By Ashley Atkins,
business development director,
Finance at Level 3
The way the markets trade has changed dramatically. Business which was once done by steely East End market traders, adept at calculating fast changing figures and securing the best price by shouting across a room, is now carried out almost entirely electronically. The market floor is gradually becoming obsolete as traders, locked to their Bloomberg terminal, feed an incessant stream of data into complex algorithms. Financial returns are increasingly tied to minute split second fluctuations of fast shifting baskets of currencies, commodities and other complex financial vehicles. In the information age, hundredths of millions of seconds can mean differences of millions of pounds.
This phenomenon has given rise to many terms de jour – high-frequency trading, hyper-frequency trading and Flash Trading are just a few, but they all have one factor in common; using volume trades in very specific windows of time to de-risk financial positions. Since the Securities and Exchange Commission authorised electronic trading in 1999, when it took several seconds to make a single trade, growth has been stratospheric. In the US, despite high frequency trading organisations representing just two per cent of all firms, high frequency trades represent around 73 per cent of all equity volumes. The Bank of England estimates similarly high percentages, estimating that 40 per cent of all equity trades come from high frequency traders. While the figures are lower across Asia, the opportunity for growth has already been marked as significant.
This intensification has of course been driven ultimately by the desire for greater profits, enabled by the law of accelerating change in technology. In a nutshell, this states that development will continue on an ever increasing growth curve, making processes faster and more efficient. Nowhere is this truer than in the delivery of low-latency connectivity to the financial sector, a sector within a sector where there is currently something of an arms race taking place.
Providers of all types of high-speed connectivity products and services in the financial space are now competing against one another in terms of latency. In a world where fractions of seconds mean better profits and less risk, latency has become the watchword of the efficient trader. Providers of this type of connectivity to the financial services market are now differentiating themselves in terms of milliseconds and even microseconds. Far from being the small difference it first appears, banks, hedge funds, boutique organisations and even day traders are investing in once relatively obscure technological products. The willingness of these organisations to pay substantial premiums to have their servers located just inches closer to that of the major trading platforms is a case in point.
From a carrier infrastructure point of view, providing low latency routes to support this burgeoning market has come into sharp focus. In lay terms, fast connectivity to transfer vast quantities of data from A to B quickly and reliably is in demand. Fibre is being bought and streets are being dug up around the City of London in order to reduce the physical distance laser light has to travel, in essence ‘straightening out the kinks’ in networks to reduce transport time. There are even tales of technologically minded traders asking for a reduction in the amount of times a fibre route travels around manholes, anything to shave off a few vital micro-seconds.
The rhetoric used by many financial exchanges relating to the time it takes to complete transactions has only served to feed this hunger for ever-faster routes. With exchanges offering up to three millisecond turnaround times for trades, the pressure is firmly on for providers of the underlying low latency infrastructure to not only be fast, but also reliable. Both of these factors allow traders to
effectively calculate reliable performance ranges for increasingly complex financial instruments. A predictable return on investment is vital as is de-risking the trading process at a time of financial instability. Every link in the delivery chain is closely scrutinised to ensure it plays its part in this mitigation. In essence, low latency connectivity is a part of a traders risk management strategy. Despite what the media says, trading is intrinsically linked to mitigating risk and removing the element of the unknown. Low latency connectivity now plays an ever-important piece in this puzzle.
Thus, the importance of low latency to the financial sector is unquestionably not in doubt. This means there has subsequently been a boom in network infrastructure investment and advances are currently largely taking place on two levels. The first involves the manipulation of laser light using electronics, with the aim of helping the light maintain an efficient and non-degraded shape. This obviously requires complex mathematical and mechanical knowledge and is currently developing apace. Secondly, there is the less technical approach of buying fibre on alternate routes and physically decreasing route distance between two points with the aim of decreasing transfer times. It is estimated that for every 20 km removed from a route, a saving of 0.1 m/s is made. So in a world where milliseconds matter, this is still a very viable option.
However, as ever more infinitesimal changes are made to networks in order to gain minute speed advantages an apogee will ultimately be reached. The limits of speed are defined by the physical laws of science and there are only so many upgrades which can be made to reduce latency, until a wall is eventually hit. Ultimately, this means that eventually a point of absolute minimum latency will be reached when infrastructure providers will have optimised their network to its zenith.
Once this point is reached other differentiators will undoubtedly come to the fore and, with no difference between connectivity rates, these factors will play a part in marking particular services apart.
Allowing traders to diversify their portfolios geographically is something that will play a major part in differentiating services. Once minimal latency is finally attained on key financial routes such as Chicago, New York, London and Frankfurt, providing similar connectivity over a wider global spread will become key. Ensuring low latency connectivity to trading platforms in supporting financial centres such as Stockholm, Paris and Madrid will allow diversification of trading strategies. It will also open up an increased range of options and ultimately providing more opportunities for profit. The race for low latency connectivity will doubtless spread to these additional routes as financial organisations become ever keener to make high-quality routes the default standard for the industry. Gradually, de-risked highly complex trades will become possible regardless of location.
In addition to this, service levels will also become a very important part of the mix. Once the ‘need for speed’ has been satisfied and increased geographical networks are underway, customers will turn their focus to quality of service and delivery to strict service level agreements. This will essentially commoditise low latency connectivity to a point where providers are measured on the breadth and quality on their offering, as much as on latency. However, this is obviously still some way off, with the unquenchable desire for low latency still very much at the front of traders’ minds.