Liquidity, as frequent readers know, is a fascinating topic to Zero Hedge. Liquidity black holes, as one would imagine, is doubly so. However, when a firm like State Street, which is at the heart of the multi-trillion dollar stock lending skeleton of the market discusses both of these concepts, one must pay attention. The below report is a State Street presentation from 2003 discussing what happens in those episodes when liquidity disappears and how that impairs all other axes of proper market function.
Of notable attention is the following section of the report:
The presence of liquidity problems in the largest of markets suggests that liquidity is not about size, but diversity.
In an illiquid market the same size of sell order will push the market down further than in a liquid market. Imagine a market where there is a large number of market participants, using the exact same information set, in the exact same way, to trade the exact same financial instruments. When one buys they all do and vice versa. Market participants would face volatility and illiquidity when they came to buy or sell. This would not be reduced by having more players, only by increasing the amount of diversity in their actions. (Indeed, on these assumptions it is possible to show that the bigger the market was, the less liquid it would be). Now imagine a market with just two players but with opposite objectives or opposite ways of defining value. When one wants to buy the other wants to sell. This market is small, but the price impact of trading would be low and liquidity would be high.
The referenced diversity is a crucial concept in today's market where an unprecedented amount of market trades occurs in undiverse dark and HFT pools. As Goldman is becoming the primary conduit of trading (whether principal or agency) in virtually all markets, the risk of a massive liquidity drain becomes exponentially larger, and the risk of an exogenous event approaches LTCM and Lehman levels. It is this key risk driver that regulators should be focusing on, instead of chasing and attempting to punish the perpetrators of the most recent market crash (we are not saying they should not, but they should prioritize and now should focus on what is most critical to maintaining a functioning market topology). The Too Big To Fail is a psychological construct which however does not have parallels in the market. Once Goldman reaches a tipping point of eliminating liquidity diversity, the potential fallout escalates. This is precisely the realm in which any x sigma events will occur in the future. And nobody seems to care.
The NYSE has officially released the correction for its lapse in reporting Goldman Sachs' program trading numbers last week.
NEW YORK , July 7, 2009 --The New York Stock Exchange today issued a correction of the program-trading-data press release issued on Thursday, July 2, 2009. Due to an NYSE system error, Goldman, Sachs & Co. was inadvertently omitted from the chart of most active firms, but the firm’s program activity was included in the total level of programs as a percentage of NYSE volume, which remains unchanged at 48.6 percent. Certain of the other data are revised on the press release below, and on the attached chart, incorporating the omitted data as well as subsequent minor corrections relating to other firms.
The data indicated that during June 22-26, program trading amounted to 48.6 percent of NYSE average daily volume of 3,449.8 million shares1, or 1,675.7 million program shares traded per day (Revised from 1,678.3 million program shares traded per day).
Program trading encompasses a wide range of portfolio-trading strategies involving the purchase or sale of a basket of at least 15 stocks.
In all markets, program trading by member firms averaged 4,896.3 million shares a day during June 22-26 (Revised from 4,898.9 million shares a day). About 34.2 percent of program trading took place on the NYSE (Revised from 34.3 percent of program trading), 0.3 percent in non-U.S. markets and 65.5 percent in other domestic markets, including Nasdaq, NYSE Amex and regional markets.
1 The NYSE calculates program trading as the sum of shares bought, sold and sold short in program trades. The total of these shares is divided by the sum of shares bought, sold and sold short on the NYSE including its crossing sessions.
Here is the corrected PT report for the Russell rebalance week. How a "system error" can lead to the drop of the firm that traded nearly 3 billion shares, yet have the Goldman numbers actually flow thru for aggregation purposes, is an open question.
Zero Hedge appreciates the NYSE's efforts in bringing transparency to the high-frequency trading markets and in fixing flawed information. Granted, one would be tempted to inquire just what other reported data the specified "system error" may have rendered completely useless, and whether this "system error" was also pertinent in the unprecedented extension of last Thursday's trading session. However, Zero Hedge knows not to push its luck: however, we can hope that in due course, all relevant information will eventually surface.
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Lots of readers interest yesterday following Joe Saluzzi's Bloomberg interview. I present a White Paper by Themis Trading in which Joe elaborates on many of the concepts that may have flown over the heads of some of the more "beginner" readers. Additionally, I recommend readers search for specific concepts within Zero Hedge - we have covered the topic of program trading and liquidity extensively here over the past 3 months.
Good to see that we have a perfectly normal, efficient and gapless market. Goldman deserves a golf clap for providing sublime hi-fi liquidity through the SLP. The chart below is not some crazy 5.0 + beta stock, it is the Standard and Poors 500 index, which, last time we checked, had about 500 5.0+ beta stocks (I jest for regulatory impact).
And just to facilitate FINRA in their investigation of IOI manipulation, and also to assuage any questions about who guns the market and paints the tape like clockwork, I present the intraday SPY IOIA chart.
In the week ended May 22, NYSE program trading dropped to a statistically significant low of 2.9 billion shares, down from 3.3 billion the week before, and from a 3.8 billion prior 52 week average. As for specific actors, no surprise, Goldman leading the government's SLP team with a 7:1 ratio of principal to facilitation/agency.
As for today's market close, with a literally parabolic jump in the last minute of trading, if anyone still thinks this market trades based on anything resembling normal behavior (unless someone had a very Jerome Kerviel-esque fat delta hedging finger or one/two moderate/large quants who had a huge index hedge imploded), I have some BBB+ rated CMBS to sell to you at par. One culprit could be hiding in the huge drop of agency trading, which this week dropped to a several month low of 1.875 billion shares.
So as essentially no institutional or retail clients are trading any more, it is just a few desperate computers trying to front run each other. And, of course, for the biggest beneficiary of this PT principal bonanza, look no further than the chart below.
Going back to today's ridiculous close, the chart below shows it all: the complete tape painting volume spike at the very end of the day speaks for itself. And as computers now simply issue forced stock recall orders to each other, painting the tape wet with manipulative intent and volume spikes into the last 20 minutes of trading every day, their human creators are left on the sidelines, trying to outshout each other as to the reason for why the market keeps rising while the economy keeps tumbling.
Rick Bensignor of Execution LLC provides a good glimpse of today's market action. As he says "The market is up 2.75% percent and sell-side trading desks are completely dead. You've got computers doing all this buying." And people wonder why Zero Hedge is so infatuated with Program Trading (usually SLP, but in this case the market neutrals, who had a knock out day today). Rick also gives some good market color on the consumer confidence spin, and how one lagging indicator today manages to push the market up over 2%, while another is promptly forgotten, when in fact both are totally irrelevant. Just a continuing case of the market focusing on positive noise and not on anything relevant.
Now with a hearty helping of futures manipulation (courtesy of the SLP?). None of this should be news to Zero Hedge readers. The video below from Fox Business News discusses all you need to know about how to prop a market about to crash. Fast forward to 2 minutes and 30 seconds.
“Something strange happened during the last 7 or 8 weeks. Doreen you probably can concur on this -- there was a power underneath the market that kept holding it up and trading the futures. I watch the futures every day and every tick, and a tremendous amount of volume came in a several points during the last few weeks, when the market was just about ready to break and shot right up again. Usually toward the end of the day – it happened a week ago Friday, at 7 minutes to 4 o’clock, almost 100,000 S&P futures contracts were traded, and then in the last 5 minutes, up to 4 o’clock, another 100,000 contracts were traded, and lifted the Dow from being down 18 to up over 44 or 50 points in 7 minutes. That is 10 to 20 billion dollars to be able to move the market in such a way. Who has that kind of money to move this market?
On top of that, the market has rallied up during the stress test uncertainty and moved the bank stocks up, and the bank stocks issues secondary – they issues stock – they raised capital into this rally. It was perfect text book setup of controlling the markets – now that the stock has been issued…”
****
Now, when Bernie was caught running a ponzi, all hell broke loose... What is the proper etiquette in this case? Should investors give the utter failure of regulators to safeguard proper market efficiency the ass or the crotch.
According to NYSE data released yesterday, things are back to normal in the shady world of NYSE program trading, where after a suspicious lull in the prior week, Goldman Sachs' SLP function (or any other 3 letter acronym of your choosing) has cranked up yet again. Now that the SLP extension has been granted (under the radar), the boys at One New York Plaza can go back to doing what they do best: dominating! (if only NYSE principal program trading in this case).
The chart below is an updated version of the Principal PT comparison among the major brokers. The odd blip is last week where GS' PT dropped markedly as did overall NYSE PT, with the slack being picked up by the other major B/Ds. This week, it seems that everything is normalizing fast.
For all who wonder which shares are poised for the next invisible hand lift off, I present an email distributed earlier today by CMC, which is a major spread betting provider in the UK, to its clients. If certain individuals at Morgan Stanley's ETF and quant trading operations want to opine as to the inaneness of the current hard to borrow nature of these stocks, now is the time to speak up (oh wait, curiously Morgan Stanley itself is in the Do Not Short list... hmmm... kinda odd that, is it not?).
Which brings up the question: who exactly is it that sets the availability of borrowable shares or the cost of borrow? Is it the custodians, the State Streets and The BONYs, who as we know are highly conflicted and have every interest in pushing stock prices higher, or is the prime broker repo desks: the Goldmans and the Morgans (both JP and Stanley) of the world? Inquiring minds want to know just who is making shorting impossible these days.
Short selling update
Due to significant increases in the cost of borrowing stock in the underlying market, along with a lack of available shares to borrow, we have been forced to restrict short selling on the following USShares:
Clients are not allowed to open any new short positions or increase any short positions in these instruments. If you currently hold an open short position, you are not forced to close this and if you need to sell in order to close a long position your order will be accepted.
Alpha magazine is out, albeit with about a month delay for frequent Zero Hedge readers, with an article that follows in the footsteps of WSJ's expose from earlier, focusing on the belated topic de jour of quantitative funds. In "Stat Arbitrageurs: Merchants of Volatility", Alpha has done a nice job of rephrasing the arguments that Zero Hedge has been disecting since mid April. Better late than never, especially when the spectre of another August 2007 is constantly just around the corner (and even closer if one reads between the lines of certain quant performance numbers that have been posted here lately).
“Stat arbs take the other side of a move,” Sunier says. “We provide liquidity. If it’s a good time to do that, we earn an economic rent as prices return to normal.”
....
It’s a dramatic turnaround for a strategy that had been all but left for dead after the summer of 2007. During the first two weeks of August that year, statistical arbitrageurs — including major players like AQR Capital Management, D.E. Shaw & Co., Goldman Sachs Asset Management and Renaissance Technologies Corp. — suffered huge losses. Goldman’s once–$5 billion Global Equity Opportunities Fund, for example, was down 30 percent; the then–$1.7 billion Highbridge Statistical Opportunities Fund fell 18 percent. For managers like Goldman and Highbridge that were able to hold on, performance snapped back later that month, but those that were forced to liquidate missed the rebound. In retrospect the crippling losses were more the result of margin calls that originated in the credit markets than of any flaw in statistical arbitrage theory, according to Andrew Lo, a finance professor at the MIT Sloan School of Management.
“There was some kind of unwinding, most likely due to a multistrategy fund that needed to raise cash to meet margin calls for other investments,” says Lo.
Investors nonetheless were spooked and took flight. Judith Posnikoff, a managing director and co-founder of Pacific Alternative Asset Management Co., an Irvine, California–based firm that manages about $9 billion in funds of hedge funds, estimates that between one third and one half of the hedge fund capital dedicated to statistical arbitrage had fled the strategy by early last year. At the same time, proprietary trading desks at many of the big investment banks also got out of the game. The exodus set the stage for a rebound in 2008. Lo points out that stat arbs tend to be long volatility, which shot up to record levels in the fourth quarter of 2008.
While the article will be mostly a recap of themes Zero Hedge has expounded upon extensively, I recommend readers take a quick look at it for an efficient 30,000 foot summary of topics that are sure to become much more relevant before all this is over.
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Goldman Sachs has hit a new trading profit record: in the past quarter the company generated over $100 million trading profit on an absolute record of 34 trading days, according to its 10-Q filed today. Not only that, but GS was profitable on 56 days in the quarter and lost money on only 8, meaning it was profitable 87.5% of the time trading in the last quarter (and this isn't even a weighted number). Notable is that the ratio of +$100MM days to -$100MM days in Q1 is 34 to 0. If one adds the orphan month of December, the $100 million+ days rise to 44, and Total Profitable Days rise to 70. The last record for GS was 28 $100MM+ days in Q1 2008. As all regulators' systems are based on statistical analysis, maybe this multiple sigma deviation event will finally set off some red flags.
Or maybe the simple explanation is that the current Oracle of Delphi at Goldman's trading desk is seeking to retire and effectively predicting every single market move with 87.5% accuracy in order to be allowed to vest her 401(k) immediately.
Sanford Bernstein analyst Brad Hintz, who has a knack for understating, provides the following observation:
“It was a good trading quarter. Their revenue return on trading assets was very, very high because bid-offer spreads were very high.”
Now correct me if I am wrong, but isn't the main reason for the NYSE's Supplemental Liquidity Provider program exactly to reduce the bid-offer spreads? And isn't the fact that Goldman is the de facto sole provider of SLP supposed to be somehow benefiting the exchange and other participants, not so much itself? Maybe this is not a question so much for GS, but really for the NYSE which has been so staunchly pushing for the SLP (and its extension), yet the only member firm it seems to be benefitting so far, is really only Goldman Sachs?
One last observation: GS also discloses not only its VaR for the quarter (which has also risen to an astronomic $266 at the end of March 31), but also the progression of the VaR over the past year. Zero Hedge would like to point out the eerie similarity between the company's overall VaR (as disclosed in the 10-Q), and the percentage of Total NYSE Principal Program trading that Goldman Sachs Principal trading desk controls (as disclosed by the NYSE), a topic Zero Hedge has discussed extensively before. Comments from readers and from Ed Canaday are very welcome.
We like you. Well, not in that way, but we are taxpayers. If we didn't like you, why would we give you billions of our money to insure your survival? So we kind of have to like you, same way we like our deviant, foster kids.
Agreed? Let's move on. As a recipient of our generous TARP contribution and FDIC guarantees, we expect you to be active in the capital markets, lend into the economy (you know, that progressively angrier Main Street) and provide liquidity when needed.
Now at this point, from our perch, we don't see much improvement in lending from you, dear deviant child, but we do see non-stop attempts to avoid pay caps and so on. Don't you want to spin of PDT just for that reason? Great! Just making sure we are on the same page...
Let's get back to our favorite pet topic liquidity. You, sweet child of ours, recently advertised about 2x to 3x of SPY volume than the next lucky broker in the hierarchy. As our favorite captain of vertical take off/landing aircraft said yesterday, too big to fail is not a policy, it's a problem. We, the taxpayers, don't want our TARP funds making the problem worse. We want it to get better.
So what was that 10% of SPY volume all about? Was it natural volume? If so, please go ahead and advertise that. We would love to know how your agency business is doing. We want that. Was is PDT trading? In that case this is very troubling. Did you advertise internal prop trading volume? Now that, as you very well know, is kind of creepy.
You know, dear MS, with 10% ADV of SPY volume applied at strategically important time frames you can affect markets? And no, we the taxpayers here at Zero Hedge don't want to see that. We don't want our levered up TARP funds to be used in this way. How about you tell us how much of this 10% of ADV was your customers, how much was ETF desk and in-house props? That will help a lot and avoid any future confusion.
And please keep our $10 that we gave to you in the first place to lend to Main Street, not to bet against anonymous financial blogs... and lose.
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If anyone actually cares about the market at this point, and is naive enough to trade, here are some observations.
HSKAX abd HFRXEMN are both about to take the bottom out of their respective charts. One can only imagine what is going on behind closed doors in East Setauket as small, more agile quants with price-only based short term momentum strategies are devouring their larger, more sophisticated brethren.
Furthermore, as Matt Rothman keeps on pointing out, the garbage sectors are flying, while recession proof consumer stocks are dropping.
Lastly, continuing from yesterday, MS has stopped printing massive (or any) SPY blocks, and the result is yet another day of dropping SPY volume: now 13% below 20 day average.
Previously Zero Hedge observed the rather curious integration of Goldman Sachs within the fabric of the NYSE's program trading environment, which, by their own admission, has everything to do with Goldman being the (monopoly) actor in the NYSE's Supplemental Liquidity Provider program. I highlighted that the program was set to expire on April 30.
Today, unsurprisingly, the NYSE posted a notice of a proposed rule change extending the SLP program another six months, until October 1, 2009 (this does not change my commitment to providing weekly NYSE program data). I appreciate our readers' existing and future feedback in this matter.
"The Exchange proposes to extend until October 1, 2009, the six-month pilot program (“Pilot” or “program”) for “Supplemental Liquidity Providers” (“SLPs”) under Rule 107B. The SLP pilot program commenced operation on or about the date the SEC approved the NYSE “New Market Model” pilot which is scheduled to be in operation until October 1, 2009. The Exchange proposes to extend the SLP pilot until October 1, 2009, the termination date of the New Market Model pilot, as the SLP program was designed to operate in the New Market Model and was established to supplement the liquidity provided by Designated Market Makers (“DMMs”) in the New Market Model.
The Exchange believes that the SLP program has added meaningful liquidity to the marketplace and improved both NYSE and overall market quality. The Exchange will continue to monitor the efficacy of the program during the proposed extended pilot period. In the future, the Exchange may propose certain changes to Rule 107B, which will be the subject of a 19(b)-4 rule filing and filed with the Commission. Until such time that the Exchange proposes changes to Rule 107B, the Exchange is requesting to extend the operation of Rule 107B until October 1, 2009."
The SEC published a notice of the NYSE proposal. Though both notices use the term "proposal," it appears that the NYSE may be using a streamlined procedure that puts the proposal into effect immediately, without the ordinary notice and comment period. (Notice and Comment period would be required for the SEC, a federal agency, unless circumstances justify rule-making now and comment later; I think that the NYSE itself--as a self-regulated organization--is bound only by its own SEC-approved regulations).
Here is what the NYSE had to say about the expedited procedure:
"The Exchange believes that good cause, consistent with the provisions of Rule 19b-4(f)(6), exists to justify making the rule change immediately effective. Rule 107B was immediately effective when filed as SR-NYSE-2008-1087 as it is similar to several other market maker rules and rebate programs of other market centers. The Exchange relied on the Commission’s “Rule Streamlining Guidance” to obtain immediate effectiveness of Rule 107B. This request for extension of Rule 107B extending the SLP pilot to October 1, 2009, should also receive immediate effectiveness treatment by the Commission."
"The Exchange believes that the proposed rule is non-controversial as it is a rule that has been in operation for approximately six (6) months and, as stated above, is similar to existing market maker and rebate rules of other market centers. Moreover, the NYSE believes that the rule has provided significant benefits to NYSE customers in the New Market Model. Such benefits include price discovery, liquidity, competitive quotes and price improvement. The Exchange contends that the benefits produced by the SLP program further justify filing the rule for immediate effectiveness."
However, the exchange is not really willing to corroborate this observation through a traditional comment seeking approach, lest it receive commentary not alligned with its steamrolling intent: "Written comments on the proposed rule change were neither solicited nor received."
Lastly, the following paragraph implies that the SLP has been extended effective immediately, and it is feasible that the SEC does not even get a chance to chime in here, essentially providing the NYSE primafacieauthority over the Federal regulator in the SLP matter. But fear not investors, increasingly cautious of Goldman Sachs' 60% dominance in NYSE principal program trading: the NYSE claims all SLP actions are merely for the "protection of investors and the public interest."
"The NYSE also requests that the Commission waive the five-day period for notice of intent to file this proposed rule change, and the 30 day period before the rule becomes operative, both of which are prescribed by Rule 19b-4(f)(6), but which may be waived pursuant to Rule 19b-4(f)(6)(iii) if such action is consistent with the protection of investors and public interest. Because the SLP pilot will expire on April 30, 2009, the Exchange requests waiver of these time periods so that no interruption of the pilot will occur. The Exchange’s request for a waiver of these time periods so that the rule may be immediately operative is consistent with the protection of investors and the public interest for the reasons described above."
The NYSE apparently intended some time ago to request this extension to the SLP program. The Federal Register, in Vol. 74, No. 072, includes an SEC notice dated April 10, to the effect that the NYSE was eliminating the roles of Competitive Trader and Registered Competitive Market Maker because, in part, their functions were now being performed by the SLP program/ participant(s).(See NYSE Rules 110 and 107A, which must be amended to effect the change). Obviously, the NYSE and SEC would not eliminate those two programs in reliance on the SLP program unless they knew the SLP program would last past April 30.
And, note that the original version of the SLP program---the 6-month pilot---and this extension both employed the expedited process mentioned in the above notice.
Most notably however, the SEC solicited comments on the SLP for the first and last time in November, when the NYSE first rolled out the SLP program and later amended the fees paid to the SLP participant(s). The only comments received were from the NASDAQ Stock Market LLC, which probably was most concerned about the SLP program encroaching upon its own turf, but the comments raise some concerns which are very well alligned with those voiced by Zero Hedge. The full text of the comments by Jeffrey S. Davis of the NASDAQ Stock Market LLC is presented below, but here are some very relevant snippets:
NASDAQ believes that the SLP Proposals grant the NYSE substantially unchecked authority to discriminate [*4] among NYSE members. The SLP Proposals lack codified standards and other vital elements of due process, and fail to explain how the NYSE will ensure that all members will be treated fairly and equally as required under Section 6 of the Exchange Act. For example
The NYSE proposes to create an SLP Liaison Committee consisting of NYSE employees, but it fails to explain whether and how that committee will represent the interest of members, when and how it will deliberate, how it will decide which firms become SLPs, how the NYSE will oversee the Committee to ensure the fair and equal treatment of members, or whether and how it will be governed by the board of The NYSE Group, the NYSE, or FINRA.
The NYSE proposes to establish a quota for SLP firms, but it fails to explain what that quota is, how it is established, why it exists, or whether it will vary by security. The proposal also fails to explain how SLP slots will be allocated among equally-qualified members before the quota is reached, what happens to equally-qualified firms once the quota is reached, or how SLP slots will be reallocated if an approved SLP fails to meet its continuing obligations. In contrast to NASDAQ's market [*5] maker standards which permit an unlimited number of equally-qualified members,the SLP Proposals create a scarce status and then fail to explain how it will be distributed.
The NYSE proposes that the Liaison Committee will assign specific securities to qualified SLPs, but it fails to explain which securities will be assigned to an SLP, how the Committee will decide to assign SLPs to each security, or how the Committee will balance the number and types of securities assigned to each SLP. The proposals also fail to explain how the interests of members will weigh in that analysis, how the Committee will ensure the equal treatment of members, how that allocation process will interact with the SLP quota, or how the NYSE management or board will oversee the allocation process to ensure the fair and equal treatment of members.
Taken together, the SLP Proposals provide NYSE with the unparalleled ability to burden competition for order flow and executions without explaining why such ability is necessary or even prudent. For example, the SLP Creation Proposal limits SLPs to firms that engage in proprietary trading, excluding NES and others that operate on an agency basis either to comply [*6] with Regulation NMS (in the case of NES) or by choice. NYSE fails to explain why this limitation is necessary or prudent.
Now the parts below are very, very critical:
NYSE fails to explain why proprietary liquidity is more valuable than agency liquidity, or why proprietary liquidity should be favored over agency liquidity. NYSE claims that the proposal is designed to prompt liquidity provision but it simultaneously disqualifies large liquidity providers...
In NASDAQ's view, these irregularities reveal that NYSE's true motivation for the SLP Proposals is to discriminate among its members and to burden some members' ability to compete with NYSE. NYSE's failure to explain adequately either the operation or the rationale for its proposed rule is evidence that NYSE's stated basis for the proposal is a pretext. NYSE's proposals are a naked attempt to disadvantage one group of members -- those that compete with NYSE -- to benefit another class of members -- those that do not compete with NYSE...
Perhaps most surprising is the NYSE's aggressive attempt to implement these proposals on an immediately- effective basis. In doing so, the NYSE prompted the Commission to act inconsistently with past practice, inconsistently with its Rule Streamlining Guidance issued in July of 2008 n5, and inconsistently with its obligation to ensure that self-regulatory organizations comply with their obligations under Section 6 of the Securities and Exchange Act [*8] of 1934. NASDAQ, as an active proponent of the Rule Streamlining Guidance, is concerned that the NYSE will undermine that streamlining effort by attempting to leverage the Guidance in an inappropriate manner.
Is it at all surprising then that the NYSE has refrained from seeking additional commentary when none other than the NASDAQ itself has previously called you out on:
1) Steamrolling a program with little/none due SEC comment solicitation. 2) Establishing this very program for the sole benefit of specific NYSE members to the detriment of other members that compete with the NYSE. 3) In fact pushing ahead in violation of SRO obligations under Section 6 of the SEC 1934 Act.
And who is the one and only beneficiary of this rampant disregard for almost 80 years of market regulatory practice? Who is it that has now become the de facto provider of "market liquidity" which however has much more sinister connotations when reading through the comments of not just some blogger but the NASDAQ Stock Market itself? For the empirically proven answer I will refer you to my prior post on this matter.
Recently, there has been quite a bit of discussion of Goldman Sachs' principal program trading dominance in the NYSE, culminating with none other than Goldman Sachs themselves providing their perspective on the matter, via spokesman Ed Canaday:
The NYSE report that Zero Hedge discussed shows Goldman Sachs trading over 1 billion shares in the principal program trading category. What the table doesn’t show, but a deeper look at the numbers reveals is that the vast majority of this total is trades by our quantitative trading desk. This desk is participating in a relatively new NYSE program called Supplemental Liquidity Providers. The NYSE started the program to attract liquidity to the exchange. As an SLP, this the desk makes markets in NYSE stocks. They often do high-frequency trading (which is simply auto-quote market making) where they send out hundreds of “baskets” of stocks at one time. Program trading, as defined by the NYSE report is any strategy that sends out a “basket” of 15+stocks at one time. I am happy to discuss this with you if that description doesn’t make sense.
In order to dig deeper into Canaday's statement, Zero Hedge performed a historical analysis of NYSE Program Trading (PT) data (which is public) and came up with some curious observations. But before I get into the results, it makes sense to evaluate the facts behind Goldman's retort and in order to do that, let's first observe just what this Supplemental Liquidity Provider program is.
The NYSE's most recent classification of the three main market participants is as follows:
Designated Market Makers
Designated Market Makers (DMMs) are at the center of the NYSE market and are the only participants in any market who have true accountability for maintaining a fair and orderly market. DMMs:
Convene both a physical auction convened by DMMs and a completely automated auction that includes algorithmic quotes from DMMs and other market participants;
Have the obligation to maintain an orderly market in their stocks, quote at the national best bid or offer a specified percentage of the time, and facilitate price discovery at the open, close and in periods of significant imbalances;
Provide price improvement and match incoming orders based on a pre-programmed Capital Commitment Schedule, which has been added to the NYSE Display Book, minimizing order latency. DMMs and their algorithms do not receive a “look” at incoming orders. This ensures that an intermediary does not see orders first, and that DMMs compete as a market participant;
Are on parity with quotes from floor brokers and those on the Display Book, encouraging DMM participation and higher market quality.
Trading Floor Brokers
Brokers on the NYSE Trading Floor leverage their physical point-of sale-presence with information technologies and algorithmic tools to offer customers the benefits of flexibility, judgment, automation and anonymity with minimal market impact. Trading Floor Brokers:
Have parity with DMMs and the NYSE Display Book, no matter whether the Broker’s order is represented physically or via an algorithm or e-Quote. That is, they can join the first displayed quote on the Book, and split stock with that order.
Have the ability to route all or part of a customer order to an external algo engine from their handheld order-management device. These algorithms offer Floor Brokers the ability to provide customers with additional execution capabilities in an environment that offers a balanced combination of technology for fast, automated and anonymous order execution; and a physical marketplace for discovering block-sized liquidity and improving prices.
Can utilize a technology feature called Block Talk to more efficiently locate deep liquidity. Block Talk is designed allow Floor Brokers to broadcast and subscribe to specific stocks they have an interest in, creating an opportunity to trade block-sized liquidity that is not accessible electronically. Since the messages contain no specific order information, customers benefit from a discovery process in a secure environment free of impact, information leakage or intermediation.
Also have the ability to identify via their hand-held order-management system the last five buyers and sellers in a stock by badge number. They can message a specific member that they are in touch with the contra side. This is valuable information for pricing blocks, as it is about real buyers and sellers, not indications of interest.
Have a special feature with their reserve orders: when the displayed amount is exhausted, reserve interest replenishes on parity. In contrast, the “upstairs” reserve order functions as it does in an electronic market: replenishing at the back of the queue.
Are positioned to act on the expanded imbalance and indication information at the open and close of the market. They can participate as agent, or convey insight into the open or close for customers’ decision making.
And most relevantly, Supplemental Liquidity Providers
Supplemental Liquidity Providers (SLPs) are upstairs, electronic, high-volume members incented to add liquidity on the NYSE.
The pilot SLP program rewards aggressive liquidity suppliers, who complement and add competition to existing quote providers.
SLPs are obligated to maintain a bid or offer at the National Best Bid or Offer (NBBO) in each assigned security at least 5 percent of the trading day.
The NYSE pays a financial rebate to the SLP when the SLP posts liquidity in an assigned security that executes against incoming orders. This generates more quoting activity, leading to tighter spreads and greater liquidity at each price level.
SLPs trade only for their proprietary accounts, not for public customers or on an agency basis.
An NYSE staff committee assigns each SLP a cross section of NYSE-listed securities. Multiple SLPs may be assigned to each issue.
A member organization cannot act as a Designated Market Maker and SLP in the same security.
SLPs have the same publicly available trading information and market data that all other NYSE customers have available to them.
It is important to note that the SLP rebate is $0.0015, usually less than half of the rebate plain vanilla Designated Market Makers receive, which is between $0.0030 and $0.0035,and as the NYSE plainly says, a member organization cannot act as a DMM and SLP in the same security. Obviously based on the rebate structure and the mutual exclusion, it would make much more sense to trade as a DMM as opposed to an SLP, not in the least since SLPs (at least according to currently available information) are very limited in terms of which securities they can actually trade for supplemental liquidity provision. Quoting Robert Airo, VP of relationship management and sales at NYSE Euronext, from late October 2008:
"We’re rolling [the SLP pilot program] out in the 500 most active names where we believe incenting SLPs by compensating them to provide liquidity will supplement all of the other initiatives that we’ve put in place to build the NYSE book."
The SLP program was developed in the days after the Lehman collapse when market volatility spiked and major questions about liquidity premia emerged, resulting in program roll out on October 29 of 2008. The full SEC filing describing the minutae of the program is presented below:
"SLP quoting will provide more liquidity and should make the NYSE more competitive. We have begun to see significant shifts in terms of the frequency with which the NYSE is at the NBBO, and we expect increases in volume and market share to follow."
With a mere 500 securities to work with, especially being excluded from being a DMM in SLP names, maybe Canaday can explain the economics to GS' program trading desk from participating in the SLP?
Another relevant question is just who are the current SLPs? It seems the answer is difficult to pin point. It is known for a fact that Goldman Sachs and Spear, Leeds and Kellogg (owned by GS) are currently definitive SLPs, with Knight Trading and Barclays also presumably becoming SLPs as well, but there has been no confirmation either way, potentially implying that Goldman could have a monopoly in liquidity provisioning. If the program is truly as attractive as GS' spokesman makes it seem, why are other major equity players not clamoring to participate in it? After all, the benefits to SLPs are "obvious."
Following up on that, has there been an extension of the SLP program recently? Zero Hedge has not heard of one. The SLP, which was approved in late October (see above) was supposed to terminate on April 30, this last Thursday: "The proposed pilot program will commence on the date upon which the SEC will approve the New Market Model and will continue for six months thereafter ending on April 30, 2009." If the SLP is now over, should one expect GS's principal volume trading to drop dramatically, if, as Canaday says, the volume is mostly SLP driven? Also, does that mean volatility in the market is about to spike as there are no entities (well, one entity) providing NBB and NBOs?
Indeed, many questions arise when one digs into the nebulous world of NYSE liquidity providers, many more than there are clear cut answers to. Perhaps it is time for Mr. Canaday to address as many of these questions as possible head on. Zero Hedge would be happy to provide him with a forum for clarification.
In the meantime, here are the facts, courtesy of the NYSE's public record keeping system.
The first chart below demonstrates total program trading in the NYSE since mid August, a month before the Lehman bankruptcy. The black line demonstrates total indicated program trading, which absent volatility, has remained relatively stable, averaging roughly 4 billion shares weekly. And while most other NYSE member firms have seen their PT volumes stay relatively flat as well, GS has seen a dramatic ramp up, controlling about 15% of PT in Q3 of 2008 which has risen to almost a quarter of all NYSE PT over the past quarter.
But while total Program Trading includes Principal trading (i.e., trading not on behalf of its clients but for its own benefit; this is the category where SLP would also fall in under NYSE guidelines), as well as Facilitation and Agency trades, the big surprise arises when one looks at a historical analysis of merely Principal trading. The chart below pulls only the Principal trading data for the top 10 NYSE members. And like before, while the total amount of total Principal trading as a portion of NYSE PT has stayed relatively flat, at about half of total PT volumes, Goldman's share has exploded over the past six months: while GS was responsible for around 27% of Principal NYSE stock trading in Q3 and most of Q4, that number has risen to the low 50% range over the past 3 months.
The last two charts demonstrate the divergence of Principal trading as a fraction of total PT by any given broker. It is obvious that while the majority of top NYSE member firms have had Principal trades stay around 40% of their total PT volume, Goldman has seen its share of Principal trading go from 60% all the way into 90%: a vast majority of all its trades are merely for its own benefit (and potentially as an SLP funnel).
And lastly, demonstrating Non-Principal trading indicates, as expected, a trend where GS' client have taken a progressively smaller relative role as part of its total PT, and currently GS Agency volume as a % of Total PT is the lowest of all top NYSE brokers, with total NYSE Agency volume remaining relatively stable.
So what is really going on here? Connecting the dots is difficult with so little freely available information, and the NYSE seems to be keeping mum on disclosing anything above the absolute minimum when it comes to the SLP, and brokers' participation in it.
My interest was piqued by one of the points Canaday brought up: "What the table doesn’t show, but a deeper look at the numbers reveals is that the vast majority of this total is trades by our quantitative trading desk." Maybe Canaday can expand on this a little more, as it is public knowledge that recently the heads of GSAM and Goldman Global Alpha left the company: Ray Iwanowski and Mark Carhart, who ran the quant operation, and Giorgio De Santis who ran research, are no longer at the company. Their departures in themselves are not surprising considering Global Alpha lost over 80% of assets or roughly $10 billion in the course of 2008 (precipitated by the quant shakeout of August 2007). But is there something else going on here? Their departures occurred at the end of March, just as Goldman's Principal % of total NYSE trades had peaked at almost 55%, yet when they departed, this number dropped by a not insignificant 12% to 43%, only to rebound promptly thereafter. Is there more here than meets the eye?
As regular readers of Zero Hedge know, the topic of market liquidity has been a major one over the past 3 weeks, and I have demonstrated that traditional market neutral, high-frequency quants, aka independent liquidity providers have not only suffered significant P&L losses in April, but have deleveraged to a point where their presence in the market is negligible, resulting in dramatic volatility spikes on low volume. Could it be that Goldman is singlehandedly benefitting from being the liquidity provider of last resort, even more so as there are virtually no other participants in the SLP program? And, as is expected, with a liquidity "monopoly", come unprecedented opportunities to take advantage of this, depending on one's view of the market. Of course, Zero Hedge is not suggesting Goldman has done this, but in a world where so little transparency exists into the core workings of the equity market, which most market traders have been clamoring has a "very fishy feel" about it, with Hard To Borrow notices appearing for such major index hedging securities as the SPY and IWR, it is no wonder that explanations are being sought.
In order to provide some much needed visibility, Zero Hedge, as noted above, is hoping Mr. Canaday will approach Zero Hedge and give a more elaborate explanation of what is really happing, and why GS is dominating NYSE program trading, which lately has become a major percentage of total NYSE volume. It is easy to see why market participants could be concerned about this particular breed of opacity. In the meantime, I will continue presenting NYSE program data, as it is everybody's right to be caught up with all the facts.
Sphere: Related Content
For the first time in many days, MS has dropped a major block from their advertised SPY trading report. In what could be turning point for the "second derivative" of after hours weirdness, today Morgan Stanley advertised "only" two 10 million blocks at 6:41pm, unlike the 30 million SPYs traded by MS day after day. Could this be i) the end of the deleveraging of PDT, ii) the end of deleveraging of (insert favorite Quant here), iii) the decline in ETF creation or iv) who the hell knows...
Regardless, there might have been a significant disturbance in the force today. We shall see if it persists.
Update: It is, of course, Goldman's prerogative to provide their view on the matter. Below is a quote from Goldman Sachs spokesman Ed Canaday (hat tip Felix Salmon):
The NYSE report that Zero Hedge discussed shows Goldman Sachs trading over 1 billion shares in the principal program trading category. What the table doesn’t show, but a deeper look at the numbers reveals is that the vast majority of this total is trades by our quantitative trading desk. This desk is participating in a relatively new NYSE program called Supplemental Liquidity Providers. The NYSE started the program to attract liquidity to the exchange. As an SLP, this the desk makes markets in NYSE stocks. They often do high-frequency trading (which is simply auto-quote market making) where they send out hundreds of “baskets” of stocks at one time. Program trading, as defined by the NYSE report is any strategy that sends out a “basket” of 15+stocks at one time. I am happy to discuss this with you if that description doesn’t make sense.
Zero Hedge will counter with its thoughts at the earliest available opportunity. However, it is curious to note that according to this disclosure, Goldman is now fully channeling its quant trading ("high-frequency trading" as disclosed by Canaday) which is much more than "auto-quote market making" through its program trading. An immediate question for Mr. Canaday is whether Goldman Global Alpha is also part of this hi-fi trading. As for the SLP program, maybe GS can disclose just what is the basis of trades that according to their program trading desk provides "supplemental liquidity"? I am sure both GS shareholders and ZH readers would be happy to get much more information on this matter.
***
Weekly NYSE program trading update. No surprise from last week, with Goldman dominating program principal trading. Curiously non-principal transactions (facilitation and agency) at Goldman are shrinking dramatically and the ratio of Principal to Non-Principal is a recent record at over 7x. Goldman's non principal transactions are much lower than almost other top 10 NYSE member firms. Also curiously total Program Trading volume has declined significantly from 5.1 billion shares in the prior week to 4.8 billion shares in the last week.
As the chart below shows, quant funds attempted to leverage five times in the month of April only to fail every single time. In the meantime the higher trading volume on both the leveraging and deleveraging phase was welcome to brokers like JPM and UBS (and maybe MS?). Net result, the quant performance numbers will be horrendous, as they did not succeed to catch up with their losses as the market went against every single quant factor in existence except for momo high frequency traders who played the simplest of all possible reversion patterns while the market squeezed progressively higher. As ZH reported, the pain at RIEF last week was already likely beyond fixing: this week's update will only make for some low calorie cake icing.
(for new readers, I recommend you read up on the attached labels to get a sense of the problem)
