Speed is the name of the game.
In the competitive arena of trading where a microsecond delay might cause trading firms to lose an order and forfeit huge profits, spending on faster trading technology has been growing and is expected to accelerate even further in the next few years.
Its an arms race and shows no signs of abating, said David Mortimer, principal at Vodia Group LLC, Concord, Mass., a consulting firm for the financial services and financial technology industries.
In fact, a new report by the TABB Group, a financial markets research and advisory firm based in Westborough, Mass., forecasts that investment in high-speed, advanced trading infrastructure in the U.S. will climb to $1.3 billion in 2010 from $860 million this year. The bulk of the investment has been and will continue to be in the equities sector.
Based on interviews with chief investment officers, chief technology officers and data center managers at 13 of the largest brokers, Jeromee Johnson, senior analyst at the TABB Group and author of the report, said that by 2010, servers dedicated to high-performance computing will account for 34% of overall servers compared with 19% in 2006. And as appetite for faster servers continues to grow, by 2010 the average server production lifespan will fall to 2.3 years vs. 4.2 years in 2006. The biggest technology expense for bulge bracket firms is in developing networks, where trading firms typically spend 25% of overall spending in advanced trading infrastructure, Mr. Johnson said.
Changes in regulation is one of the drivers for increased investment in faster trading technologies. For example, one of the components of Regulation NMS is the order protection rule that requires trading centers to establish, maintain, and enforce written policies and procedures reasonably designed to prevent the execution of trades at prices inferior to protected quotations displayed by other trading centers, subject to an applicable exception. To be protected, a quotation must be immediately and automatically accessible. (Reg NMS was passed in June 2005 on a phased basis and is aimed at strengthening the quality of U.S. equity markets.)
Vodias Mr. Mortimer believes that speed is the only way firms can profit from stipulations like that.
As the regulations change anywhere in the world, youve got to reassess and redesign your ability to profit from the new regulations and most of (the regulations are) trying to promote quote-driven markets. And in quote-driven markets, youve got a data set of information that you can use and speed becomes more important than (in) the other kind, which is quantity-driven markets, he said.
Most of the spending is going to come from large investment banks, global hedge funds and exchanges. But TABBs Mr. Johnson said that a large number of small hedge funds and small proprietary trading companies might decide to invest in a faster technology even though it serves them for only a few months. Thats because the profits they will garner will justify even a $1 million or $2 million investment, Mr. Johnson said.
So will the money train ever stop?
Mr. Johnson and Mr. Mortimer disagree on the answer.
Mr. Mortimer believes that so long as proprietary trading revenues of Wall Street trading heavyweights like Goldman Sachs Group, Credit Suisse Group and Bank of America continue to grow, there will be no letup in investment. If revenues decline, the first reaction will be an abatement of the furious spending on trading technology.
Not likely, Mr. Johnson counters.
He said if investment banks fail to generate money from their proprietary trading technology, they will try to grow profits by offering execution services to money managers and hedge funds and charge commissions on those.
To build that business and differentiate that business, would they invest in technology? Probably. I dont see them saying Instead of doing it electronically, pick up the phone and call me, or write a letter and put it in the mail, Mr. Johnson said.