Ms. Fran Spielman
City Hall Reporter
Chicago Sun Times
Sept. 12, 2019
Dear Ms. Spielman,
It has come to our attention that in a 9/11/2019 interview on WEBZ you have repeated the Financial Industry Lobbyist claim that if Illinois implemented a local financial transactions fee or LaSalle St. Tax (LST), Financial Trading in Illinois could be moved out of state by “flipping a switch” as a true fact when all of the evidence indicates the contrary. It would be extremely costly and disruptive for trading, and especially “High- Frequency Trading” (HFT) estimated to comprise 50% or more of all trading, to relocate. Copied below are the relevant sections in a comprehensive LaSalle Street Tax Q&A with references that show this. The full Q&A can be accessed here.
(5) Wow! But can the exchanges afford to pay this tax? Wouldn’t they move?
The LST is not a tax on the exchanges; they don’t trade. It is a tax on the buyers and sellers of futures and options contracts traded in the exchanges. The exchanges would simply act like the hardware store that collects the sales tax when you buy a hammer. And then sends the tax to the State of Illinois. Contrary to claims by lobbyists that the exchanges could easily move trading infrastructure out of Illinois, such a relocation would be enormously costly and disruptive. The CME facility in Aurora for example is the size of seven football fields and reportedly is going to be expanded by 500,000 square feet to more than fifteen football fields, and at other facilities throughout the Chicago area “high frequency traders” (see 7 and 10) seeking to place their servers as close as possible to trading matching engines have “co-located” near other exchange. All of these trading and exchange facilities would have to be relocated together and customized high-speed straight-line transmission connections to trading in New York, Asia, and other locations around the world would have to be rebuilt. Straight-line transmission is used for nanosecond time savings that allow high frequency traders to get an information edge on other traders as described in the Michael Lewis book Flash Boys for options and stock trading in Chicago and New York. Chicago is a key time zone player in 24 hour global trading strategies between New York and Asia. Recent news about the “Gazillion Dollar Standoff Over Two High-Frequency Trading Towers” in Aurora next to the 7-15 football field Chicago Mercantile Exchange trading center confirms that even slight changes to existing trading transmission infrastructure would lead to enormously costly legal and physical infrastructure disruption and costs as new and existing players battle to maintain their preferred trading (or scamming) access to matching engines. Also trading “clearing house” facilities and their links to all of the financial institutions in Chicago would have be relocated and reconnected. Finally, in the unlikely event that the exchanges were able to provide credible data indicating that profit reduction from trading volume losses due to the LST was large enough to justify the costs of relocating out of Illinois, the state could negotiate a lower LST that would likely still raise billions in public revenue. Currently, detailed data on trading is generally not publicly available.
(8) Would these traders move to another exchange?
The products that are proposed to be taxed are not traded on any other exchange. In addition, some of the products that would be taxed, such as the S&P 500 index futures and options, are exclusively licensed to these two exchanges. While another exchange could seek regulatory approval to trade some of the other products, doing so would take some period of time. Moving trading liquidity from one market to another is extremely difficult. Once an exchange has captured all the volume in a product, it is difficult for a later entry to establish a market that is attractive to traders. Since traders need other traders to trade with unless a critical mass of them move together, they cannot move. In economics this is called a “collective action” problem.
(12) What is liquidity and what role does that have on the exchanges just picking up and moving to Atlanta?
Liquidity is a generic term for the size of the trading market. HFT's do not actually add to liquidity, or the facility of legitimate economic trading for risk hedging purposes, as they sell as quickly as they buy and generally make daily profits on quick turn-around trading, See p. 9-11 of this. These traders are thus skimming off revenue from the non-HFT traders that they prefer to trade with, rather than taking a proportional share of losses that would add to potential gains for other traders (as derivative trading is zero sum minus fees). Moreover, as noted in (8) above, real liquidity, or non-HFT trading volume, is very hard to move. This is compounded by the fact that, as noted in (10) above, the only traders who would have a real incentive to relocate their trading due to an LST are HFTs since the LST would be negligible for other traders. But HFTs need non-HFTs to skim off of as they can't make consistent profit by trading with other HFT traders employing similar (scamming) techniques. So trading could only realistically relocate if the exchanges physically moved, and the only incentive for this would be fee losses from trading volume as the exchanges would not be directly taxed by the LST. Once one exchange has captured all of the volume in a product later entry is extremely difficult even when such an effort is backed by major financial institutions. For example, in 2011 the Electronic Liquidity Exchange (ELX) opened for trading offering many of the same products traded on the CME and CBOT – but with one significant difference: ELX charged $1.25 – $2.00 less, equal or more than the $1 - $2 fee proposed for the proposed LST, in clearing and settlement fees to trade the same contracts as the CME and CBOT. ELX had another advantage: the exchange had the backing of JP Morgan Chase, Morgan Stanley, and Goldman Sachs. What happened? ELX’s best volume was achieved when their monthly trades in some contracts almost equaled the daily trades in the same contracts on the CME. Clearly the $1 - $2 difference was not enough to overcome the collective action problem that arises when trying to move liquidity from an existing liquid market to a new, illiquid market.
We respectfully urge you to publicly correct your misstatement and set the record straight on the abundant evidence that financial trading could not easily relocate out of Illinois in response to a carefully drafted LST. We would be happy to make ourselves available to answer any further questions that you might have about this.
Sincerely,
Ron Baiman, Bill Barclay, Sidney Hollander, Bruce Parry, Joseph Persky, and Mel Rothenberg
For the Chicago Political Economy Group (CPEG) www.cpegonline.org
Tel: (312) 996-2687