A market isn't a market without confidence – and regulators know they have a real confidence problem on their hands because of high-frequency stock trading. Unfortunately, that's about all they know.
The debate is nowhere near settled about the risks and benefits of the new breed of computerized trading that enables some traders to jump in and out of stocks in fractions of a second, thousands of times a day, in an attempt to capture tiny bits of profit that add up to big wins over time.
What is increasingly clear, however, is that it's scaring some longer-term investors out of the stock market. The evidence is only anecdotal, but the refrain is common. From retail investors commenting on The Globe and Mail's website to Tony Fell, who once ran the country's biggest brokerage, the message is the same: The markets are seen as a casino where high-frequency traders are winning too often for it all to be just chance.
And that, says Susan Wolburgh Jenah, chief executive officer of the Investment Industry Regulatory Organization of Canada (IIROC), is "a big problem" for regulators. That's because promoting safe and fair markets is only part of the job. Unless there's also confidence in those markets, regulators haven't succeeded.
"That's what's causing us all to be concerned," she says. "When you get to the point that there's such uncertainty and so much skepticism about what's going on in the equity markets that you feel like it may be prompting or encouraging people not to participate for fear of being taken advantage of, or because they don't feel they can compete, or they just don't understand the rules of the game any more, or because it's just evolved so dramatically they don't recognize what it is any more, that is a legitimate concern for regulators."
As head of the regulator charged with monitoring daily trading on Canadian markets, Ms. Wolburgh Jenah is at the epicentre of the debate.
Proponents say practitioners of high-frequency trading (HFT) make it easier to buy and sell because there are always orders out there to trade against, and that tightens spreads between bid and ask prices.
Opponents say the HFT shops destabilize the markets and use information gleaned from flooding the market with orders to win unfair advantages.
The advocates argue that " 'It's the way of the world, people who are in denial are Luddites,' that whole school of thought," Ms. Wolburgh Jenah says. "Then there's the school of thought that is 'We don't understand the markets any more, this new breed of participant has come in and taken over.' "
She is not sure where the truth lies. "There's merit to both sides. The issue for regulators is to figure out at the end of the day what's harmful in this, and why. And if there is harmful activity going on, we have to stop it."
The problem is, nobody has yet proved anything. The Bank of Canada published a study last year that concluded that the effects of HFT are "not fully understood." The topic of HFT was very hot at the mid-May meeting of international securities regulators in Beijing. Again, a lot of talk. Few answers.
It's not even clear how much trading in Canada comes from high-frequency trading. Some estimate it was as high as one-third of market trading activity recently, although there are some who say the proportion has declined in the meantime. (Though that, too, is in dispute.) Getting an impartial opinion is difficult. Almost anyone with a view into the market, and where orders are actually coming from, sits on a trading desk and is conflicted – either because they accept trading and the fees that come with it from HFT practitioners, or they are trying to have HFT tightly regulated to protect existing trading businesses from HFT competition.
The good news is that IIROC should be in a good spot to break the tie. As the day-to-day monitor of every trade in Canada, the regulator has a huge database of transactions and orders it can mine to look for answers.
In the meantime, it comes down to gut feeling. Mr. Fell's advice last year was for regulators to move quickly – calling on them to "get on it" because "HFT is a major market integrity issue."
Ms. Wolburgh Jenah isn't ready to do more without the research to back her up. "We have the data now, we're trying to really understand it, delve into it and let it tell us what the issues are and inform policy development, as opposed to trying to make it up as we go."
Even if IIROC does move ahead with measures on HFT, it's going to be a trick persuading investors who have lost faith to come back. The regulator knows it.
"It's a big issue," Ms. Wolburgh Jenah says.