The data industry is in trouble. Plagued by declining revenues, the data providers seem to be between a rock and a hard place - hamstrung by increasing competition, an aging infrastructure, an ever increasing amount of content, and a customer base that wants to pay less. Much less. But while these issues are challenging, the next three years will be even more vexing as the impact of new market structures unfurl.
Decimalization, client connectivity, electronic and algorithmic trading have and will greatly change the data business. Declining spreads and commissions are forcing dealers to automate trading desks and substituting algorithmic "smart servers" for traders.
Algorithmic servers analyze market data to make real-time trading decisions, often carving up large orders to reduce market impact. As large blocks are split, they generate significantly more data as algorithmic trading engines search for liquidity.
These new trading algorithms will only become more pronounced as the technology becomes more available, orders become smaller, and the ability to trade larger blocks becomes virtually impossible. Currently, The Tabb Group estimates that only 5 percent of buy-side orders are sent via algorithmic engines while 25 percent of large sell-side orders are managed this way.
However, as the penetration of algorithmic trading increases and NYSE market structure changes facilitate more technologically advanced execution, these numbers will only increase, pushing the quantity of market data through the roof.
Data providers will not be ready for this transition as three issues - speed, functionality, and value - will be difficult to obtain with their current infrastructure.
First, algorithmic engines use vast quantities of high-speed high-quality market data. The infrastructure of the more traditional market-data providers is generally not tuned to provide data at this speed. To increase transmission speed, many high speed algorithmic-trading vendors and direct-access providers obtain data directly from the exchange, bypassing traditional vendors and shaving off tenths of seconds in transmission latency. Cost is also a factor as many algorithms capture extremely small market opportunities.
Second, as the buy side and hedge funds become more involved with direct access and algorithmic trading, they will have greater use for market-data products. While this is positive for market-data providers, typically buy-side traders and hedge funds have different data needs than sell-side firms (the data providers' largest market) requiring a new set of data and distribution products.
Third, market data is traditionally sold by the seat. Algorithmic trading technology makes both buy- and sell-side traders more efficient, requiring fewer traders and fewer salespeople. Fewer traders and salespeople translate to fewer data users and reduced revenue.
These issues are forcing market-data providers to heavily invest in technology infrastructure to increase speed and deliver solutions to a new customer set when the most advanced of their customers are looking directly to the exchanges for their data.
To survive the next five years, data firms must do some very serious soul searching. Do they continue to provide data in highly liquid, extremely fast, and cost conscious electronic markets, or should they cede them to the direct access and algorithmic players? Should they focus on the less transparent slower-moving markets where they can add value? And if they abandon a market, will it create a new competitor who will eventually migrate into the high-value, high-margin business?
Or do the vendors bite the bullet, make the difficult decisions, and rationalize their high-cost infrastructure, develop new solutions for high-speed transactional markets and create products for a whole new set of customers. Do they do all this to ensure that as fewer traders manage more positions and customers their revenue stream will not deteriorate.
While there is much confusion in the data market, there is one thing that is crystal clear: in an age where trading is predicated on market data, market data will not get any less important. The only question is who will be positioned best to take advantage.
Larry Tabb is founder and CEO of Westborough, Mass.-based The Tabb Group, a financial-markets strategic-advisory firm. [email protected]
Larry Tabb is the founder and CEO of TABB Group, the financial markets' research and strategic advisory firm focused exclusively on capital markets. Founded in 2003 and based on the interview-based research methodology of "first-person knowledge" he developed, TABB Group ... View Full Bio