February 2010

AUTOMATED TRADING: the need for speed

Sophistication of electronic trading platforms is vital, as a lag can cause losses. Hosting solutions for proximity and colocation can minimise latency, says Mike Powell of Thomson Reuters
sportscar.jpgThe trading landscape for electronic markets has evolved rapidly over recent years as regulatory and competitive factors focused the sell side on quality of execution, and technology enabled broader adoption of high-frequency trading strategies. Trading technologies, new financial products, alternative liquidity sources and lower transaction costs have all driven demand for greater speed of access to markets. Sell-side firms are increasingly concerned with the ompetitiveness of their execution capabilities, with the Tabb Group, a financial markets research and strategic advisory firm, estimating that if a broker’s electronic trading platform is five milliseconds behind the competition, it could lose at least 1% of its flow. While this remark is targeted at the North American equities market, the trend is unequivocally spreading to Europe and Asia.

In turn, the buy side is becoming increasingly sophisticated in its trading strategies. The emergence of new trading venues has fuelled the growth of low-latency, statistical arbitrage strategies across both the buy and sell side. With an increasing trend towards trade automation, key structural changes such as sponsored access and the growth of high-frequency and event-driven trading, there is a tremendous demand for both proximity and colocation hosting solutions to minimise latency.

Location is increasingly becoming central to trading strategies as data centres replace trading floors as the hub of execution. Research estimates that only 2% of market participants are truly high-frequency players; however, they contribute more than 70% of trading volume. In addition, the proliferation of the use of algorithms across the buy and sell side, and the competitiveness of the sell-side industry means that the majority of participants are concerned with performance.  Low latency infrastructure, therefore, is not solely the realm of the high-frequency firms.

Conversely, algorithmic trading and automated order processing have created conditions for a perfect data storm, where accelerated data volumes and requirements for ultra low latency put significant stress on many trading systems. This introduces massive peaks in trading volume (and accompanying data rates) and potentially increased volatility. The need for processing, analysing and storing all the data at high speed has intensified. 

So while the growth in the number of trading venues offers new opportunities to improve returns, at the same time they are driving cost and complexity. Hosting is one solution that greatly lessens the complexity and better manages the overall cost of ownership. It can improve time to market for buy- and sell-side firms upgrading their capabilities and overcome a lack of technical expertise or internal resources for some firms. Smaller sell-side firms and brokers will have to examine their business model in the face of this and either justify the additional investment required to remain competitive in a fragmenting, latency-sensitive world, or look at alternative options such as white labelling or outsourcing to larger firms.

Physical distance to some markets means that latency is too high for certain multi-venue trading strategies, but colocation at all the venues is not always an option, both commercially or limited to members of that marketplace. Without the expertise and resources to set up regional hosting facilities in-house, the opportunity is lost. Similarly, firms looking to enter offshore markets where they don’t currently have a presence face the challenges of building the necessary infrastructure and support teams on the ground.

Lowering total cost of ownership
There is growing demand for proximity hosting solutions that enable firms to lower their total cost of ownership, reduce complexity of deployment in dealing not only with multiple points of liquidity but also multiple technology and service providers, as well as improving overall time to market. Many industry analysts talk about the fragmentation of liquidity in relation to exchanges and electronic trading venues, but there is less focus on key important points such as the underlying availability of data centre space, the number of disparate providers, the consistency of service levels (including power limitations), and the quality of comms connectivity between locations. These issues add further confusion in determining the right location strategy to align with a firm’s business model.

Competitor differentiation is a primary focus, as is efficiency, and the offloading of non-core business processes is critical to financial institutions. This trend was prevalent prior to the financial crisis but has intensified under the current highly competitive and cost-conscious environment. The buy side in particular is looking to gain competitive advantage from operating a light-touch, fully managed service.  Performance and simplicity are key demands and a single solution offering packaged networks, market connectivity, price discovery and prime broker connectivity provides a vital edge in a rapidly changing market.

Several technology and market data firms now offer colocation and proximity hosting solutions to meet the needs of customers focused on enhancing their trading capabilities. The demand for managed services will continue to grow more broadly, with many firms looking at the potential for outsourcing their entire market data infrastructures and large chunks of their mid- and back-office processes – a natural extension of the growth in areas such as fund administration. As competition in the automated trading space intensifies and the activities of the financial institutions become more sophisticated, the infrastructures required to support these activities become more complex and therefore more expensive to operate. 

Clients are now looking to outsource the maintenance and support of their entire trading infrastructure, including access to real-time, low-latency cash equity, options and futures price data, low-latency news (both economic and corporate),  historical tick-by-tick price data, execution quality, foreign exchange and OTC pricing and tools for back testing and validation of trading strategies. The advantages of latency performance and outsourcing can be brought together and executed in a colocated environment.

When looking at front-office applications, a highly scalable, high-throughput messaging platform with appropriate low-latency market connectors can bring consistent, predictable performance and act as the essential building block upon which a firm can develop its trading strategies. It is not so much the combination of services but rather the interoperability of services across the various deployment formats that provides the biggest global advantage. The ability to normalise consistent standards not only simplifies development initiatives, but can dramatically improve the implementation time associated with rolling out new proprietary or third-party applications. 

If a client selects a colocation service for high frequency trading applications, deployed or hosted direct feeds for its on-site programmatic trading systems and/or a consolidated feed for its OMS and other front-office applications, interoperability is key to overall efficiency and competitiveness. We will continue to see firms turn to outsourced and managed service offerings to reduce their cost of ownership, improve time to market or simply to focus on their core business.  

Looking ahead
The challenges of exploding market data volume, an industry focus on latency and meeting a demanding development schedule of both new venues and next generation platforms from existing exchanges has escalated costs and questioned traditional strengths for many market data and technology vendors. This has been further exacerbated by the growing importance of emerging markets as market participants become more global and nimble in searching for investment return. These factors impact a vendor’s entire end-to-end proposition, from the collections network and ticker plant processing to the deployment of feed offerings with the characteristics to meet current and emerging requirements of a diverse customer base.

• Mike Powell is global head of enterprise information at Thomson Reuters

©2010 Funds Europe

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