banned by any State, particularly, in Italy where the Italian and London Stock Exchanges have realized by now, a completed fusion (34) . Instead, it is the activity of the so-called regulators, that is, the Monitoring Authorities of trading, which should change from a simple “historical analysis” of the data to an “analysis in real time” of same.
Arnuk and Saluzzi (35) supply their own personal interpretation, according to which:
1.rendering the orders valid for, at least a second, would eliminate the capacity of the trader to exhibit an order of negotiation and cancel it immediately after, in the moment
in which such order intercepts nothing. The orders of the type “run and delete” are emitted not to offer quotation alternative and/or negotiation on a security, but because they can allow one to map the rule underlying the order issued by an investor;
limiting the activity of trading software for levels of daily volatility of a market great than 2%, a bond which until October, 2007, the NYSE put in place, would contain the overall volatility of the markets. But it is well to remember that the regulation was eliminated to favour the growth of the business of the high-frequency trading, which was seen as a source of income.
Starting from the beginning of the 90’s, the growing speed of the elaboration of the processors made the development of techniques of analysis possible which, in the past, were considered unthinkable. This greater trading speed has required a growing “econometric” contribution on the part of the software and a consequent – significant – increase in the investments in information technology by the companies of Wall Street, to store and statistically elaborate the increased quantity of information. Today, the necessity of high speed electronic trading is growing. The so-termed “networking at low latency”, that is, the simultaneous trading of orders in a reticular manner” is, by now, a competitive parameter in the global financial sector (36) .
In terms of real, industrial and productive economy, the improvement and sophistication reached in the techniques of “high-frequency trading” does not supply any “added value”. With this statement, it is not intended to advance in this article, any demagogic arguments. Quite the reverse. The technological evolution achieved in electronic trading contributes to the tracing of each transaction, thereby increasing the certainty and transparency in trading on the Stock exchange.
Beyond the obvious aspects (briefly treated in this article) of increased volatility and potential manipulation of the stock exchange markets (through the extraction and “exclusive” analysis of reserved information by means of software, what is also held necessary to underline is the pro-cyclical effect of the high-frequency trading.
The practice of exchange, in fact, tends to exaggerate any excess (of demand or supply) of the economic cycle, in particular, in a bearish logic of the Stock Exchanges. With the object of identifying a measure (even approximate) of the weight of the Stock Exchanges on the GDP, the following table is shown, taken from the ‘Milano Finanza’ of the 12th September last.
Given the specific weights in the table, and observing the data of capitalization (not as aggregate, but as sum of “economic values” of the quoted societies), one can deduce that:
- in a bullish market, the high-frequency trading can produce speculative bubbles. The elevated volatility (characterizing a picture of high frequency trading) and the multiple risks deriving from the high frequency trading in primis, liquidity of low quality and the multiplication of sham signals on the market tend to make the stock brokers believe the rise in prices as speculative and not structural. In this sense, the increases in the capitalization of the societies are not traced to a greater “economic value” of the quoted societies. In this scenario, the rise in stock (favoured by the high frequency trading) will have contained effects (or none) on the GDP;
- in a bearish market, the high frequency trading can have an effect on the real economy. The deterioration of the stock market values of many societies, even though, also these are considered by the stock brokers as speculative, could cause reactions in public opinion (more sceptic, instead, with regard to the increases). The domino-effect of a downward trend could develop through the increase of panic and irrationality in public opinion and be exaggerated by the existence of trans-national stock markets like London and Zurich, which represent the more international European markets (in the sense that they comprise the largest number of foreign securities).
In this sense, it is plausible to say that falling stock markets and greater volatility could give rise to adverse consequences on the economic-financial cycle, both in the Country where the stock market has been hit by the downward trends (amplified by the high frequency trading), and in all the foreign Countries where the societies quoted on the affected stock exchange reside, whose capitalization has been impaired.
(1) A source code is a set of instructions written in a programming language which, to be carried out, must be compiled. Consequently, the source code can be read and interpreted, as well as corrected and modified, while the compiled programme is more or less incomprehensible because it is translated in machine language and, therefore, cannot be modified. (2)The server is a high performance computer localized in a network, the access to which is allowed to multiple users. The server gathers and puts programmes and data at disposal, keeping them in memory, accepting connections from other clients, as authorized. (3) LinkedIn (www.linkedin.com) is a social network of professionals of all over the world, present in 170 industries and 200 Countries. (4) The NASDAQ is the electronic stock exchange par excellence. Founded 8th February, 1971, in New York, it is the result of a decision of the National Association of Securities Dealers, (NASD) from which the name NASDAQ makes the acronym National Association of Securities Dealers Automated Quotation. The Stock Exchange is the property of the NASDAQ Stock Market. .Notwithstanding it is noted as the Stock Exchange of technological securities, in reality, around 3,200 operating societies in multiple sectors are quoted in the NASDAQ. In October, 1987, right in the middle of the Stock Exchange crisis, the Small Order Execution System (SOES) imposed the use of an electronic method to enable the users to make their requests at any moment. (5) The indices Standard&Poor’s 500 represents the 500 U.S. biggest societies quoted in order of the market capitalization. (6)The business of the banking investment is oriented to the revenue derived from the sale of financial instruments quoted through electronic trading systems. (7) The Trading Book represents the portfolio of financial instruments held by an intermediary, authorized to negotiate securities on the Stock Exchange, until the requirements of purchase and sale of securities of his clients are satisfied. (8) The latency of transmission of a link is the time necessary (expressed in milliseconds) employed by a server or computer to reach another in network (be it Internet or LAN. In the network environment, the factors that mostly influence the propagation of the signals are the means that transport the information and the equipment (for example, switch or router) which the signal passes through on its journey. For low latency, therefore, we mean a reduced period of waiting or delay with which a signal reaches destination and guarantees a connectivity of the highest performance. (9) The dark pools represent negotiation systems alternative to the official Stock Exchanges. They allow investors to negotiate higher amounts of securities, in absolute anonymity, without revealing to the market the price of the transaction. The dark pool type of investment platforms are, offered, among other things, by societies like liquidnet and BATS. (10) We use the definition furnished by the Italian Regulations (Art. 1. para 5, Quarter of the Legislative Decree, N° 58, 24th February, 1998, modified by Art. l, of the L.D.164, 17th September, 2007 (11) When the client confers an order of purchase or sale to the bank, he specifies the relative modalities of execution of the “order” in relation to his own requirements.In detail, we could have: order “at best” It is the most frequently used type of order. It indicates that the investor is willing to buy (or sell) at the best price on the market at that moment. An “at best” purchase order entails, for example, that the investor is willing to buy at the best “ask price ” present at the moment .Analogously, an “at best” sale order indicates that the investor is willing to sell at the best “bid-price” present at the moment. In general, the “at best” orders are utilized when the investor wants to realize a quick operation; the “limit order” – with price limit The ”limit order” implies the specification by the investor of the maximum price at which he is willing to purchase (or sell) a security. The risk for the investors lies in his not being able to buy (or sell) the number of shares desired. The “limit order” proposals can be specified with the following modalities of execution: “run and delete” ( the proposal is effected, also partially, for the quantity available in the Book and the remaining balance is automatically cancelled); “perform all or delete” (the proposal is performed for the entire quantity or, if impossible, automatically cancelled); “valid until the expiry” (the proposal remains on the market until the expiry of the contract); “valid until the specified date” (the proposal remains on the market until the specified date); -“valid for the session” (the proposal remains in the market until the end of the session. (12) The "bid-price" indicates the best proposal of buying in the Book of the electronic market, that is, the highest price that an operator is willing to pay for a determinate stock of securities (13)The “ask price” indicates the best proposal of selling in the Book of the electronic market, it refers to the lowest price at which an operator commits himself to cede a determinate stock of securities. (14)Art. 1. para 5, Quater of the Legislative Decree N° 58, 24th February, 1998 (Unified Code of the Finance, which acknowledged through the Community Law of 2004, the indications contained in the European Regulations. (15) That is, a market maker whose operations are dictated from a trading software. (16) Michael Mackenzie. High Frequency Trading under Scrutiny ft.com 28th July, 2009 (17) Certain systems of electronic trading are the property of the Stock Exchange itself. Others are private and managed by Finance Societies (Among the most noted examples are; Instinet; Reuter’s Dealing 2000 and Bloomberg). (18) Ref: Note 9 (19)The example chosen is banal, but it helps to understand the dynamics of the High Frequency trading, minimizing the number of support definitions. (20) Sal Arnuk, Joseph Saluzzi, Toxic Equity Trading Order Flow on Wall Street. The Real Force behind the Explosion in Volume and Volatility, Themis Trading, February, 2008. (21) Let us hypothesize that an institutional investor issues a purchase order of shares in the price range of 20-20.05 dollars/share. For the purpose of execution, a purchase order (or sale) is fragmented into different batches: the first batch of 500 shares is assigned to the investor at the price of 20 dollars; the trader issues a purchase offer of 100 shares at the price of 20.01 dollars, the trader results assignee. After the trader’s order is executed, there will be 100 shares in portfolio plus reimbursement of liquidity of around 0.25 cents. Subsequently, the trader, by issuing very many purchase orders (of the type “run and delete”) will make the share price rise to the same level at which he bought it, that is, 20.01 dollars. At this point he will offer the 100 shares on the market. The institutional investor will be available for purchase, since he has not yet entirely dispatched his purchase order. The trader will earn nothing from re-selling the shares, but will collect another 0.25 cents for having executed a further order. (22)The liquidity of a financial instrument is measured by the constant presence on the trading book, of prices, (whether of buying or selling) with competitive spread and elevated offer quantities. (23) Acronym of Global Electronic Trading Company (24) The choice is always directed towards large companies with high free float. The float is the quota is share capital not held by the shareholder of reference or by the control group of a society, that is the quota of capital actually circulating on the market. In Italy, the CONSOB fixes a minimum limit to the float of quoted securities (today, it’s 20%), to guarantee a level of sufficient liquidity for smooth trading. (25) CHI-X is the property of the Japanese Nomura Holdings. (26) With the intention of maintaining the necessary competitiveness with respect to the process of present consolidation and alliance between the international Stock Exchanges, on the 1st October, 2007, the Italian Stock Exchange S.p.A, finalized the integration with the London Stock Exchange LSE, creating the second world Stock Exchange group for capitalization, also the first in Europe. The integration operation was realized through the reserved offer to the shareholders of the Italian Stock Exchange S.p.A. of shares of the LSE Group Plc Holding, which controls the respective society, in exchange for those held in the Italian Stock Exchange, at a ratio (with change) of 4.9 ordinary shares of the LSE Group Plc, for 1 of the Italian Stock Exchange. The proposal was approved by the Italian Stock Exchange shareholders at 99.92% of the capital, 8th August, 2007. Following the integration, the LSE Group Plc, became the Holding of the LSE Plc and of the Italian Stock Exchange S.p.A, the respective marks remaining unaltered. At the 3lst March, 2008, the overall quota held by the Italian banks of the British Holding were equal to 15%, with 5.95% shares of Unicredit and Intesa SanPaolo 5.33%. (27) Only NASDAQ –OMX have a superior system, l’INET Trading System, with the capacity of more than a million messages per second. (28) Colt offers services of proximity hosting at low latency in Europe, since 2007. At the moment, Colt is connected to more than 25 of the most important Stock Exchanges and multilateral Trading Facilities , including the principal stock exchanges , among which Deutsche Stock Exchange, SIX (previously SWX, Chi-X, Turquoise and BATS. Colt manages in hosting seven of these stock exchange systems in its own data centre. (29) KVH was founded in Tokyo, in 1999, as operator of communications and IT services for the Asia-Pacific area. Through the data centres and the optic fibre networks based on its own infrastructures, KVH offers to company clients solutions to integrate IT and communications management, which include management services, networking data, Internet access and vocal services. KVH launched its service of proximity hosting in 2008, using its Tokyo data centre as a hub, on the basis of experience matured in the network connections with the Tokyo Stock Exchange and the Osaka Securities Exchange. Furthermore, the Tokyo data centre of KVH was approved by TOCUM (Tokyo Commodity Exchange) and TFX (Tokyo Financial Exchange, as point of access and provider of proximity hosting, since 2008. (30) The Art, 12 of the L. Decree N° 164 of the 17/9/2007, modifying Section II(“Trading systems different from the regulated markets”) of the Unified Code of Finance, in Art. 77 bis has attributed to CONSOB the task of individuating, with its regulations, the minimum requisites for the functioning of the multilateral trading systems. (31) (2-00l04) To the Minister of Economy and Finance Declare that: that the high frequency trading (HFT) is a type of technology, evolution of the classic trading on-line, which allows through a sophisticated computer programme, which allows a great number of operations on the financial market in a very brief span of time (in the order of 100th of a second). Few operators possess such technology and, thanks to this, those who do are able to make enormous profits; After its introduction, in 2005, however, the HFT has given rise to many doubts among the experts of the financial sector, and has been, many times, suspected of allowing, due to the high speed and the elevated number of operation it is able to effect, a real and proper manipulation of the markets by the possessors of this technology, at the expense of the competitors and majority of the investors; It follows that a bad use or violation of the security of a HFT system could have serous repercussions on the financial markets, which are, moreover, undermined by the uncertainty due to the economic crisis; Considered that: At the present time, according to the Press, where it I allowed, the HFT would control half of the trading; a recent episode involving this very violation of the security of the HFT system of the banking group, Goldman and Sachs, provoked the request by the Congress of the United, for intervention by the Securities and Exchange Commission, to present a Bill banning the use of the HFT systems. It was asked of the Government if it did not hold it urgent to intervene for the purpose of banning, also in Italy, the use of the HFT systems. (32) The term insider trading means the sale of securities (shares, bonds, derivatives) of a determinate society, by subjects who, for their position within the same society or for their professional activity, have come into possession of confidential information – not of public dominion – (“privileged information”) which, for its nature, allows the subjects who use it, a privileged choice compared to the other investors on the same market. In Italy, the misuse of privileged information is disciplined b y the Legislative Decree N° 58, February 24th ,1998, Financial Unified Code (TUF), which has acknowledged through the Community Law, 2004, the indications contained in the European regulations. Pursuant to t he provisions laid down by Article 184, of TUF, perpetrates the crime of insider trading: […] whoever, being in possess of privileged information by reason of their quality as member of administration bodies, direction or control of the issuer, participation in the capital of the issuer, that is, of the exercise of a work activity, profession or function, also public, or of an office: a) purchase, sells or performs other operations, direct or indirect, for his own account or on behalf of third party, on financial instruments, utilizing the same ‘privileged’ information: b) communicates this information to other, outside and beyond the normal exercise of the work, of the profession, of the function or of the office: c) recommends or induces others, on the basis of this information, to perform any of the operations indicated in letter a)”. The Article 181, para 1, specifies the concept of “privileged information: […] information of a precise character which has not been made public, concerning, directly or indirectly, one or more issuers of financial instruments, or one or more financial instruments which, if rendered public, could significantly influence the prices of such financial instruments”. (33) Pursuant to the provisions laid down by Article 185, (Manipulation of the Market Para 1 of the TUF “Whoever divulges false information, exaggerated or tendentious, or realizes simulated operations or other suitable devices to provoke a significant alteration of the price of financial instruments, or the appearance of an active market of same is punished by a term of imprisonment up to three years or a fine from one to fifty million lire”. (34) Recently, with regard to Xavier Rolet, Chief Economic Officer of the London Stock Exchange, has stated that “the high-frequency traders have been a necessary source of liquidity for the Stock Exchanges”. (35) Sal Arnuk, Joseph Saluzzi, Toxic Equity Trading Order Flow on Wall Street. The Real Force behind the Explosion in Volume and Volatility, Themis Trading, February, 2008. (36) A poll conducted by Colt at the beginning of 2009, between the principal investment banks showed that the reduction of the delay on the networks is considered a strategic factor for the electronic trading