Virtu IPO aims to present friendly side of high-frequency trading

At a publicity event in London last week author Michael Lewis professed "no great antipathy to the high-frequency traders exploiting the problem" of the US equity market.

Now this week Virtu, one of the world's largest high-speed proprietary traders, is due to list, aiming to show exactly how it navigates a world where some 13 exchanges compete for business with alternative trading venues and bank-owned platforms.

"The typical Wall Street approach is to exploit a problem," says Mr Lewis, whose controversial book Flash Boys, released a year ago, put high-frequency traders at the centre of a system he said was "rigged".

"If you saw a hole in an oil pipe, most people would seek to fix it. Wall Street would look to build a village around it."

The pressure from the book has helped accelerate some Securities and Exchange Commission investigations into bad behaviour. But a survey of 245 market participants last month by Convergex, the US agency broker, found there was still widespread concern about high-speed traders.

Convergex found 57 per cent thought markets were "unfair" while the number of those who had changed the way they interacted with markets had doubled in the past year, to 42 per cent.

Now as Virtu plans to finally list, having pulled back amid the furore last April, some say its 180-page IPO filing offers a more accurate insight into the modern trading industry. The bottom line appears to be bigger is better in the cut-throat world of rapid fire trading.

Virtu describes itself as one of the world's largest market makers, earning a profit on differences on the spread between bid and ask price of more than 11,000 instruments and hedging their risk by taking positions in correlated securities and indices.

"It [the market] has become a video game and it needs what these companies bring. They supply liquidity into the market," says Larry Weiss, head of US trading at Instinet, an agency broker. Even so, he notes, "it's really started to be dominated by handfuls of big players because of the cost of technology".

For the sceptics, technology that can deliver only one overall losing trading day in the past 1,485 trading days for Virtu seems just too remarkable.

Others argue it reflects Virtu's knowledge of trading, positioning and cutting-edge technology that allows it to execute 5.3m trades a day globally across equities, currencies, commodities and fixed income. Widespread availability of cheap, high-speed technology means only 49 per cent of those trades were profitable, with the rest either unprofitable or neutral.

Data from last year's failed IPO allowed Greg Laughlin, an academic at the University of Santa Cruz, to argue Virtu's success was more down to large numbers.

Using an assumption that Virtu had a 51 per cent win rate on its trades, Mr Laughlin calculated that one trade a day gave it a 52 per cent chance of a profitable week. Executing 10,000 a day gave it a 99.999 per cent chance.

Estimating that Virtu executed 2.5m-3.5m trades a day in the US equities market, he concluded: "Given these statistics, we can readily show that the chances of Virtu's operations experiencing a money-losing day are vanishingly small."

A research note two weeks ago by Credit Suisse underlined the point. Its analysts were given a teach-in by Manoj Narang, chief executive of Tradeworx, a midsized US high-frequency trader. Mr Narang estimated he had a slightly higher win rate of 53 per cent, but he was not as successful longer term.

"The only difference between Tradeworx and larger HFT firms is that Tradeworx is four to five times smaller - therefore it has an 86 per cent daily winning percentage compared to other larger firms at 99 per cent," Credit Suisse notes. Larger firms earn in a day what it would take Tradeworx to earn in a week, it concludes.

That, combined with low market volatility, explains why many small and mid-market companies, such as Infinium, Eladium Partners and Chopper Trading have pulled out of the market in recent months.

While the economics may benefit bigger companies, their role at the centre of daily trading is making them a target for regulators.

One particular concern to many is the impact of European capital rules, which will apply to more proprietary trading firms as of 2017. This will force them to set aside significantly more capital on their balance sheets, particularly if they trade fixed income or interest rate derivatives.

"Combine that with internal organisation requirements and we see a crunch in the smaller firms. The biggest firms will have a head start," says Johannah Ladd, secretary-general of the European Principal Traders Association.

There may also be other challenges. A plethora of new venues have emerged, such as IEX and Canada's Aequitas, looking to shield investors from the worst effects of HFT. Yet as IEX, the "heroes" of Flash Boys, note, Virtu accounts for about a fifth of trading on its exchange.

However, even transparency has its limits. As Mr Weiss says: "It's still a young business and to project five to 10 years out is virtually impossible."

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