By Matthew Lempriere
With the 2012 Olympics in sight, all eyes will turn to London (especially those of the BT team, as the official communications partner of the Olympics and Paralympics), where we will watch world class athletes participate in tough and demanding events where a split second can make the difference between winning and losing. But what we should remember is that the competitive edge that an athlete gains over their rivals does not just come down to the individual themselves, but the infrastructure that they have around them; such as kit, training conditions and diet. A combination of these things will ultimately come together and be the key to beating the competition and winning gold.
The same is true in the world of electronic trading. The innovative brains behind the most cutting-edge instruments or complex trade strategies on today’s trading floors would be incapable of making their concepts become a reality without the modern technological infrastructure that is built around them. Where low latency was once an exclusive playground for arbitrage specialists and market makers, it has now become main-stream and is no longer confined to specialist trading systems, but is a requirement for all advanced trading strategies.
As well as coming into the mainstream, increasingly innovative trading strategies and their reliance on the latest, most advanced technology, such as algorithmic and quantitative trading, has pushed the issues of automation, latency and risk management technology further up the agenda. Latency is critical to take advantage of the swings in price and increase in order flow, and is grabbing board-level attention with senior latency-related positions being created within financial institutions to ensure that sustained focus is put on trading desks’ latency capabilities and for taking advantage of low latency to remain competitive. The rise of complex financial instruments has done much to propel reliance on technology further amongst both buy-side and sell-side organisations. This has happened to such an extent that the traditional division between the front and back office, in terms of their relative importance to the trade process, has been almost eradicated. Complex instruments, evolving investment vehicles, regulation and increased investor sophistication have caused the gap between the front and back office functions to narrow considerably. Technology, from the front office through to the back office, must move in tandem to enable the industry to be able to sustain growth and innovation.
In Europe, the trading landscape has undoubtedly changed in recent years with technological innovation and regulatory change – with initiatives such as the Markets in Financial Instruments Directive (MiFID) – providing the catalyst for a rise in alternative trading venues and off-exchange order books. These alternative trading venues have been responsible for growth in the number of trades made as large block orders that may be sliced into smaller bundles of trades to obscure them from the market. In Asia, we have a variety of different markets each with their own set of rules and regulations, so the technology must be able to react and interface with multiple venues. Both network and server technologies have had to provide the capacity for financial institutions to scale and take advantage of these increased volumes.
In response to this changing landscape the buy-side has needed to expand their use of algorithmic trading, direct market access and smart order routing technology to take advantage of liquidity fragmentation and alternative trading venues – the by-product of a post-MiFID world. The take-up of FIX standards by the buy- and sell-side in recent years has also stimulated the blossoming of electronic trading systems and algorithmic trading strategies.
The buy-side has also had to widen their scope and capacity of trading instruments, to trade options and derivatives as well as cash. The result of this, especially when combined with the financial crisis, has meant that the buy-side has had to become increasingly aware of risk and transparency issues, and the technology necessary to achieve high standards in these.
The events over the last year serve as a reminder that the industry has traditionally under-invested in risk management capabilities. Prior to the downfall of Lehman Brothers and Bear Stearns, nobody questioned the viability of counterparties, but in this new environment, audit trails and transparency in trading activities are paramount. Operational efficiency and technology capability have become increasingly important issues in the wake of the credit crunch. And there is no question the regulatory focus on the global perspective will be on transparency.
New areas of the trade lifecycle are becoming latency sensitive and it is now an increasing requirement for every link in the trade execution and trade processing chain to adopt lower latency technology with areas such as risk management and reporting being pressured to move towards lower latency models.
As higher levels of trading are carried out on technology intensive execution venues, automated trading strategies, fast low latency connections and greater processing power are increasingly required in order to remain competitive. Algorithmic trading and direct market access are competitive necessities in today’s global financial markets and market speeds of around 70,000 ticks per second, milliseconds, and fractions of milliseconds, increasingly matter as firms try to capture, analyse, and trade on fast-moving data. Like a sprinter racing for a gold medal, the traders’ ability to take advantage of latency is influenced not only by their skill as a trader, but also the tools they have at their disposal including hardware and software architecture, network topology and the physical distance from execution venues.
Financial institutions are establishing a latency and performance baseline, through which they can begin to understand how they fare against their competition. To stay ahead of the competition however, financial institutions need a resilient network infrastructure, with a number of low-latency services to facilitate fast electronic trading as well as the ability to host their algorithmic trading engines, in a fully-managed environment offering the fastest access to exchanges and securities trading venues globally.
Trading firms will also increasingly need to be as close as possible to the markets, in order to minimize trade execution times and find infrastructure providers that can place their servers virtually in the middle of execution venues, to take advantage of low latency market access to trading and market data.
The ability to monitor and measure end-to-end network latency in real time will also become increasingly essential for institutions to be able to understand latency with microsecond granularity, see volume spikes and potential packet loss, and understand latency trends and network and application behaviour under the pressure of increasing traffic volumes. In the coming months financial institutions will undoubtedly apply a more measured evaluation towards their business models and the budgets they have available for technology and infrastructure development. Initially, it is thought that postcrisis infrastructure integration phases will focus on rationalisation, which will enable firms to eliminate their duplicate systems and thus be more competitive from a latency perspective. As we see the division of small, agile players who deal in more complex instruments versus larger, bulge – bracket providers that have a more streamlined product suite, there will be a change in technological demands from each party. Both groups will be shackled by cost and capital spending and will require technology and infrastructure products on a service basis as well as having the ability to access pools of capacity and infrastructure as and when they need it, rather than investing in large technology overhauls. On the trading markets, speed is everything. Milliseconds and microseconds will continue to determine the success or failure of trading strategies as will reducing latency, with being quick enough to compete continuing to be a big industry driver. However, investing in the technology and infrastructure to provide these capabilities may be prohibitive and institutions will increasingly have to look to service providers that can offer a range of solutions to suit their changing latency needs; from broader solutions that manage their IT infrastructure systems and increase the flexibility across trade execution and processing, to more specific solutions that provide access to market data, trade execution, and trade cycle applications and services.
By Matthew Lempriere