Being slower than the competition, even if only by a few milliseconds, can be costly to both brokers and exchanges, according to a new research report.
A new report released by the Tabb Group, ‘The Value of a Millisecond: Finding the Optimal Speed of a Trading Infrastructure’ has highlighted the importance of low latency for exchanges and electronic communication networks (ECNs) as they battle for market share.
The report claims that 16% of all US institutional equity commissions are affected by latency risk, totalling $2 billion in annual revenue.
“The benchmarks for speed have reduced latency in exponential terms,” comments Willy Reporter, author of the report and senior consultant at Tabb Group. “Open outcry was measured in seconds, whereas electronic venues now boast matching capabilities in microseconds – and the stakes are high.”
He also noted that as matching engines within newer execution-venue infrastructures move into single-digit-microsecond capabilities, this competitive advantage will need to be equalled by the traditional exchanges. If it isn’t, Reporter believes, “the 8% loss of market share experienced by other execution venues in 2007 will only continue to grow.”
For US equity electronic-trading brokerages, handling the speed of the market is critically important, as Reporter believes that latency impedes a broker’s ability to provide best execution.
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, explains Reporter. “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.”
In terms of IT spending on messaging infrastructure, Tabb Group does not foresee any major increases in the near future as a reduction in maintaining legacy investments is forecasted. However, it is predicted that low-latency expenditures will almost double, from just under $100 million to $170 million by 2010.
“Governance is lacking when front- and mid-office latency concerns are addressed without including back-office concerns such as risk management.” adds Adam Sussman, director of research at Tabb Group, “But dealing with overall performance is like the classic ‘Whac-a-Mole’ game: hammer down one problem and another pops up somewhere else.”
The research note investigates how various functions within the trading world, from execution venues to brokers, are now dependent on the speed of the trading infrastructure. The research also addresses the role of smart order routing and focuses on recent advancements within messaging and its related touch points. These include the ability to tune the interaction of the applications to find an optimal balance between the three major causes of latency, and the negative impact each has on business functions.