With Presidential candidates ramping up rhetoric on proposed policy changes, exchange traded fund investors may want to watch for Hillary Clinton’s rise in the polls as the Democratic candidate has proposed reforms to regulate the financial industry
Democratic presidential hopeful Hillary Clinton unveiled new taxes targeting high-frequency traders that some market watchers argue could indirectly raise costs and disrupt the equities market, reports Bradley Hope for the Wall Street Journal.
Specifically, Clinton suggested a tax on “excessive” cancellations of buy and sell orders that could diminish risk-taking and misconduct on Wall Street.
The spike in cancellations by firms has “unnecessarily burdened our markets and enabled unfair and abusive trading,” according to Clinton.
High frequency trades refer to a type of trading strategy utilized by computerized firms that rapidly execute orders on new information or changes in supply and demand for stocks, bonds, futures contracts and other exchange traded securities. The trading activity is done very quickly, with dozens of orders per second at times, and the firms may change orders in a moment’s notice, which include many cancellations.
Increasingly popular ETF trades have experienced more canceled orders than stocks, according to the Securities and Exchange Commission – for every stock traded, about 20 orders are canceled, while every ETF traded, 80 are canceled. ETFs have a higher frequency of canceled orders due to their arbitrage mechanism, which tries to bring in line an ETF’s market price and that of its underlying net asset value.
ETFs are made of a basket of underlying securities. If an ETF shows a premium or discount to its NAV, market makers help keep the market value of an ETF in line with the fund’s underlying basket of securities. If an underlying component experience a change, then the ETF market maker would have to cancel existing offers to buy or sell and replace them with new orders to reflect the sudden change in the component.
Market observers argue that with Clinton focusing on cancellations, a tax on the normal process could hinder an important function of market makers – market makers would typically execute a simultaneous buy and sell order to arbitrage or capitalize on the small difference between prices throughout the day.
“If it’s a small fee used for regulatory purposes, then it could be helpful. If it’s more than that, it could end up costing investors more money in a lot of ways,” James Angel, a professor at Georgetown University who studies markets, told the WSJ.
Consequently, to accommodate a potential new tax on trading, a market maker may be forced to widen spreads to accommodate the added costs, which would only “end up costing investors more,” Bill Harts, spokesman for the high-frequency trading group Modern Markets Initiative, said.
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Max Chen contributed to this article.