Is Technology to Blame for Rigged Trading?
Using telecom technology to cheat Wall Street investors? I'm shocked, shocked, I say. But is the technology at fault, or the way it's being used? And what will this mean for the future of collocation and low-latency services targeting the financial services community?
Having repeatedly written stories of how financial services companies and traders were driving telecom network operators to deploy more high-speed, low-latency fiber-based services to gain an advantage, often calculated in milliseconds, in the trading of stocks, I wasn't entirely surprised to hear the 60 Minutes report Sunday that some of the high-speed high jinx weren't exactly fair… though not illegal. It's not clear to me whether what is unfair is not the speed of the trade or the information being obtained.
In an interview of author Michael Lewis, on the show to promote his upcoming book, Flash Boys, the CBS news program showed how some traders buy high-speed services and collocate their servers in the same data centers as financial exchanges in order to gain faster access to trading than the average investment company or investor.
Those high-speed traders are trying to gain millisecond advantages in the timing of their trades, and are able to detect incoming orders and essentially place their own orders in faster, thus jumping the line and driving up the cost of at least part of an original trade.
As one of those interviewed, Brad Katsuyama, who once headed the Royal Bank of Canada's investment team, explained it, the process would be like ordering tickets online and having someone able to see your request for four tickets, jump in line ahead of you and drive up the cost of two of those tickets before your order is completed.
Interestingly, Katsuyama -- who was the hero of the 60 Minutes piece -- got fed up and left the RBC to create his own exchange, IEX Group Inc., which literally uses long lengths of spooled fiber-optic cable, contained in its trading platform, to inject 350 microseconds of delay into all trades, thus eliminating the high-speed trader advantage.
So, using technology to combat a technological advantage -- quite clever.
As this Bloomberg BusinessWeek article notes, New York State Attorney General Eric Schneiderman is looking into whether it's legal to sell products and services which offer faster access to data and richer information on trades than is available to the public.
It's this "richer information" part that has me a little confused. If anyone who wants to buy faster high-speed links and pay for collocation space can do so, bearing that not-inconsiderable cost, that isn’t an unfair advantage. But if, by doing so, companies are able to gain access to information from those exchanges on other incoming orders, and to short-cut their way in front of those orders, that hardly seems right or legal.
The impact of Lewis's book and any resulting investigations on the sale of low-latency and collocation service to the financial trading industry -- a very lucrative target market and anchor tenant for many telecom players -- will be fascinating to follow. Of course, the bigger impact will be on the American equity markets. As Bloomberg notes, the volume of trading on the major US exchanges is three times as great today as it was in the go-go '90s, and that's a lot of money changing hands and a lot of income being generated for traders in the process.
— Carol Wilson, Editor-at-Large, Light Reading