Could exchanges’ data centre migrations leave participants subject to latency arbitrage?

Data centre moves by Euronext and SIX Swiss Exchange could increase implicit costs by allowing larger firms with faster connections to take advantage, says Cowen’s James Baugh.

With Euronext’s data centre due to migrate from Basildon in the UK to Bergamo in Italy on 6 June it’s opened up for question whether venues’ new data centre locations could leave some participants at a disadvantage.

The move will take Euronext 600 miles from its current location and from the London-base concentration of MTF matching engines. According to big xyt data shared exclusively with The TRADE, this will add around six milliseconds to round trip latency between it and other multilateral trading facilities (MTFs).

Geographical distance from the London regional data centre is the biggest contributor to differences in European Best Bid Offer (EBBO) between various venues, big xyt found.

It goes without saying that those trading firms with the fastest connections have greater opportunities to take advantage of large distances between venues trading the same instrument and this could increase implicit costs when trading those instruments.

“Today when executing in names where the primary data centre is dispersed like in Scandinavia or Switzerland i.e., where the domestic market is operated locally and not in London like the alternative MTFs (and Euronext today), we do see a degradation in pre and post trade performance,” said Cowen’s head of European market structure, James Baugh.

“As an interesting proxy to market fragmentation post-Brexit when UK venues were allowed to restart executing in Swiss names, we did notice an increase in implicit costs when trading Swiss shares, particularly in smaller sizes.”

For Baugh, the subsequent increase to implicit costs could see participants opt for alternative execution channels that are less subject to latency arbitrage and distance – aka dark books.

“This could drive more business away from those lit markets which are considered more toxic – those very markets Euronext is so keen to protect. Although to be fair, post-Brexit it makes little political sense for Euronext to continue to run their markets from London,” added Baugh.

Euronext, alongside other incumbent European exchanges, have been vocal in their preference for lit and transparent markets and this outlook has been effectively translated into recent regulatory updates made by the European Commission and ESMA.

Updates including limiting the systematic internaliser (SI) regime and introducing a new blanket double volume cap (DVC) for dark trading – both areas that the UK has been decidedly more flexible on in a bid to foster competition in its markets post-Brexit.

However, Euronext disregarded claims their move to Bergamo would increase costs. Instead suggesting that as the venue is moving from a single provider setup to an open model, this would improve cost efficiencies and ensure competitiveness by giving users a “choice in terms of connectivity”.

“Using empirical data from a number of market quality providers, it is clear that the market quality of large primary venues whose data centre is located on the continent does not suffer from the geographical distance from London,” the exchange told The TRADE.

“As such it is not anticipated that the implicit costs will rise as a result of the Euronext move. In addition, Euronext operates a number of liquidity programmes which can be adjusted to address any deviations in terms of liquidity dynamics.”

SIX Swiss Exchange names could be subject to the same fate with both its data centre and Bolsa y Mercados Españole’s (BME), which it acquired in June 2020.

SIX Swiss had not responded to a request for comment at the time of publishing.