As trading hits warp speed, market cops have a growing headache: Clocks can't always keep up.
Most brokers and trading firms now use high-speed computers to fire off thousands of orders in the blink of an eye, and the acceleration is hindering regulators' ability to know precisely when buyers and sellers are matched up.
The Financial Industry Regulatory Authority and Securities and Exchange Commission—the primary overseers of U.S. stock markets—and the U.K.'s Financial Conduct Authority are tightening rules to impose stricter time-keeping standards.
Regulatory and trader clocks can fall out of synchronization when they don't regularly benchmark time keeping against government master clocks or if they measure time in different fractions of seconds.
Without the ability to clearly reconstruct the order of market events, regulators say they may struggle to detect abuses such as "spoofing," where a trader manipulates prices by entering and canceling orders for a stock to lure other traders into the market, and other illegal practices that distort prices.
"If two clocks are out of sync by even a 10th of a second, it's impossible to do proper surveillance across multiple platforms," Martin Wheatley, chief executive officer of the Financial Conduct Authority, said in an interview. "People will always have an edge in trading, but you have to make sure the market still has integrity. That's very much a regulatory responsibility."
Many transactions are completed in millionths of a second. At such speeds, it is increasingly difficult to track the time and order of trades because of a phenomenon called "clock drift." This is when the time keeping of a broker or other trader is slightly out of sync with regulators' official time based on government atomic clocks.
A further chronological complication: Different trading venues and firms record data at varying levels of precision, creating mismatched trade stamps.
The issue of clock synchronization was raised with lawmakers last week at a Senate banking committee hearing on markets.
Exchange time stamps are "universally ignored because they are not synchronizing to a common clock source and cannot, therefore, be sequenced with each other across market centers," testified David Lauer, president of the market-research firm KOR Group LLC. Regulators should intervene to improve synchronization, he added.
With investigations into high-speed-trading practices by the SEC, Federal Bureau of Investigation and New York Attorney General's Office, lack of precise records could be a stumbling block in trying to prove whether a high-speed strategy is illegal or abusive, analysts say.
Finra, Wall Street's self-regulator, is considering requiring all its broker-dealer members and exchanges to sync their trading clocks to within less than a second of the country's official clock to reduce the impact of clock drift. Finra's Order Audit Trail System currently requires them to sync to within a full second, or 1,000 milliseconds.
Clocks must be synced with the National Institute of Standards and Technology's atomic clock, or similarly precise time provider, before the opening of the markets and at regular intervals during the day, according to current Finra rules.
Finra also has issued a rule that will require off-exchange trading venues to report the time of trades down to the millisecond, starting on Sept. 29.
Currently, these venues must submit data down to the second, though many already report in milliseconds. Exchanges submit data with time stamps at the millisecond level.
Making syncs extremely accurate is needed because of the proliferation of algorithmic trading, said Thomas Gira, executive vice president of market regulation at Finra. Much trading in the stock markets is executed by computer systems that use algorithms to quickly buy and sell in different marketplaces.
Inaccuracies in time could make it difficult to determine whether a fast trader was engaging in "layering," which involves entering orders for shares of a stock with the intention of creating the false impression of strong demand.
Under the strategy, once another investor takes the bait, the fast trader sells the shares at an inflated price and pockets the profit.
Most high-speed traders and brokers measure the speed of their orders at least down to the microsecond, or one millionth of a second. By locating their trading computers next to the stock-exchange computers and using top-of-the-line technology, such as microwave networks, they reduce the time it takes to buy and sell securities.
Inaccuracy of time stamps also makes research into high-frequency trading more difficult, said Austin Gerig, a senior research fellow in complex networks at the University of Oxford in the U.K.
The "discrepancies make it impossible to know the exact sequence of market events that have occurred both within and across securities," he said.
The broader issue of the accuracy of clocks and time stamps on orders is also under review by the SEC and U.K. regulators.
The SEC included discussion of clock drift in the rule ordering the creation of the Consolidated Audit Trail, a massive regulatory project that would allow it to oversee trading in stocks and options in real time.
When built, the CAT will require all time stamps to be accurate down to the millisecond and clocks to not have drift of more than 50 milliseconds, according to a presentation by the exchanges on the technical outlines of the system.
"Any drift of such a system's clock relative to the clocks of other systems of course hinder the time-sequencing of cross-system events," the SEC rule says, adding that regulators could still perform a detailed analysis of a single venue with great accuracy.
The U.K.'s Financial Conduct Authority is also weighing a proposal to require its marketplaces to sync up with an atomic clock to avoid clock drift, said Mr. Wheatley, the CEO.
Exchange executives said they favor increasing the accuracy of clocks in the market system.
Chris Isaacson, chief global information officer of BATS Global Markets Inc., said the company approved of "decreasing the maximum synchronization leeway to 100 milliseconds."
Original article found here. Authored by: Bradley Hope