According to TABB Group in a new research note, “The Value of a Millisecond: Finding the Optimal Speed of a Trading Infrastructure,” the ability to quickly receive, manage and relay order book information has become critically important to the competitiveness of exchanges and electronic communication networks (ECNs).
This has lead exchanges to evolve toward the newer ECN model, which is why TABB Group estimates that 56% of all exchange revenues are exposed in 2008 to latency risk, up from 22% in 2003.
“It’s about time-to-market, literally. The benchmarks for speed have reduced latency in exponential terms. Open outcry was measured in seconds, whereas electronic venues now boast matching capabilities in microseconds and the stakes are high,” says Willy Reporter, senior consultant at TABB Group and author of the research note.
As matching engines within newer execution-venue infrastructures move into single-digit microsecond capabilities, this competitive advantage will need to be equaled by the traditional exchanges “or the 8% loss of market share experienced by other execution venues in 2007 will only continue to grow,” says Reporter.
For US equity electronic-trading brokerages, handling the speed of the market is of critical importance, because “latency impedes a broker’s ability to provide best execution. In 2008, 16% of all US institutional equity commissions are exposed to latency risk, totaling $2 billion in revenue,” adds Reporter.
As in the Indy 500, the value of time for a trading desk is decidedly non-linear, Reporter says, and accordingly, TABB Group estimates that if, for example, an agency-broker’s electronic trading platform was five milliseconds behind the competition, it could lose at least 1% of its low-touch flow, putting the industry-wide value of those first five milliseconds at $4 million each.
Up to 10 milliseconds of latency could result in a corresponding 10% drop in revenues, and from there it gets worse. “If a broker is 100 milliseconds slower than the fastest broker, it may as well shut down its FIX engine and give up on offering low-touch business,” says Reporter.
While overall IT spending specifically on messaging infrastructure is expected to remain flat approximately $1.8 billion through 2010 due to a reduction in maintaining legacy investments while shifting resources toward improving latency-related management TABB Group estimates that low-latency expenditures will almost double, from under $100 million currently to about $170 million by 2010.
As the markets continue to race ahead due to the technological improvements in analysing and executing trades, participants on both sides of the trade need equally fast market- and operational risk-management capabilities or the consequences will “net” a dire result at the most inopportune time. “Governance is lacking when front- and mid-office latency concerns are addressed without including back-office concerns such as risk management,” says Reporter.
“But dealing with overall performance is like the classic ‘Whac-a-Mole’ game. Hammer down one problem and another pops up somewhere else,” adds
Adam Sussman, director of research, TABB Group.