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Trading in Europe: Coping with Change

Published in Automated Trader Magazine Issue 21 Q2 2011

By their nature markets are seldom static, but the current situation in Europe appears both particularly fluid and demanding. Mergers between trading venues, new market participants, new trading strategies and new attitudes to latency all have the potential to consume time and resources. But as Patrick Lastennet, Director Financial Services Segment at Interxion explains, there is a better way.

At present, hardly a day seems to pass in Europe without some new initiative or change in the trading landscape. Fascinating as this may be to the casual observer, for organisations that simply wish to focus on their core trading expertise, it potentially represents a major headache. Making connections to new markets or dealing with the connectivity consequences of market mergers can quickly burn up resources if handled in house, as well as proving a distraction from the business of trading.

Three key attributes

However, this situation is not inevitable; if an external provider can offer three key attributes, trading firms can insulate themselves from the consequences of European change, both now and in the future.

The first of these key attributes is centralised connectivity; assembling and maintaining connectivity to multiple liquidity venues on a piecemeal basis in house is a major undertaking. If an external provider has the 'critical mass' to be able to offer a wide range of connectivity to all the desired trading venues and trading technology under one roof, then both cost and complexity can be massively reduced without compromising on performance.

However, this alone is insufficient; a shed full of connections plus some generic telecoms knowledge is not a complete trading connectivity solution. Any credible facility provider must also have the second key attribute - niche expertise. Centralised interconnectivity, plus a deep understanding of available trading venues and technology, is the vital combination that can deliver painless access to pan-European trading.

Figure 1

Figure 1

This degree of expertise also increases the probability of a provider delivering proactive rather than just reactive solutions. For example, a recent hire by Interxion realised that many German institutional investors were in need of streamlined access to Deutsche Börse Group's trading systems. This resulted in the March launch of a fully managed, shared access solution for DBAG's trading systems at Interxion's Frankfurt data centre, which has significantly reduced both the cost and complexity of connectivity for participants.

The third and final attribute is for a Data Centre provider to be hosting liquidity venues' matching engines or access points within its facility. This not only ensures ease of access, but also delivers consistent multi-market low latency in a single location, which in turn hugely simplifies the trading/connectivity process as well as facilitating the implementation of multi-asset strategies (see "Strategy expansion" below).

Exchange liaisons

One of the greatest challenges currently confronting market participants in Europe is the change in landscape, with the BATS/Chi-X merger being just one example. Any merger (or the emergence of a credible new trading venue) has significant connectivity consequences. With the exception of liquidity providers or ultra high frequency firms whose in house connectivity expertise is a matter of competitive advantage, the majority of market participants would ultimately benefit from this being handled by an external specialist. A centralised point of connectivity that can simply deal with all the necessary (re)plumbing on their behalf is the obvious remedy.

However, much depends upon market coverage. If two venues merge and consolidate onto one trading platform for which the data centre cannot offer a point of presence (or can only deliver indifferent latency performance) little is gained. The obvious ideal is for any point of connectivity to be hosting the maximum number of trading venue access points with the minimum latency to each (or better still the actual trading engines).

This flexibility advantage also applies when an existing venue makes a significant technology change. For example, when NYSE Euronext moved its European trading operations from London and Paris to Essex in 2010, Interxion's clients were largely unaffected because they could continue using the same infrastructure - NYSE Euronext's SFTI PoPs, located in Interxion's London, Paris, Amsterdam and Brussels data centres - to access the exchange's matching engines. This degree of flexibility is a core business objective to ensure that clients using facilities such as Interxion's City of London location will always benefit from fast connectivity to multiple markets whether trading venues, consolidate, fragment or even relocate (see Figure 1).

Strategy expansion

The decline in trading costs post-MiFID has had important implications for the type and range of trading strategies that can be employed:

• Existing trading strategies that were previously not commercially viable can now be profitably deployed because of lower marginal costs.

• An increasing number of participants are now looking to diversify away from strategies that are the focus of 'crowd' activity - they do not wish to be chasing the same inefficiencies as others.

In both cases, these strategies typically require access to multiple venues; where pairs trades might once have required access to two equity markets in different countries plus an FX venue for hedging, these more complex multi leg and multi venue strategies place a premium on centralisation. In many cases this centralisation is effectively mandatory; without it, the strategies cannot be traded profitably.

The corollary to this is that as the profitable half life of trading strategies continues to decline, the time taken to deploy a new strategy becomes increasingly critical. In this context, a facility provider offering a centralised point of connectivity backed by segment expertise is a far more attractive option than having to deal with all the necessary market plumbing in house or via a generic facility provider.

Server Farm

Latency attitudes

It has become increasingly apparent that industry attitudes to latency are changing. While there are those whose entire business model depends upon the absolute minimum latency, many others are now questioning their need to compete in this space. For them, the focus is now on balancing the costs of minimising latency with maximising profitability. When doing so they are increasingly concluding that independently maintaining their own connections and full colocation with multiple trading venues simply cannot be justified.

Some may adopt a 'half way house' by keeping the most latency sensitive items (such as their decision making engines) in the exchange data centres, while less sensitive items (such as pricing and risk engines) in an alternative location.

Nevertheless, when doing so, they need to have confidence in the scalability of their data centre provider; they obviously do not wish to be forced to fragment their trading infrastructure across multiple locations because their provider ran out of space or power. For this reason Interxion places a lot of emphasis on its ability to deliver scalability of space and high-density power in all strategic European markets.

However - particularly where firms' strategies require access to multiple markets but are not massively latency-sensitive - they are often concluding that their trading infrastructure can be centralised in a single location as long as it can provide sufficiently fast access to the desired markets. In this respect, much depends upon where the trading decision is made. Some strategies demand a trading decision as close as possible to a single market, whilst other strategies (e.g. inter market arbitrage) may use a central point between the markets involved to collect the market data, make a trading decision and then execute on the venue of choice.

A major consideration when deciding which provider to use for this purpose is not just minimum latency, but consistent latency. They will have stress tested their models so they know they are likely to prove profitable under certain latency assumptions, but this risk/P&L testing will be irrelevant if any of the providers and applications along the value chain deviate from expected performance levels.

Patrick Lastennet

Patrick Lastennet

Newcomers, partnerships and ecosystems

Another notable recent change in European markets has been the expanding demographic. Those such as conventional asset managers that might previously have traded equities by phone with their brokers' execution desks or left FX hedging to their custodians are considering a more hands on approach.

In most cases these new participants do not have extensive in house technology resources and will be looking to buy not build. Therefore, anything that can smooth their path to efficient market access is welcome so they are often looking for a fully managed service that will allow them to connect to multiple exchanges through a single interface.

To deliver this service whilst maintaining neutrality, Interxion hosts a large number of industry leading managed services vendors capable of aggregating the numerous trading venue connections under one roof. However, for many new clients availability is only part of the picture; they also need consultancy to arrive at the best possible solution for their particular needs. Again, this is where the niche expertise mentioned earlier is invaluable; once a client's business and trading processes are clearly understood, it is possible to recommend a combination of services and technology on a completely neutral basis that is a best fit for their requirements.

This combination of facilities and expertise also has a longer term benefit for all categories of market participant - the evolution of a trading ecosystem. Once a centralised point of trading access reaches critical mass it starts to attract more vendors, trading venues and trading firms and a virtuous circle of greater liquidity, lower cost and improved access results. This has recently been particularly apparent with European trading platforms; for example Burgundy recently went live in Interxion's Stockholm data centre and saw its market share rise rapidly from 4% to more than 7%, while both the SIX Swiss Exchange and Bolsa de Madrid have opened access points in our Zurich and London data centres respectively. A similar ecosystem mindset applies to trading technology vendors; in recent years, Quod Financial, ICF Systems, Fixnetix, QuantHouse, Algo Technologies, NYSE Technologies and Interactive Data have (among others) chosen to collaborate with Interxion.

Conclusion

The European trading landscape has changed almost beyond recognition over the past five years and may well change as much again (or more) in the coming five. Coping with this change does not have to be a hugely disruptive or expensive undertaking; choosing the right data centre provider to enable multi market connectivity can effectively future proof your trading infrastructure, leaving you free to focus on your core business. That provider should be able to offer the right combination of facilities, technology, partnerships and expertise. Determining if they can actually deliver these involves asking the right questions; the provider with the right answers is hopefully already apparent...

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