demystifying exchange colocation

8/6/2019 Demystifying Exchange Colocation

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Demystifying exchange colocationJune 2011

A f a

a-tm grup

Researched and written by:


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Demystifying exchange colocation

An industry brieing prepAred bya-team gRoUP or nyse technologies 2

irduColocation has established itsel as the access mechanism or trading rms requiring the

astest possible execution. Its widely accepted that or rms wanting the lowest latency

access to a specic market there is no substitute or placing their trading applications as

close as possible to the matching engines themselves, making it the solution o choice or all

but those ocusing on multi-venue multi-location arbitrage.

But the perception to date has been and justiably so - that exchange colocation is

a premium service reserved or the larger institutions. For many smaller and remote

practitioners hedge unds and prop traders who lack the IT resource normally associated

with colocation cost is a prohibitive actor in their decision whether to colocate.

New exchange technologies, however, are allowing venues to help ease the burden o

colocation or these players. By packaging technology-based services into entry-level

oerings, innovative exchanges are lowering the cost o entry and allowing smaller players

to compete on a level playing eld with their larger rivals.

This paper discusses the key drivers, benets and challenges associated with the trend

toward colocation. It describes key actors practitioners should take into account in their

assessment o colocation possibilities, and suggests that rms should take a close look at

the acilities and potential community aspects on oer.


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K P: Colocationneednotbeasdifcultorasexpensiveasiswidelybelieved.

Colocationisasuperiorconnectivitysolutioninpurespeedterms

Itsimperativeforpractitionerstoselectacolocationset-upthattstheiroverallbusiness

strategy. There is no shortage o access choices available within the market.

Thecolocationfacilitiesandrelatedservicesonofferfromanexecutionvenuecanbea

signicant actor in a rms strategy choice, as it can impact the success o that strategy

in terms o ROI.

Thecommunityaspectofanygivencolocationvenueie.whatotherexecutionvenues

and other service providers are available on-site can also be a actor in strategy choice,

oering practitioners a wider range o trading options.

Compute-on-Demandservicesarenowfeasibleduetoemergingexchange

technologies. They allow a rm to outsource the inrastructure burden to the service

provider and thereby concentrate on their core trading strategy. These services can also

allow participants to implement strategies much aster as the inrastructure is in place

and pre-congured.

Thisalsoopensupthepossibilityofcolocationtosmaller,moreremoteplayerswhowant

to access markets without the need or a local IT team.


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curr ldp d trdInterest in colocation as the solution to the requirement or ast access to electronic

markets has been growing steadily over the past 36 months. The trend has its origins in the

tremendous growth in automated and algorithmic trading techniques, which have grown in

market acceptance over the past seven or eight years.

Algorithmic trading is no longer the exclusive remit o the largest broker/dealers. As

exchanges and trading platorms have become more electronic, so brokers have increased

their use o electronic connections to handle a growing proportion o their order fow, and

indeedofferedtheirclientsaccessinthiswaythroughtheuseofDirectMarketAccess

(DMA).

With new technologies driving the speed o new execution venue trading platorms,

rms have been developing aster access through a wide range o latency-reduction

techniques. In a matter o months, latency measurements have shited rom milliseconds to

microseconds, and already market participants are speaking in terms o nanoseconds or

measuring individual processes within the electronic trading fow.

At the same time, market events have driven investors to consider investments urther

aeld. No longer are und managers beholden to their domestic markets. As investors have

become more sophisticated, and as market inormation becomes more widely available,

many und managers are looking beyond their traditional markets or superior returns.

This is driving execution services providers to seek out access to markets that previouslyhad been outside o their sphere o operations. New technologies have encouraged

connections to remote marketplaces or electronic traders. As a result, Continental European

trading rms are increasingly interested in connecting to key markets in and around London,

or example, as are rms rom as ar aeld as Chicago, Singapore and Sydney.

But with speed o access

increasingly o the essence,

those establishing long-

distance connections

are understandably

nding themselves at a

disadvantage, simply due

to the laws o physics: thegreaterthedistancefromtheexecutionplatform,thehigheryourtradinglatency.Many

remote rms will simply not trade a market i they cannot achieve market-leading execution

times.

Against this backdrop, its been accepted among the majority o market practitioners that

colocation o a rms trading systems at the same physical acility as the execution venues

matching engines is the optimal solution to the latency challenge. By minimising the physical

distance between the practitioners system that receives market data and generates orders,

and the exchanges own trading platorm, practitioners can be condent that they are

accessing the marketplace as ast as possible, and critically with the same perormance as

the other players.

But to date, colocation hasnt been the deault solution or many market players, chiefy

because o its cost. Rather, its been the better-resourced market practitioners who have

been able to take advantage o its clear benets. The cost o colocation can be substantial

Whl xm h ca l avaa, m ca cm wh clca.


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- the practice has historically required signicant investments in equipment, space and linerentals, and ongoing management and maintenance.

This barrier to entry has kept many rms that could clearly benet out o the colocation

marketplace. Instead, theyve soldiered on with remote connections or where available or

appropriate with lower-cost proximity hosting solutions, which involve renting rack space

close to the execution venue but not within the same data centre acility. While proximity

hosting can yield speed advantages and can be an optimal solution or serial arbitrageurs

in terms o pure speed it is unable to compete with colocation and still presents rms with

the challenge o building out equipment in remote locations where they may have limited

resource.

Chiefy as a result o these

cost actors, many players

have been unable to take

advantage o colocation.

This places them at a

trading disadvantage to

their larger, better resourced

peers, which are able to rest

assured that their colocated

trading engines have as

good a chance as any o completing a trading strategy as designed, signicantly boosting

the protability o their trading operations.

But new technologies are being adopted by execution venues that are starting to level theplaying eld. Exchanges are beginning to oer a broader range o technology services that

are lowering the upront costs and overheads associated with colocation, opening up the

possibility or smaller and more remote rms to take advantage o the practice. For these

rms, colocation can help them gain access to the liquidity they require to successully

execute on their trading strategies.

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Wh ar h r c D?Notwithstanding the costs o set-up and ongoing maintenance, any colocation decision

needs to t with the overall business strategy o the rm. Firms are increasingly

considering colocation because it is being accepted as the only way to give certain

trading strategies a ghting chance o being successul. Speed o access is no longer a

specialised requirement; rms realize that unless they adopt low-latency inrastructures

they are likely to trade at a disadvantage, as those with aster systems beat them to

available liquidity.

Assuch,thedecisionisincreasinglyhowandwheretodistributetradingsystems?rather than whether to colocate. And here its imperative or practitioners to select a

colocation set-up that ts their overall business strategy.

This involves assessing

to which markets its

important to maintain

low-latency connectivity.

While high requency

traders may operate

across a wide range o

execution venues, they

need to understand thoseor which a connection

measured in milliseconds

is no longer acceptable.

Trading rms need to

understand which o their markets they need to access within microsecond timerames,

so that they can identiy which they need to consider or colocation.

Beyond the obvious costs o rack rental, local server equipment, and telecommunications

connections, there are a number o other unctions that need to be assessed or

consideration. Any rm looking to colocate needs to understand how its trading systems

will receive market data, both rom the colocated marketplace and rom other sources

that may impact order generation.

To meet new and emerging regulations, rms need to ensure they have the necessary

pre-trade risk controls and checks in place within their execution systems. The ability

to integrate systems to handle this requirement at the colocation acility needs to be

ascertained, and the cost o implementing such systems needs to be considered in the

cost-benet analysis o the overall colocation set-up. For example, is it important to your

strategy that the colocation provider oers a low-latency multi-market data eed or your

trading system.

Practitioners may also need access to order-routing systems to handle away trades,

unlled orders that could be routed to alternative markets, execution venues or dark

pools. Again, the availability and cost o these systems must be incorporated into thecolocation decision-making process.

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h c ha ma mac a.


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A rm considering colocation must analyse all o these actors beore taking inrastructuredecisions. Not only can they impact direct costs, but their provision and operation

or otherwise can be instrumental to the success or ailure o the overall colocation

strategy. Indeed, many rms today are able to calculate the business benet based on

the milliseconds or indeed microseconds o latency they are saving.

Thisopportunitybenet

also applies to an

additional set o more

indirect actors. These

might be described as

thecommunityaspect

o any given colocation

acility, and concerns

what other execution

venues, or markets, and

other service providers are available on-site. Unrelated, but complementary execution

venues sometimes share data centre environments, and the ability to arbitrage between

them or otherwise link trades on either venue on a colocated basis could be a actor in

the colocation decision. The ability to switch between venues at high speed could open

up a range o trading options that otherwise may not be possible.

Whats clear rom this emerging picture is that the colocation decision-making process

extends beyond the direct costs o inrastructure and maintenance. Firms must ensure

the set-up ts their overall business strategy. But they also must explore the possibilities

or additional benet aorded by the acilities on oer at the colocation site in question,since these may have a material impact on the protability o the trading strategy.

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q.


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a chk l r cThe colocation question is perhaps not quite as simple as it at rst appears. Practitioners

need to do their homework, and business and technology heads considering a colocation

approach should bear in mind the ollowing key questions:

a) Which locations ft your business strategy? When deciding which markets to colocate

in, the trading rm must decide where it will get the greatest return on its investment.

One actor in this is access to the liquidity required to successully deliver in the

trading strategy. While this is straightorward in the case o single-venue strategy,

when other venues and asset classes are added to the mix, the situation can become

more complex.

b) What technology services are on oer at your target markets colocation acilities?

No two colocation sites are equal. Innovative execution venues are branching out to

oer their colocation customers additional services. These can include eedhandlers

and data eeds to oer access to third-party market data, pre-trade risk management

capabilities and order-routing systems. By packaging these services, these innovators

can oer them to colocation clients on a shared-cost basis, dramatically reducing the

cost o entry and o ongoing maintenance.

c) What community services are available? As they expand their colocation acilities,

innovators are attracting a rat o adjacent service providers. These might include

market data or analytical services providers and other content-oriented services.

But they are increasingly including alternative trading systems, oten in related assetclasses like utures, options and oreign exchange, all o which markets are seeing a

prolieration o new, electronic trading platorms. The presence o a trading acility or,

say, derivatives within the same acility as the underlying instrument can oer lucrative

trading opportunities.

d) What level o service and support do I receive? Its imperative to understand what

levels o service to expect rom a colocation venue. This clearly applies to the local

equipment and connectivity, and any additional services o oer. But colocation sites

housing multiple markets may yield service savings when it comes to upgrades. With

most major venues conducting signicant technology upgrades every 18 months or

so, the ability to deal with multiple markets through a single inrastructure upgrade can

have a material impact on trading strategy returns. It is also important to know whether

the colocation provider can muster engineering resource on site to x an issue i yourtrading inrastructure goes down, and how much they would charge or such a service.

I the data center acility is custom built or nancial services with the requisite ocus

on up-time, fexibility and security that can oten be a compelling actor in the decision

process.

Exchange operators are ocusing their attention on making it easier and cheaper or rms

previously precluded rom colocation to participate. Colocation specialists like NYSE

Technologies, whose traditional colocation customer base is comprised o sell-side rms

and large market makers, have developed new models or providing entry-level colocation

services typically geared towards the buy-side, smaller rms with less IT resource and

oreign rms with no local IT. Checking all the boxes on the list above, these oerings can

take either a managed services or menu-driven approach, refecting the act that there isno one-size-ts-all solution or colocation services.


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nw er-lv PbNYSE Technologies is

pioneering the managed

services approach with its

ComputeOnDemandoffering

that gives smaller and distant

rms access to the acilities

they need to take advantage

o NYSE Euronexts global

colocation acilities such as

theirdatacentersinMahwah,

New Jersey and in Basildon,just outside London. The

service enables rms to

either rent a physical blade

within a shared colocation

environment, or a virtual

server within a colocated

cloud. The service attempts

to simpliy the commercial

charges or a package o technology services, highly customisable to t the specic client

requirements.

The model allows the colocation client to lease the hardware precongured with marketdata, order routing, pre-trade risk management and other NYSE Technologies-provided

systems. The server comes with a single standard API that allows the client to code, run

and manage their own trading strategies and algorithms on the server within the NYSE

Euronext colocation acility. Various levels o service and support are available, again to

ttheneedsandbudgetoftheclient.Similarly,ComputeOnDemandsupportsarange

o connectivity options, ranging rom dedicated line to virtual private network and cloud.

This is a signicant break rom the traditionally infexible world o exchange colocation

and connectivity.

For those who preer a more menu-driven oering, NYSE Technologies has developed

anunmanagedentry-levelcolocationmodelthatalsokeepscostslowwhileofferingthe

kind o latency perormance enjoyed by major players. Using this approach, clients are

able to select rom a range o options:

Rack/hardwareprovisioning

Connectivitybetweenthecolocationhallandproductionenvironment

Connectivitytoadditionalvenues/tradingplatforms

VPN/virtualcontrolcircuitaccesstoexternalservices

By opening up its entry-level oerings, NYSE Technologies is attempting to demonstrate

thatitseasiertocolocatethanmanypractitionersthink.NewComputeOnDemand

models and underlying exchange systems are taking away the complexity and lowering

the cost.

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tradingApplicaions

Muli-Marketrading

Multi-Marketdata

riskManagement

Communityservice

Hoting

Connectivity


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irdu nyse thcmpu o DmdTrading rms need a ast and reliable low-latency inrastructure to support their trading

strategies and meet the demands o clients. They dont need the capital expenses,

infexibility and maintenance burden o traditional colocated solutions.

ComputeOnDemandisanewmanagedsolutionbeinginitiallylaunchedintheUS

with a progressive global roll-out optimized or colocated trading environments, built by

people who understand the dynamics o the markets. Connected to the Secure Financial

Transactions Inrastructure (SFTI)network,itprovidesyouwithultra-lowlatencyaccess

to hundreds o buy-side and sell-side traders around the world, as well as to hundreds otradingservices.ComputeOnDemandallowsyoutofocusyourtimeandenergyonthe

eorts that drive the success o your rm.

cumr ch cu w- rruur. Building your own low-latency trading

inrastructure requires large capital investments.

Rdu rk. It can take a long time to work through your rms

procurement systems to get equipment purchased and installed. Adding new services

can then take weeks.

adp rpd d. Building and maintaining your own inrastructure

requires long-term commitments to a set amount o capacity. Adding, or subtracting,

servers is neither cheap nor easy.

Kp rdwr d wr up d. It takes a lot o time and technical expertise

to research and build out low-latency trading environment. Keeping that inrastructure

current may then involve negotiating a lengthy internal procurement process.

R pr rruur.A large and dedicated operational

group is required to maintain and monitor all aspects o trading solution, at all hours o

the day and night.

m ur pr.Makingsurethatyourinfrastructuresupportsasafeand

secure trading platorm requires a signicant expertise and constant vigilance.

su Bf n p p rqurd. WithComputeOnDemand,NYSETechnologiesownsthe

inrastructure. You simply lease as much o it as you need.

Rpd r-up d p.All equipment is pre-provisioned, reducing startup times

rom a ew months to a ew weeks. New SFTI services can be added in days.

sb ddd rdwr. Packages start rom a single server and scale to t a

customers requirements. Each server is allocated a local disk drive or ast I/O. Additional

storageisavailablethroughtheStorage-OnDemandsolution.

s--r qup. NYSE Technologies takes ull responsibility or building,

upgrading and maintaining a state-o-the-art trading inrastructure.

24/7 d r. NYSE Technologies provides management and

monitoring o the hardware, network, operating system stack, and storage backed by our24x7ServiceDesk.Ourmarketdataandorderentryexpertiseprovidesunrivaledsupport.

Wrd c sur. NYSE Technologiess security team ensures the SFTI network is

protected against all threats. The servers are updated with the latest security patches,

ensuring your data is kept private and secure.


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The inormation contained herein is not intended to constitute legal, regulatory or fnancial advice and should not be relied upon in lieu o

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Technologies or its afliates

abu nyse th

AdivisionofNYSEEuronext(NYX),NYSE

Technologies provides broadly accessible,

comprehensive connectivity and transaction

capabilities, data and inrastructure services,

and managed solutions or a range o customers

requiring next-generation perormance and expertise

or mission critical and value-added trading

services. NYSE Technologies oers a diverse array

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Side, including order routing, liquidity discovery

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Dealersandexecutiondestinationsglobally;the

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Venues and Exchanges, including multi-asset

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advanced integrated solutions or the global capital

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inormation visit: nysetechnologies.nyx.com

www.-mrup.m


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demystifying exchange colocation

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