Improved risk controls can give systematic trading firms and HFTs greater trading capacity
By James Williams – Technology vendors are constantly looking for ways to support increased activity in systematic trading. Trading firms, of which high frequency traders (HFTs) are but a sub-sect, are applying high precision engineering to shave millionths of a second off their latency profile.
One such firm, Solarflare, provides low latency software and 10GbE network solutions for precision time synchronisation for application servers in co-locations at the world’s major trading centres. It has installations in all the banks and exchanges, and many trading firms.
“For example, we power the networks at Cboe, Deutsche Boerse, Nasdaq, and the NYSE, just to name a few,” says Bruce Tolley PhD, vice president of solutions marketing at Solarflare.
Explaining the order execution, throughput and trading benefits, Tolley comments: “With various third party and open source benchmarks we can show three to four times improvement in message throughput and 50 per cent reduction in latency while maintaining very small jitter in the trading system.
“Since our solution is application transparent and supports the standard Linux API, Sockets, customers have no need to rewrite their application to take advantage of the performance benefit.”
Increasingly, systematic traders require low-latency high-performance 10GbE switch to server solutions. Results showed that in TCP testing, server-to-switch-to-server mean latency was as low as 3.6 microseconds. Solarflare recently conducted low-latency switch and adapter testing in conjunction with Arista Networks, the market leader in ultra-low latency 10GbE and cloud networking solutions, and was able to replicate the results referenced above “in a multivendor system”.
Solarflare also provides a middleware OS bypass solution named OpenOnload. The software works in combination with its 10 Gigabit server adapters to enable what is known as “kernel bypass”.
“This means we are able to eliminate the overheads and delays of the operating system by giving the network application direct access to the network hardware while maintaining protocol conformance and application transparency. NYSE was able to go from testing to operational deployment within in a matter of weeks.”
Latency is only half the story for systematic traders. Equally as important is getting access to market data. This is the fuel in the engine. Latency is irrelevant if you don’t have the data to execute a strategy. Interactive Data is a leading provider of ultra-low latency market data and trading architecture to support the growing systematic trading community. It offers 10GbE level data, providing millions of updates a second. Trading firms can choose to get a consolidated data feed, or have it piped directly from the exchange if they are a HFT.
“Between one exchange and another the data is the same. From a client’s perspective, you only have to implement the feed once. Then, whatever markets you want to add, the feed will be delivered to you in exactly the same format,” explains Henk D’Hoore (pictured), Head of Product, EMEA.
How trading firms intend to use market data will dictate whether they go down the co-location direct market route or not. But given the broad range of strategies being used, a typical systematic trader might well have one or two co-locations for certain time-sensitive strategies, and settle for a consolidated feed for others. With its 7ticks trading infrastructure, Interactive Data can support clients in a variety of ways.
“We make it our primary goal to help clients with change,” says Rob Lane, European Business Manager, Trading Solutions at Interactive Data. “If you decide to do co-location trading in Germany, great, we can facilitate that. If you decide to swap to a data centre with Interactive Data in London, no problem. If you then decide you need a consolidated data feed for Asia, we’ll do that as well. The client has the ability to change their choice of regions and asset classes as strategies change.”
“The overall 7ticks infrastructure is designed to support HFTs with its cutting edge design.
“We are able to use our 7ticks infrastructure to deliver our consolidated and direct feeds. One of our ticker plants sits at the Equinix datacentre in Slough, London which is where various liquidity pools are located,” continues Lane.
Exchanges are starting to get more involved in the provision of managed services, to both complement and compete with the likes of Interactive Data. NASDAQ OMX Group bought FTEN, a provider of real-time risk management, at the end of 2010 to improve transparency. And just last month (February 2013), the London Stock Exchange acquired two thirds of GATElab, a low latency trading solution provider, in a bid to move more into the OMS space.
“The GATElab acquisition continues to diversify our technology offering with initial projects focused on access and risk technologies. We hope to work with them to offer more services that collaboratively link in to MillenniumITs core platform technologies,” comments Nicolas Bertrand, Head of Equity & Derivatives Markets, London Stock Exchange Group.
“Some exchanges are building out a Chinese menu of services for trading firms, whereas other exchanges are starting to scale back. So it’ll be interesting to see how things develop,” says Lane.
At the heart of the evolution of electronic trading is risk management, the provision of tighter controls, and greater transparency. Incidents like the May 2010 Flash Crash need to be avoided, and that responsibility falls on all participants, from the exchanges to the clearing brokers, to market vendors and traders.
As one of the world’s leading investment banks, UBS is all too aware of the need to support systematic traders in all facets, from low latency trade execution and clearing through to risk management. Last August, it launched Quant HQ, a joint venture between the firm’s Prime Services and Direct Execution businesses.
“We invested a lot of money and effort in building the infrastructure requisite to monitor the risk checks that are demanded by the market to ensure no one is gaming the system. We want to be respectful of managing the integrity of the market place,” says Gerry Polizzi, Senior Prime Brokerage Relationship Manager for Prime Services.
Charlie Susi is Global co-Head Direct Execution. He notes that increasingly clients are not only strengthening their own internal risk controls but are asking ‘What controls do you have in place for me?’ “Systematic traders want to consult with us on how we can be their safety net. They worry about their exposures and risk controls. Likewise, we at UBS worry about them trading under our name and what controls we have in place.”
Electronic traders understand that it’s not a case of having speed over safety.
“The change in posture among the HFT community in the past two years has been profound,” observes Nick Solinger, Chief Marketing Officer at Traiana, a leading post-trade network owned by UK interdealer ICAP supporting FX, equity derivatives and exchange-traded derivatives.
“There was concern, suspicion even, when we first rolled out this solution to the market. But now I would say that demand on the buy side is greater than it is from the clearing brokers. Even the best and most sophisticated market makers still have software engineers, designing algos that can potentially go wrong. People understand the need to adopt best practices.”
Traiana has developed a kill switch solution, which prevents market order limits from being breached. By having an independent system, the clearing firm sets out its limits, the client sets its own internal rules, and both sides can monitor activity. That the buy side is embracing such solutions shows that the electronic markets are maturing.
Typically a systematic trader will send out hundreds of thousands of orders. Only a small per centage ever gets filled. Traiana’s kill switch monitors order activity on the way in and what gets filled on the way out. Because each clearing broker will set rules and limit orders for each client, if there’s a glitch in the algo and limits are breached, the kill switch automatically cancels the execution.
“It’s a high-speed real-time system. We’ve invoked the kill switch more than five times now. Twice, buy-side firms have invoked it to stop their trades because of a defect in the trading algo, twice by clearing firms because their client is in distress, and once in the case of a breached limit.”
UBS’s Susi says that Quant HQ is not just about offering low latency. “It’s about risk controls, risk management, and consulting with the client. Our role is to protect everyone and provide the right liquidity at the right time.”
Susi is part of a working group to help exchanges implement kill switches. “It’s important that they have that safety net. Systematic traders need it as well. I think, set at the right level, there should be economic disincentives for loss of orders if you have no intention of trading.
“Systematic traders are also supportive of these measures because in their minds, if there are a handful of firms doing things inefficiently it gives the whole industry a bad name. Putting controls like kills switches in place is a good thing. Everyone will adapt.”
Solinger believes that the adoption of kill switch solutions and other risk tools can directly work to the advantage of trading firms. The more risk controls in place, the more likely clearing brokers will be comfortable at extending market access and trading capability.
Says Solinger: “We have one top name client and we saw their limit get loosened dramatically once we had the real-time monitoring kill switch watching over their activity. They were able to add 10 to 40,000 additional trades a day based on the expansion of their limit capacity. So getting better risk controls gives you greater access, greater limits, and ultimately gives you greater trading opportunities.”
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