As the author of Moneyball, The Blind Side, and The Big Short, Michael Lewis attracts attention to any topic he writes about. That's why the public's attention has been on High Frequency Trading (HFT) in the month or so since Lewis released Flash Boys.
Much of the recent media frenzy around HFT has focused on whether the practice is in some way unfair. But, the reality is that we aren’t really in a new era of market dynamics -- low-latency, computerized trading has been around for years, ever since the demutualization of all exchanges at the turn of the century.
High transaction speed has always been a competitive advantage for financial firms, especially across liquid markets. The need to execute trades quickly is why the calamitous open outcry method was once a necessity on trading floors, and it's the reason why silent, millisecond-long HFT practices have since muzzled it.
Consider how important automated trading practices have become in the industry. Automated and algorithmic trading accounted for 91.5% of US futures exchange trading volume in 2012, according to the Commodity Futures and Trading Commission's (CFTC) September 2013 Concept Release on "Risk Controls and System Safeguards for Automated Trading Environment."
Contributing to this increase is the number of firms that have switched to electronic transactions in the aftermath of the Great Recession, following legislation enacted to increase transparency and visibility in trading.
With HFT and electronic trading on the rise, financial firms are now asking themselves whether their legacy IT infrastructure is sufficient to support a higher volume of these transactions. To continue to justify a presence in the derivatives markets, firms need to be sure their technology engines are commensurate with the needs of clients, remain cost-effective and offer a wide range of venues to enact transactions.
Increased costs will prove a major issue for these firms as they explore ways of optimizing their technology. However, given the pressure to meet new reform mandates and implement risk management procedures, firms cannot afford the risk of not updating their IT infrastructure. Given the scale and cost involved with any transition, financial firms have started to outsource their trading infrastructure and technology requirements to established third-party data centers.
Finding a data center that can provide financial firms with the "three C's"
Data centers often act as infrastructure hubs for financial firms facing the challenge of operating in today's competitive markets. They can help financial firms generate optimal return for their clients, even amid the constant flurry of activity, and keep costs low. Further, certain carrier-neutral data centers provide firms with access to the three C's -- connectivity, coverage, and community -- which are vital as firms future-proof their trading practices.
Connectivity is essential, as it allows firms to take advantage of a data center's proximity to core trading venues to drastically reduce latency. Pressures of HFT are forcing financial firms to constantly improve the speed at which they execute transactions, or else be trumped by competitors with better technologies or processes. To keep up with demands, many trading firms are hosting their infrastructure in carrier-neutral data centers with financial hubs in order to benefit from both colocation HFT, which enables firms to sit right next to matching engines of exchanges, as well as proximity HFT, which occurs when trading firms are centrally situated among top exchanges and can aggregate market data feeds.
Firms also require coverage across multiple locations that provide access to all types of derivatives trading structures, including derivatives traded over-the-counter (OTC) and through exchanges, as well as the mass of new end-points, such as clearing, settlement, and risk management. For example, by connecting to both OTC and exchange venues via a single carrier-neutral data center provider that spans multiple countries, firms can run Value at Risk (VaR) calculation from one point, optimizing their use of collateral and potentially making major savings.
Certain carrier-neutral data centers providers also ensure that firms have access to industry-specific communities of interest. These communities bring together companies operating in the same sector so that they can benefit from fast and low-cost interconnectivity and establish valuable business relationships. As derivatives trading firms confront the effects of HFT and electronic trading, they can tap into these hubs to learn from the practices of their peers and improve their own services.
Although the recent changes to the derivatives market have created upheaval across the trading community, they will undoubtedly produce maximum returns for clients in the future. Trading firms have been forced to examine their IT infrastructure, and are no longer able to justify unproductive legacy systems as the cost of trading has increased and eaten into the strong returns provided by the derivatives market. Firms will need to adapt to the new trading landscape, choosing both their connections and their connecting partner carefully to ensure success.Bill has over 18 years of financial services industry experience in a variety of strategy, sales and marketing roles at Tibco Inc and Thomson Reuters. Before taking up his current position in September 2013 at Interxion, Bill drove business development for Elektron Managed ... View Full Bio