Information, Liquidity and the Center of Opportunity
For many, latency was once the be-all and end-all of electronic trading. But as globalization and the whipsaw of quantitative easing drives a tighter coupling between debt and currency markets around the world, there's a more important directive emerging for market participants - access to information, and lots of it. As John Knuff, General Manager of Equinix Financial Services, explains, information is what begets liquidity - and you need high-quality information in a timely manner in order to manage risk and trade smarter.
One consequence of the turmoil in sovereign debt markets over the past couple of years has been a sharp increase in electronic FX trading, as non-domestic investors have sought to manage their currency risks. This has been accompanied by commensurate growth in the electronic trading of instruments - such as non-deliverable forwards - that have historically been traded OTC by phone. A further factor supporting growth has been greater use of centralized clearing. Collectively, these elements have all helped in boosting electronic FX volumes in the trading ecosystems, particularly in the big three foreign exchange markets - Tokyo, London and New York.
One of the most intriguing aspects of this growth has been its global distribution. The three principal FX trading time zones of Asia, Europe and the US have remained, but an increasing number of participants are "following the sun" - moving to deploy equipment in all three regions and managing the overall strategy from their home-office locations.
Among these regions, Asia is particularly interesting because of the transition currently underway. While Tokyo has historically been seen as the FX trading hub for the region, regulatory and tax factors have given both Singapore and Hong Kong an opportunity to jockey for this position. The huge imponderable is China and the government's strategy for the internationalization of the renminbi. The point at which the renminbi becomes freely tradable internationally is as yet unknown, but the potential liquidity is obviously massive. Regardless of that timetable, maintaining a presence at the intersection of Asian market data is critical to your ability to compete successfully in a region that continues to evolve.
Another geographical point of interest is the FX activity transition underway between London and New York. While London has historically been regarded as the global center of FX trading, activity in New York has been rising sharply - largely due to the sheer density of the electronic foreign exchange trading community there (approximately double that of any other center in terms of concentration of FX traders). The shift to electronic trading and the linkage with centralized clearing have clearly played a part in this, and are now being driven by the broadening of algorithmic trading strategies beyond what many refer to as "high frequency trading" or "HFT" . Many of these strategies originated among the New York trading fraternity for use in US futures and equity markets but are now being applied to FX, which has quickly created a dense cluster of FX trading activity in the city.
How well connected are you?
As strategies broaden, one of the most striking changes in recent years has been the much wider acceptance of the idea that trading opportunities are not just found on single venues or within a single asset class. This in turn has driven a huge upsurge in "multi-asset connectivity" as trading firms position themselves in the center of numerous venues that trade both the same and diverse instrument types.
The major caveat here is the physical proximity of these firms to trading venues, data sources and their counterparties. Spending millions of dollars on cutting-edge hardware and brilliant minds producing cutting-edge software isn't a great investment if the same care and devotion is not paid to the location where the equipment is installed. As information sources proliferate, where you deploy can be even more critical than what you deploy. A key element in FX trading success is to have a presence in a location with the highest possible connectivity density in terms of trading platforms, information vendors and other traders. Right now, isolating your trading infrastructure places you out of the game, no matter how great your kit.
This need for high-information density also applies to those who are not necessarily trading FX as an asset class. The activities of central banks have created an upsurge in FX trading associated with risk management. And quantitative easing has the same ancillary impact on other asset classes as well, such as equities and futures.
Not just about the trading
A further important shift in market behavior that also plays to the strengths of high-density locations is information. Apart from the need to trade FX as part of the risk management of open positions in other asset classes, there also has been a major upsurge in the number of informational (non-trading) feeds to which participants connect.
In many cases, these are being used for other risk management functions, such as pre-trade or portfolio risk analytics. The underlying concept is that if a firm can broaden its span of awareness (both geographically and across asset classes) so that it has up-to-date information, then that is a very good way to manage risk. This informational slant on community density is becoming increasingly important and is a major driver of the growth seen in data center-based FX communities. It is also extending now to not just the raw information, but also to the same site availability of the tools (such as complex event processing) with which to analyze/process it.
This trend is part of the move towards "trade smarter - not just faster" that we noticed developing after 2007. Market participants have become increasingly aware that speed doesn't make a bad trade better. The previous emphasis on being as close as possible to a trading venue's matching engine has been superseded by a desire to have single-location access to information across a wide range of inputs from multiple markets in multiple formats (for humans as well as computers).
This has become extremely apparent to us because of the huge increase in connection requests for data feeds, news and analytics we have seen (as opposed to market trading connection requests), and was one of the factors behind the opening of our major new NY5 data center. Information begets higher-quality liquidity; a community of trading firms with a broader span of awareness creates a more desirable order flow.
Cost and speed
While accessibility and critical mass have much to recommend them, high-density trading communities also deliver two other important benefits - cost and speed. The economies of scale of having multiple trading venues and information feeds under one roof are substantial anyway. However, in a trading environment where a single trading firm might need to connect to five trading platforms, 10 data sources and 15 counterparties, they effectively lower the entry barrier to new types of trading style and strategy. Furthermore, in a dense, localized trading ecosystem, it is typically possible to make all these connections in a day, thereby reducing the time-to-cost takeout, as well as time to revenue.
Obviously this sort of environment delivers a speed advantage in the traditional latency sense because of the close proximity of all the various components. However, it also applies in the sense of time to market and agility. If a trading firm identifies a new opportunity, then it has the strongest possible motivation to capitalize on it as quickly as possible, before it is also spotted by the competition.
If the new opportunity requires a new connection, then a dense trading ecosystem is well-placed to deliver it swiftly. This would be important in a world of single-market strategies, but in one where new trading opportunities are often multi-asset and/or multi-venue in nature, it is critical.
As market structures evolve, exchanges and other trading venues have recognized the need to have a formal customer access strategy that benefits their clients and grows the client base. These firms have extended their strategies to move access points to broad bases of customers in addition to providing colocation space inside their own facilities.
As a result, at Equinix we now host some 80 different trading venues and exchanges that are quickly accessible to potentially thousands of customers. Perhaps counter intuitively, this model is driving a virtuous cycle where more customers beget more venues in one location, which in turn attracts more customers and information/analytics providers to the data center. Furthermore, the cost savings this delivers to trading venues and exchanges begets lower trading costs for customers, which make new types of strategy possible… thus begetting higher volumes, and so on...
It is apparent that the fragmented way in which FX was previously traded has changed utterly in recent years. The economies of scale, time, cost, opportunity and convenience have seen to that. Couple that with the underlying growth in FX volumes associated with the move to electronic trading and other factors, and the value proposition of these new FX trading ecosystems seems overwhelming.
Not only is this benefitting existing trading firms, venues and vendors - it is literally democratizing access to financial markets. Smaller trading groups that were previously unable to justify a data center presence now find the barriers to entry so low as to be scalable. By the same token, new niche vendors of data and analytics have inexpensive large-scale access to a massive concentration of potential clients.
Finally, new trading venues no longer have the overhead of massive infrastructure build-out to contend with before they can sign their first customer. So, the concentration of global information inside dense interconnection points has transformed these strategic facilities into the world's new financial centers of opportunity - as a new era of trading emerges.