In grappling with the data explosion currently afflicting financial markets, speed sustainability and artificial intelligence are all increasingly critical factors, but their impacts will not be as smooth as anticipated, according to a new white paper from UK business and consulting firm Detica.
The report, How the New DNA of Markets is Driving Comprehensive Change Throughout the World of Finance, explores six financial global mega trends in 2006, including an “explosion” in data.
If recent trends are anything to go by, data management issues will be increasingly critical for exchanges. And, anyone cynical about data volumes exploding need only glance at figures from derivatives exchange Eurex, which are typical throughout the market. Here quotes per day have increased from 10m daily back in January 2005 to 145m a day by May 2006, with the maximum load having been an incredible 3600 quotes per second on DAX options.
For Euronext.LIFFE the ratio of quotes to trades in 2004 was just 2.16, by 2005 it was almost eight and had shot up to over 17 by 2006. And, on Euronext.LIFFE, each incoming client message (c.150m per day) generates up to four messages (a reply to the trader; a message to the market (in short-term interest rate products); a strategy leg update; and, a market depth update), which could imply 450m to 600m total messages. Figures from the Options Price Reporting Authority confirm the explosive trend.
“When it takes 17 packets of data to make a trade that’s a fairly significant issue in terms of data traffic,” notes Detica white paper co-author Patrick L. Young, who is also a director of the Swiss Futures & Options Association and author of the ‘Exchange Manifesto’.
The Detica paper says that the ability of algorithmic trading systems to slice and dice orders into tiny slivers means that data volume is only headed in one direction. “Not merely up but frankly just about as close to vertical as possible no matter what the scaling on the chart.” Goldman Sachs predicts that ‘black box’ trading systems could account for 60 per cent of all trades on the London Strock Exchange (LSE) inside a year.
Peter Bennett, principal, Exchanges & Market Data at HCL, who was involved in the development of LSE’s ‘Big Bang’ project, told FT Mandate that “positive feedback” through surging market data volumes together with the inherent instability of the market is a potentially lethal cocktail with dangerous consequences.
“With order books changing so rapidly, you’ve got increasing volumes of market data coming out at ever higher frequency…and on the other hand high transaction rates going in,” says Mr Bennett.
“This is going to force whoever the liquidity providers are – be they the traditional exchanges, banks, MTS’s or whoever – to build the fastest transactions known to man.”
Potential “catalysts” for “positive feedback” include panic selling in overpriced markets, credit derivatives hedging (a domino effect), benchmark tracking strategies and market microstructures, he adds.
Craig Heimark, strategic consultant and a private investor based in Palo Alto, California, states: “The explosion in data will continue, though the race to speed is approaching its limits as we are getting fairly close to the exchanges themselves being the slow point…and there’s little point being faster than the exchanges.”
The situation is “not merely” an issue in credit derivatives says Mr Heimark but actually applies to most asset classes. He thinks firms will start to separate IT investment and only a top few firms and some specialists will continue to build most systems in house. “Most firms will purchase IT services rather than build or even configure purchased IT software,” he adds.
Steve Mitchell, global financial services director, Detica, adds that apart from the data issue, the biggest potential impact on markets is risk. The industry “needs to adapt much further if it is to avoid potential dangers down the line” Mr Mitchell contends. And, in virtually every aspect the need to have greater and multiple risk gateways will be “significant due to the ability of exchanges and their counterparties to transact vast amounts of business per second.”
The co-authors warn that the risks of “even a partial automated trading incident are highly significant”. This year the Tokyo Stock Exchange witnessed a systems outage and exchange IT systems like those at Euronext are already outstripping Moore’s Law.
In respect of the OTC markets, Detica adds: “When the traders involved include a substantial number of black boxes…the prospect for chaos are multiplied enormously.
“Regardless of whether the initial error is caused by human intervention, human interference with the black box itself or a pure computer problem, potential ramifications and the damage to market confidence are enormous,” says Mr Mitchell.
Clearing organisations will have to keep pace with market developments. For the OTC space, ending intraday margining will be an absolute pre-requisite, said Mr Young.
“Live real-time margining of all positions is the ideal target, which is likely to prove a project to stretch the capabilities of all but the best IT managers in the capital markets,” the paper concludes.
