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In this article, Mike O’Hara and Adam Cox of The Realization Group look at how regulation and technological advances are encouraging the buy-side to take matters into their own hands when it comes to trading infrastructure. Mike & Adam speak with Brian Ross of FIX Flyer, Jacob Loveless at Lucera and Stuart Turnham of Equinix. The benefits for buy-side players from this trend extend well beyond cost. As power shifts away from the sell-side and buy-side firms broaden their horizons in terms of connectivity, they are finding that new trading possibilities quickly open up. In a world where electronification is still spreading into new asset classes, agility is very much the name of the game.
Technology and regulation are changing the way the market works in fundamental ways, and one of the areas where that change is most starkly visible is in the relationships between the buy-side, sell-side and vendor community. As regulators demand greater transparency and new technology offers more opportunities, large buy-side participants are suddenly finding they have far more choice when it comes to market access and how they do business.
This dynamic is seen clearly in a newfound focus on connectivity. Regulatory change is pushing the sell-side to unbundle its offerings, which in turn is prompting investment firms to consider arranging their own connectivity and ancillary services. In such an environment, large buy-side participants may be taking on some new costs but they are also reducing others. More importantly, they are gaining control.
In the not-too-distant past, a medium-sized buy-side firm had limited choices when it came to market connectivity. Brokers, and the OMS and EMS vendors they worked with, offered connectivity at a certain price and that pretty much was that.
“Buy-sides will look for cheaper connectivity solutions as they take on the cost and then will likely explore alternative trading partners to find the best liquidity choices.”
Brian Ross, CEO of FIX Flyer
But as the sell-side is being forced to itemise its services and charge for them separately, and as cloud-computing technology changes the very nature of the market infrastructure, buy-side firms are starting to see a new array of choices. Fixed connectivity on demand and the use of cross-connects are just two of the ways that they can change the way they access the market.
“Buy-side participants that today are already in the cloud using shared services for most of their IT needs are going to start looking for other connectivity models once they have to pay the bill,” says Brian Ross, CEO of FIX Flyer. “Buy-sides will look for cheaper connectivity solutions as they take on the cost and then will likely explore alternative trading partners to find the best liquidity choices.”
Stuart Turnham, Director of Enterprise and Financial Services for EMEA at Equinix, has noticed a similar change in the power dynamic.
“Changing the market conditions has created an environment where financial services firms feel comfortable with the idea of outsourcing and open purchasing data centre and interconnection services directly from a colocation provider or technology services vendor colocated in the same data centre. We have seen this first hand with our buy-side clients, who are now in more of a powerful position in the market, when it comes to IT architecture,” Turnham says.
Cloud computing, Turnham says, effectively creates a kind of infrastructure shop whereby a lot of firms can plug and play. “Once regulation is defined and security concerns are mitigated many financial services business applications and IT workloads will move to cloud-based platforms, including public cloud services. This will enable many buy-side firms to renovate existing IT models proving insufficient for the task post Basel III – and therefore be agile enough to enter new markets globally directly and not always have to rely on a brokerage arm.”
“The buy-side are now in more of a power position in the market, when it comes to IT architecture.”
Stuart Turnham, Director of Enterprise & Financial Services for EMEA at Equinix
Equinix, the leading global data centre and interconnection provider, is seeing an increase in the number of direct relationships it has with buy-side firms, including hedge funds and traditional asset managers. Outside the core product offering, the company finds itself essentially acting as a concierge, using it’s colocation facilities as a meeting place for which to directly connect market participants in close proximity to the supply chain members, counterparties, customers and partners they need to, across multiple asset classes.
Turnham says buy-siders’ increased desire to take matters into their own hands appears to stem from two issues. “Increased business agility and cost control over their own infrastructure,” he says.
“In today’s world this is possible, as it’s a lot easier to provision the deployment of IT infrastructure to the architecture you desire than it used to be.”
But it is not only the ease with which the buy-side can deploy infrastructure that is putting the focus on costs. It is also due to a change in the way different firms work with each other. “The buy-side is effectively going to be looking at costs more,” Ross of FIX Flyer says.
“In the past, they didn’t push back on vendors because the sell-side, in the end, was paying for things, whereas now they have to look at more efficient models themselves.”
Ross says buy-side participants may not have focused on connectivity costs because they were using an outsourcing model in terms of their OMS or EMS providers. “A lot of them outsource their IT to essentially virtualised environments in the cloud. I think now they’re actually going to start looking at those costs a little more closely.”
In other words, the costs were always there. They simply weren’t always so visible to buy-side participants.
“They’ve probably ignored them in the past because they were likely getting paid through commissions or getting paid through the sell-side,” Ross says. “Now you start looking at different opportunities.”
Once a buy-side participant starts to take responsibility for its connectivity and infrastructure, it starts to consider ways to enhance its performance.
“Since the trading infrastructure is no longer being paid for by a specific broker it opens the door to saying, ‘I can go to more partners and get better execution.’ I think that’s really where a change in connectivity has to happen,” Ross says.
Of course, with great buy-side power comes great buy-side responsibility.
“From a regulatory standpoint, across the whole of financial services there’s more reporting and compliance required than ever before,” Turnham of Equinix says.
This translates to a larger, and much more complex, flow of data that needs to be captured, analysed, stored and distributed.
“As a lot of this data is associated with more rigorous valutation processes and portfolio analysis, it is starting to need to be reported to the regulators much faster and in much more detail and although buy-side firms are adapting to these market conditions, many of their existing IT models are not – in particular those relying on batch jobs and excel spreadsheets – as firms will require more computer power and data storage capacity than their current infrastructure and system architectures can provide”, Turnham says. “For them to invest in their own adequate infrastructure and technology maintenance, it would prove too costly an exercise, so they are looking to cloud computing – especially infrastructure-as-a-service and more niche software-as-a-service cloud providers – to help.”
In this brave new world of buy-side power, it may be helpful to think about what exact role technology plays for investment firms.
“We do three things in technology,” Jacob Loveless, CEO at infrastructure-as-a-service provider Lucera, says. “We move data, we work on data and we store data. That’s it. That’s our entire industry. There are networking companies, compute companies and storage companies. So making those three functions consumable as a service, that’s infrastructure-as-a-service. Then everything layers on top of that.”
“The most economical model for these things is for shared utilities that you pay for on a consumption basis. So it’s absolutely going to happen. Economics will force it to happen.”
Jacob Loveless, CEO at Lucera
Lucera sees the movement towards shared services as something that goes beyond the buy-side and is part of a larger picture, one where standardisation and market economics lead to efficiency.
For instance, a FIX engine is now commoditised so there is little commercial advantage to be had from differentiation.
“It’s a utility,” Loveless says. “There’s a reason why we don’t all have our own power generators. The most economical model for these things is for shared utilities that you pay for on a consumption basis. So it’s absolutely going to happen. Economics will force it to happen. It’s just a question of when.”
That question of when, thanks to regulatory pressure, seems to be now. Ross says MiFID II is pushing market participants to focus on their trading operations. “That’s the door for cloud providers with infrastructure/software/connectivity as a service, which can help buy-side and sell-side move from a CapEx to an efficient Opex model.”
The regulatory impetus towards new forms of connectivity is part of a broader drive to give the buy-side more choice.
For instance, MiFID II is encouraging the trend by pushing for the unbundling of research from other brokerage services. Ross says that unbundling may encourage buy-side participants to expand their trading partners, which in turn could lead to a rethink of the FIX connectivity price models that have been around for a decade or more.
“If there are cheaper ways to do it, then people are going to be a little bit more cognitive of that,” Ross says. “The whole MiFID II piece is about better trading models and that comes with lowering overhead and being able to be more efficient there. So the cloud vendors are going to start changing the way FIX is handled, it won’t just be controlled by network providers and EMS/OMS vendors going into that space.”
But just because buy-side firms may want to cut out the ‘middle-man’ cost that a broker or EMS/OMS vendor represents, that does not mean they want to be managing a huge number of relationships themselves.
The end game appears to be one where the utility model dominates. This, according to Loveless, is where a firm essentially wants it to work like indoor plumbing, just turn it on and it works. Firms don’t want to deal with the complexity and the cost of managing 30, 40, 50 connections either locally in the data centre or across data centres.
Loveless says the hedge fund community has been at the forefront of this trend, recognising that the network is not necessarily a differentiator, and saving costs along the way.
“More than that, it buys you time to market. If I can spin up a client with the click of a button, that’s going to make a material impact on a business where spinning up a client used to take 45 days. That time to market is a powerful tool.”
In addition to the time-to-market factor is the flexibility in terms of services that comes with outsourcing. “It means you’re not stuck with long-term decisions,” Loveless added. “You’re not making a one-year, two-year, three-year commitment there. You’re clicking a button, you’re enabling a service, you’re trying it for a little while and if it works, you keep it. If not, you delete it.”
It also is not just regulation and technology that are driving change. The post-crisis policy imperative for ultra-low interest rates has, in an indirect way, played a role.
“We are in really the sixth year of the nuclear winter of low interest rates,” Loveless says.
This situation has meant that volatility – with the occasional jolt of market turmoil notwithstanding – has generally been low as well, which has placed the onus on firms to find other ways to boost performance. Broader connectivity is one such way.
“If you want to get better execution in foreign exchange, you’re not talking about connecting to five, six, seven places. You’re talking about connecting to 50, 60, 70 places and that’s just a different class of problem,” Loveless says. “You have low vol, you’re going to do some cost savings but really you want to just try to weather the storm”.
For the buy-side, the upside of trading new markets and the downside of having to deal with a more complex IT challenge creates a strong incentive for managed services.
Turnham says provisioning infrastructure can sometimes be “a bit of a complex, long and inhibitive procedure”, referring to buy-side participants that can have smaller IT departments.
“As mentioned we are seeing buy-sides deploy IT infrastructure more directly with data centre providers, but at the same time we are seeing the market leverage third party technology vendors and managed services in new geographic markets or additional asset classes.”
He adds: “Long term it is simply going to become too costly and innovatively prohibitive to maintain/provision all you need in-house.”
That has prompted buy-side firms to “multi-source” the niche providers that best fit with the applications and IT workloads the business requires. Echoing the themes that both FIX Flyer and Lucera highlight, Turnham identifies two important reasons for this.
The first is performance. “ A cloud services provider can focus on the delivery of its services as its core discipline and therefore is going to provision those services to the highest standards and SLA accordingly, often better than anyone could in-house.”
A second is agility, which he says will become increasingly important in financial services.
“As people go in and out of markets and as electronic trading truly moves across multiple asset classes, you’re going to see market participants want to spin up and shut down new application and systems, trial new algorithms and enter new geographic markets within very short periods, almost overnight.”
If investment firms are having to rely on their own IT departments to deploy technology in a geography that’s not native, it will often take too long and firms might miss the very market opportunity they were wanting to develop a business strategy around in the first place, meaning they will not be able to capitalise as quickly as if they were multi-sourcing what they needed from specialist providers, cloud and collocation providers to do that, he says.
Loveless of Lucera adds that relying on shared services offers one more, very important benefit: it can boost technological performance.
“We have this really interesting thing that has happened in the last seven or eight years. Network I/O continues to dramatically outstrip disc I/O. Given large amounts of scale out of a system, and lots of network connectivity, you’ll be able to read from a system faster than you’ll be able to read from a local disc. If I take your raw data and I split it across 100 servers and then I give you 10 gig cross-connects – which costs basically nothing – you’re going to be able to read that data faster from me than you’re going to be able to read it from yourself.”
Mastering the markets has long been a matter of mastering the networks – both human and technological – that make them up. What is different now is that the technological networks have changed so radically in the past few years. Any firm that has not moved with the change may find itself at a distinct disadvantage.
That may come from the higher costs and diminished flexibility arising from overreliance on sell-side brokers, or it may come from the reduced performance and agility stemming from using outdated systems. But for the firms that embrace their newfound power, a very different picture emerges. It’s a picture based on having more choices and gaining more control.
The Realization Group spoke with one top executive at a tech-oriented quantitative fund to hear his views on how the trading landscape is changing, both for his fund and others.
Connectivity trends
Complete reliance on brokers for trading connectivity solutions is rarer now. Broker-neutral solutions began to become more popular as much as 10 years ago and are now common. “I don’t see that particularly going away,” the executive said. His firm puts all of its brokers on a broker-neutral platform.
OMS/EMS solutions
A lot of funds are still using legacy EMS/OMS systems. “We’ve actually built our own, which in a way is cloud based in that we host part of it in AWS (Amazon Web Services).”
Cloud usage
This fund uses the cloud extensively for research, post-trade analysis, TCA and similar work. “We haven’t shifted any core info there or any trading there, but we’ve essentially used that as the centre of our research infrastructure.” The executive knew of other quant firms increasingly using the cloud, not only start-ups but also established multi-billion-dollar firms. “I definitely see that’s the way.” Cloud providers allowed for more flexibility, particularly as funds took a hybrid approach, as his fund did.
The community
“I find it interesting talking to other COOs who are a lot less tech-focused on how old-school their infrastructures are… There are still people out there who have their own data centres and things like that – which is very, very 1990s.”
What’s needed for greater adoption of new technology?
The fund executive summed it up in one word: education. That applied both to regulators and their potential misconceptions and to investors as they needed to recognise the importance of technology/vendor due diligence.
