Bulge bracket firms are looking to get a foothold in the high-frequency trading business as a result of proposed new regulations that will alter the playing field for sponsored access.
To get into the game, brokerage firms are ramping up their technology capabilities to increase their speed–an arms race, as one broker described it–to move from single-millisecond execution times to microseconds.
The catalyst behind the strategy is a Securities and Exchange Commission proposal that changes the game for brokers who provide access directly to markets for rapid-fire traders. The rule would require sponsoring brokers to put in risk management controls and supervisory procedures.
Installing such pre-trade controls would create a buffer and slow down high-frequency traders’ access to the markets, as each order would need to cycle through the various compliance checkpoints.
By at least one definition, high-frequency traders are firms that send out 1,000 orders per second. They require the absolute lowest latency, if they’re going to complete trades faster than everyone else. For them, speed rules.
If approved, the SEC rule will make the business of sponsored access more attractive to big firms like Credit Suisse, UBS, Barclays Capital and others. According to one estimate, the sponsored-access business is between $200 million and $300 million a year.
But up to now, the business has been nurtured and built up by a few clearing firms who have catered to high-frequency traders, mainly broker-dealers who have gained an advantage by using their own risk checks and not those of their clearing firm. But the SEC’s new rule would require risk checks for all clients at the sponsoring broker–a leveling of the playing field, if you will.
If everyone must incorporate risk checks, the thinking goes, newcomers will have more opportunity to win business.
Dmitri Galinov, head of liquidity strategy at Credit Suisse Advanced Execution Services, said Credit Suisse made a decision six months ago to develop a sub-millisecond hyperlow latency infrastructure product to woo new business. The SEC introduced the rule proposal on Jan. 13.
"The main focus going forward, in terms of additional flow, is to get broker-dealer clients who currently use clearing firms that provide naked access," Galinov said.
The consultancy Aite Group estimates that high-frequency trading is 50 percent of the average daily trading volume. Of that, unfiltered sponsored access is 38 percent and 12 percent is filtered sponsored access, meaning that once SEC rules go into effect, three-quarters of the market is up for grabs.
Credit Suisse’s new infrastructure platform with risk-checking software, Market Access Gateway, is in beta testing with a hedge fund client. According to Galinov, the technology has produced trading execution times close to 50 microseconds one way, and he thinks that can be tweaked a little more.
Owain Self, Americas and EMEA head of algorithmic trading at UBS, said his firm’s push to a sub-millisecond trading infrastructure was rooted in providing sponsored access and exchange colocation to high-volume traders who may previously have used a competitor’s infrastructure rather than UBS’s.
"If high-frequency traders or firms need to go through a broker’s system, brokers need to have the best system at the ready. I need to have the best and lowest-latency system at the ready to meet this need, and just to be competitive overall," Self said. "The naked- and sponsored-access rule changes threw a healthy new wrinkle into the competitive mix. This creates a new opportunity that can either get us new business or draw business from another broker-dealer."
Noting the cost of the IT investment involved, Self said being competitive in any form of trading for clients in today’s markets requires the most robust low-latency technology. UBS does this continuously by wringing the most efficiency out of its infrastructure, switches and routers.
"Our core technology design continues to serve us. But to compete for this particular type of flow, we must continue to optimize that technology–to remove things such as unnecessary components or network hops–so we can keep getting more performance from it," Self said.
Barclays Capital, which has already reduced latency in its SubM infrastructure system’s speed to the 300- to 350-microsecond round-trip range, is pushing the envelope and lowering speeds further to get a piece of the high-frequency pie.
"We want to win their business and, at the same time, keep our eye on the whole space and not just the very-high-frequency slice," said John Stracquadanio, head of product management for prime services at Barclays Capital.
Stracquadanio said that while Barclays is exploring further reductions in latency–looking to reach speeds of 50, 75 or 100 microseconds one way-he is equally focused on having appropriate pre- and post-trade compliance checks. Maintaining the proper balance is the issue.
"We have to be stable and operationally excellent across the board." Stracquadanio said. "It won’t be enough to just be fast. We are in the middle of assessing at what point the balance between investing more and shaving off a little more speed makes sense."
Cutting microseconds and reducing latency is big business among the industry, as the most recent report from the Tabb Group estimated infrastructure investment would reach $170 million in 2010. That figure was only $100 million in 2008.
Still, not all broker-dealers have the technological or financial resources to do this. Some are turning to vendors to help them. One vendor told Traders Magazine his company was in talks with "big firms" who want to enter the high-speed risk-check infrastructure game, but do not themselves have the requisite resources available.
And not all bulge firms are hell-bent on having the absolute fastest execution systems. Goldman Sachs is content with its single-digit millisecond infrastructure. And providing the fastest sponsored-access system is only one part of its business, not the basis of it.
"For us, the microsecond profitability map just is not valid. Shaving a few microseconds doesn’t factor into our decisions," said Rishi Nangalia, managing director and global head of business development at Goldman Sachs Electronic Trading. "Speed is of course a factor in winning business, but not the only factor."
Goldman Sachs offers its clients sponsored access through a small vendor-based system. If the SEC mandates certain risk checks, Nangalia said the firm will implement them across all the different systems it uses.
Rather than speed, Nangalia and his team focus on the execution quality of the firm’s dark pools, ensuring its algorithms are optimized and keeping the latest infrastructure hardware in place.
"Our clients haven’t told us we need to execute in microseconds or milliseconds," Nangalia said. "They do tell us that they do not want to miss a market quote or that the market data on our screens is stale or fresh. They ask, ‘Are your algos reacting to market movements as best they can?’"
If the big brokers choose to put their resources into improving their high-frequency trading infrastructure, that investment will pay off with greater market share, said Chris Bartlett, director of trading and trading technologies at high-frequency trading firm Nobilis Capital. He thinks small and medium sponsored-access providers will have their work cut out for them to compete with the large firms. "Within the next couple of years, this speed arms race will cease to be a race, given the amount of capital moving into it from the bulge brackets," he told attendees at the recent TradeTech conference in New York.
