cdu likelyup soon in senate inquiry into asic, page-215

Tony Jones. reporter from the ABC has Broadcast the following regarding HFT. Some CuDeco shareholders have made submissions to the Senate Inquiry into ASIC, and have asked for HFT to be investigated insofar as it concerns CDU trading on the ASX.
"TONY JONES, PRESENTER: "The markets are rigged". When best-selling author Michael Lewis made that pronouncement last month, it sent shockwaves through the American financial and political system.

The FBI and the US Attorney General are both investigating the claims and the head of the US Securities and Exchange Commission had to front Congress to allay fears that mum-and-dad investors were being ripped off.


Flash Boys chronicles the rise of a very particular kind of trading on the stockmarket: high-frequency, lightning-fast trading where decisions are made by algorithms over analysts and within markets that are only partially visible to ordinary investors.

The result, claims Lewis, is a market so distorted as to render it a risk to the whole system of shareholder capitalism, which is of course at the heart of Australia's financial system and America's economy.

So to discuss his book and the fallout from it, Michael Lewis joined us from our London studio.

TONY JONES: Now, after the trauma of the GFC, your simple statement that the markets are rigged has got everyone's attention. What's the evidence for that?

MICHAEL LEWIS: Well, the evidence is laid out in some detail in this book I've written,it is that the - at least in the American stockmarkets, but also in some of the foreign stockmarkets and other markets, foreign exchange and fixed-income markets, in their transition from being markets that were run by people to markets that take place in a computer, there's kind of been a built-in grift. And the grift is this: that the exchanges sell special access to the information of what's going on in the exchange to high-frequency traders, so high-frequency traders have actually advanced word of prices. They know prices before you and I do. And then they also buy the right to trade against our stockmarket orders from brokers and banks. So there's a built-in - I guess the polite word would be arbitrage for high-frequency traders and the exchanges have become really in the interests of their own profitability, very unlevel playing fields.

TONY JONES: Now the complexity of how this happens is so mind-boggling that some people simply didn't know it was happening. Take a little time to explain how your hero in this narrative, a 24-year-old trader called Brad Katsuyama, came to figure it out in the first place.

MICHAEL LEWIS: Brad Katsuyama was the head of stockmarket trading at the Royal Bank of Canada in New York, so - which is a peripheral institution in New York. But he was nevertheless dealing with hundreds of millions of dollars of trades each day. And this begins because of changes that take place in the markets in kind of early 2008. He notices that the screens on his trading desk, which were normally reliable indicators of what the stockmarket was - it was pictures of the various stockmarkets in the States - whereas once they would tell him what the price of Microsoft was and he could act on that price, the minute he tries to act on it in 2008, the price moves as if it knows what he wants to do. So he goes to buy - so say there are 10,000 shares in Microsoft offered at $20 a share. Whereas he could previously just hit a button and buy them, now when he tries to go to buy them, Microsoft goes up in price and he can't get them. It's as if people are anticipating what he wants to do. And it turns out that every investor in America's having this problem, that hedge funds and mutual funds and insurance companies are buying big blocks of stock when they go in to try to trade. It's as if someone in the system knows what they want to do before they do it, gets in front of them and takes a little cut to get - before they get to do what they want to do. And so the story is really a detective story of Brad Katsuyama figuring out what on Earth just happened. And he's the only - he's probably not the only one - certainly not the only one who figured out what just happened, but he's the only one who screams to high heaven when he figures it out.

TONY JONES: He gets together a team of experts including an Irishman who's an expert in high-speed fibre cable networks and they actually work out what's gone on here, and in the end, the mystery is unravelled and it's all about getting an advantage in milliseconds or microseconds. Can you tell us how that worked?

MICHAEL LEWIS: Sure. Well actually in this particular case, he ends up identifying a handful of different predatory strategies that high-frequency traders are using. In this case what's happening - and they figure out kind of by actually going in the tunnels and seeing where the fibre optics are laid. He's sitting in southern Manhattan when he's trading on Wall Street. He hits a button to buy stock. The signal travels up the West Side Highway in a fibre optic tube and out the Lincoln Tunnel where it reaches one of 13 exchanges in New Jersey first called the BATS Exchange, which is just outside the Lincoln tunnel. There on the BATS Exchange are perched high-frequency traders with small orders to buy and sell lots of different stocks. And they detect his interest in buying whatever he's trying to buy and they race him and beat him by maybe less than milliseconds, maybe microseconds, to the other exchanges that are offering the same stock, they buy it, drive the price higher and sell it to him at a higher price. And it's - so in this particular case, the strategy is called a racing strategy - it's racing from one exchange to the other. And it's driven by the fact - which is kind of a new fact in our financial markets - that you can buy and sell shares in the same companies on more than one exchange. And so there's markets in more than one physical location. So the minute you turn up at one exchange, you're being raced to the other exchanges by these high-frequency traders who've built special networks that are faster than everybody else to essentially front-run you in the market.

TONY JONES: Now I've seen recently Brad Katsuyama interviewed about this and he describes this kind of skimming process with a simple analogy of going online to buy cinema tickets. Could you expand on that for us.

MICHAEL LEWIS: It's scalping. And so it's as if every time you went to the - before you wanted to go to the cinema, someone was detecting your interest, buying all the tickets in the theatre and raising the price on you. It's that kind of effect going on systematically, basically with every stockmarket order.

TONY JONES: Now you describe this as legal front-running. Can you explain what that actually means for people unfamiliar with these kind of market terms?

MICHAEL LEWIS: Well, front-running is when an insider is able to detect what some actual investor wants to do and goes and does it in front of them and raises the price of their doing it. So it's scalping or front-running. It's a pretty simple concept. The question actually is whether it's legal and there's an argument that's broken out in America. The FBI, the Department of Justice and the New York Attorney-General are now all open investigations into the activities of high-frequency traders and there is - the problem at the core of this is that the stock exchanges - and not just the US stock exchanges; this is a disease we have exported to the world - their business model is now - at the centre of it is selling special, faster access to prices and information about what's going on in the exchange to a handful of people for huge sums of money, to the high-frequency traders. And the question is: is that legal? And it's pretty clearly against the rules laid down by the SEC, but the SCC here, our Securities Enforcement Commission, is - has been very ambivalent about this. It's condoned this behaviour.

TONY JONES: Can I - since your book came out, obviously lot of people are asking these questions: is the market rigged? And this question was asked to the chair of the SEC at a House of Representatives committee just the other day and Mary Jo White said, "No, the markets are not rigged." When asked the question, "Is this kind of thing insider trading?," she said, "Well, we're not really sure. There's some confusion about that." I mean, what is the confusion?

MICHAEL LEWIS: Well it's the purest form of insider trading. If I get to know the results of the horse race and make - and then get to make bets with you on the race and you don't know the results of the horse race, it's really - I have the purest form of information, which is the prices of the stocks in advance. I think - look, when the new chairman of the SEC is in front of Congress and is asked, "Are the stockmarkets rigged?," she can't say yes, no matter what. I mean, I think that they are in a very confused state at the SEC and they're - look, they're at odds with all these other organisations that are investigating the market and we may be in a very curious place here in the States. We may be in a place where the New York Attorney-General is trying to put people in jail for activity that the SEC turned a blind eye to.

TONY JONES: Just give us an idea of how much money is at stake here. One $9 billion hedge fund, just one, estimated that it was losing, because of these kind of trades, $300 million a year. Is it known, is there any way of calculating how much money is being skimmed off and where it's going to?

MICHAEL LEWIS: This is a great question and the short answer is no. Because what you'd want to do of course is go across - go to all the high-frequency traders and add up their revenues - how much are they making from this? They're all private. They all are unbelievably secretive. I mean, secretive beyond - they make the Pentagon look like an open place. And so one doesn't know exactly. What one can see is that, for example, a single high-frequency trader one year - in a lawsuit we saw a single trader at a firm made about $90 million a year and was furious he wasn't paid more, quit and went and created his own firm, where I'm told he's making multiples of that. We know that they pay billions of dollars a year for speed advantage. So Brad Katsuyama,in identifying the predatory strategies he's identified, puts a bit of a price tag on some of them. When you start to kinda eyeball it, you know you're looking at minimum $5 to $10 billion a year and maybe $20 or $30 billion a year. But in a way, that is not even the problem. In constructing the markets for the benefit of the high-frequency traders - because the exchanges and the banks are all in on the take - in constructing the market for their benefit, the real cost is the complexity that's introduced into the market and the instability - so, flash crashes and IPOs going wrong and exchanges going down for hours on end. All of this, if you talk to software developers who write the programs that run the exchanges, will tell you it's a result of like them having to service the complex needs of high-frequency traders.

TONY JONES: You came part of the way there to answering who they are, these high-frequency traders. A couple of questions here. Are they the new wolves of Wall Street? And who do they work for? Because we hear there are so-called dark pools operating inside major banks and financial institutions. These dark pools appear to be where the traders, the high-frequency traders live.

MICHAEL LEWIS: So, the premise of this whole story, this book, is that this character, Brad Katsuyama, is going to go - he's going to investigate and describe the new financial markets for you. And it's all of the - kind of like the images, all these terms: dark pools and high-frequency traders and the way the exchanges are actually functioning - it's all new. Nobody has a mental picture of it. So, you think of the wolves of Wall Street and you think of the movie of course. These characters are nothing like that. I imagine their sex lives are very boring. They are - they're technical people. I mean, they're technologists who - they're the kind of people who might be very good at walking into a casino and counting cards at the blackjack table. They are - but what's happened in the financial markets is there has been a shift in the balance of power away from the old-fashioned testosterone-filled trader to the software developer who is able to write algorithms, to write computer code that is able to skim money out of the market. And the firms themselves are agglomerations of these people and they're not who you expect. For example, an awful lot of Russians in this market. And if you ask why, a Russian will tell you: well, one, the software programming training and computer coding training in Russia left them especially well-suited to create speed out of a computer for complicated reasons. And two, they grew up in an economic system where they would constantly to have to game things, so they're always looking for the edge, the loophole in regulations and rules and so on and so forth and so they're sort of built for the financial system. The dark pools ...

TONY JONES: Michael, one of the ironies of this is that the high-frequency trading was actually brought in, encouraged by new regulations in 2005 in order to break the kind of monopoly of the big trading institutions, the New York Stock Exchange, NASDAQ and so on. So along came these guys with their algorithms, but isn't this part of the problem because wasn't the GFC in fact set off by algorithms like this that people simply didn't understand?

MICHAEL LEWIS: You've put your finger generally on a big, broad problem, and that is that the black box quality of a lot of what goes on on Wall Street creates problems in and of itself. So the Global Financial Crisis, which at the heart of it - the heart of it is very complex financial instruments that are designed to disguise risk, that disguise the risk of bad loans being made and make them look OK. And the only reason they look OK and wouldn't be completely obviously bad to anybody who examined them is these complicated things that nobody understands. So what's happening is the US stockmarket - but not just the US stockmarket, the - a lot of financial markets are being turned into black boxes and no-one understands how they work. And you just know that their lies the road to disaster: that the minute you can't actually comprehend your own stockmarket, you've got a problem.

TONY JONES: And this actually brings us back to your hero, Brad Katsuyama, because you write that his most distinctive trait was his desire to explain things and that was what was so seditious about him.

MICHAEL LEWIS: It was,we've at the point in our financial world where actually being able to explain things and the desire to tell people the truth is a radical act and that's - when he discovers what he discovers, he could have easily turned around and made money for his bank as a trader with what he learns. Instead he goes on a public information campaign and starts to tell investors how their market works and their jaws are on the floor. I mean, sophisticated people are listening to him saying, "I knew something was wrong. I knew I was losing money in my trading in a way I'd never lost it before, but I had no idea why." I mean, a hedge fund manager tells him, "I thought I had a leak inside my firm and I had an insider trading problem because people seemed to know what I was going to do before I did it." So, it is - this was the beauty of him, both as a person and as a literary character, 'cause he enables me to explain the markets through him 'cause he's made such an effort to do it.

TONY JONES: Now one final question because you set him up very carefully, Brad Katsuyama, as a moral human being and now he's established his own exchange with systems put in place by him and his experts to neutralise the advantage that the high-frequency traders give to other people. So the problem is, possibly, that he's been backed by some pretty, shall we say, ruthless hedge funds himself. So, I guess the question is: as a character, do you think he will be able to maintain this high level of morality as he gets more powerful and more influential?

MICHAEL LEWIS: This is a really good question and here's the heart of the matter. The heart of the matter is he has identified one of the big problems on Wall Street is the incentive system. So when the exchanges are owned and run by middlemen, as they are, they will be run for the benefit of middlemen, like high frequency traders. What he's tried to do is build an exchange where his incentives are in line with the incentives investors, of the people who are actually, like, doing what the markets are supposed to do, which is find ways to channel capital to productive enterprise and his investors are a range of people. They're mutual funds, they're hedge funds, they're private big investors, but he's - and it's diffuse. He retains control of it. The question is: if he gets really big - and it is entirely conceivable to me that he becomes a huge chunk of not only the US stockmarket, but his model as adopted in other markets. The question is: how corruptible are they? And I suspect because he's established trust as his brand, that all the - the real value he brings is not the gismo he created to neutralise high-frequency trading; it's the fact that people trust him and he knows that. There's been an awful lot of pressure on him not to be corrupt. But as we all know, as things get bigger and money gets bigger, it's harder and harder. So let us cross our fingers and hope that he doesn't let us down. I'd bet on him. I'd bet on him.

TONY JONES: Michael Lewis, it's interesting to hear that bet that you make there. There's good and bad in this gripping tale. We thank you very much for taking the time to come and talk to us about it.

MICHAEL LEWIS: Thanks for having me."

It is to be hoped that the outcome of the Senate Inquiry into ASIC will be good for these CDU shareholders who made submissions. Retail investors generally will too....Max