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Demystifying exchange colocation

June 2011

An industry briefing prepared by a-team group for

Demystifying exchange colocation

introduction
Colocation has established itself as the access mechanism for trading firms requiring the fastest possible execution. Its widely accepted that for firms wanting the lowest latency access to a specific market there is no substitute for placing their trading applications as close as possible to the matching engines themselves, making it the solution of choice for all but those focusing on multi-venue multi-location arbitrage. But the perception to date has been and justifiably so - that exchange colocation is a premium service reserved for the larger institutions. For many smaller and remote practitioners hedge funds and prop traders who lack the IT resource normally associated with colocation cost is a prohibitive factor in their decision whether to colocate. New exchange technologies, however, are allowing venues to help ease the burden of colocation for these players. By packaging technology-based services into entry-level offerings, innovative exchanges are lowering the cost of entry and allowing smaller players to compete on a level playing field with their larger rivals. This paper discusses the key drivers, benefits and challenges associated with the trend toward colocation. It describes key factors practitioners should take into account in their assessment of colocation possibilities, and suggests that firms should take a close look at the facilities and potential community aspects on offer.

An industry briefing prepAred by a-team gRoUP for nyse technologies

Demystifying exchange colocation

Key Points:
Colocation need not be as difficult or as expensive as is widely believed. Colocation is a superior connectivity solution in pure speed terms Its imperative for practitioners to select a colocation set-up that fits their overall business strategy. There is no shortage of access choices available within the market. The colocation facilities and related services on offer from an execution venue can be a significant factor in a firms strategy choice, as it can impact the success of that strategy in terms of ROI. The community aspect of any given colocation venue ie. what other execution venues and other service providers are available on-site can also be a factor in strategy choice, offering practitioners a wider range of trading options. Compute-on-Demand services are now feasible due to emerging exchange technologies. They allow a firm to outsource the infrastructure burden to the service provider and thereby concentrate on their core trading strategy. These services can also allow participants to implement strategies much faster as the infrastructure is in place and pre-configured. This also opens up the possibility of colocation to smaller, more remote players who want to access markets without the need for a local IT team.

An industry briefing prepAred by a-team gRoUP for nyse technologies

Demystifying exchange colocation

current landscape and trends

Interest in colocation as the solution to the requirement for fast 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 of the largest broker/dealers. As exchanges and trading platforms have become more electronic, so brokers have increased their use of electronic connections to handle a growing proportion of their order flow, and indeed offered their clients access in this way through the use of Direct Market Access (DMA). With new technologies driving the speed of new execution venue trading platforms, firms have been developing faster access through a wide range of latency-reduction techniques. In a matter of months, latency measurements have shifted from milliseconds to microseconds, and already market participants are speaking in terms of nanoseconds for measuring individual processes within the electronic trading flow. At the same time, market events have driven investors to consider investments further afield. No longer are fund managers beholden to their domestic markets. As investors have become more sophisticated, and as market information becomes more widely available, many fund managers are looking beyond their traditional markets for superior returns. This is driving execution services providers to seek out access to markets that previously had been outside of their sphere of operations. New technologies have encouraged connections to remote marketplaces for electronic traders. As a result, Continental European trading firms are increasingly interested in connecting to key markets in and around London, for example, as are firms from as far afield as Chicago, Singapore and Sydney. But with speed of access increasingly of the essence, those establishing longdistance connections are understandably finding themselves at a disadvantage, simply due to the laws of physics: the greater the distance from the execution platform, the higher your trading latency. Many remote firms will simply not trade a market if they cannot achieve market-leading execution times.

can While proximity hostingpure yield speed advantages, in terms of speed it cannot compete with colocation.

Against this backdrop, its been accepted among the majority of market practitioners that colocation of a firms trading systems at the same physical facility 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 platform, practitioners can be confident that they are accessing the marketplace as fast as possible, and critically with the same performance as the other players. But to date, colocation hasnt been the default solution for many market players, chiefly because of its cost. Rather, its been the better-resourced market practitioners who have been able to take advantage of its clear benefits. The cost of colocation can be substantial

An industry briefing prepAred by a-team gRoUP for nyse technologies

Demystifying exchange colocation

- the practice has historically required significant investments in equipment, space and line rentals, and ongoing management and maintenance. This barrier to entry has kept many firms that could clearly benefit out of 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 facility. While proximity hosting can yield speed advantages and can be an optimal solution for serial arbitrageurs in terms of pure speed it is unable to compete with colocation and still presents firms with the challenge of building out equipment in remote locations where they may have limited resource. Chiefly as a result of these cost factors, many players have been unable to take advantage of 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 of completing a trading strategy as designed, significantly boosting the profitability of their trading operations.

Colocation can help smaller and to remotely situated firms gain access

the liquidity they require to successfully execute on their trading strategies.

But new technologies are being adopted by execution venues that are starting to level the playing field. Exchanges are beginning to offer a broader range of technology services that are lowering the upfront costs and overheads associated with colocation, opening up the possibility for smaller and more remote firms to take advantage of the practice. For these firms, colocation can help them gain access to the liquidity they require to successfully execute on their trading strategies.

An industry briefing prepAred by a-team gRoUP for nyse technologies

Demystifying exchange colocation

What are the factors in a colocation Decision?

Notwithstanding the costs of set-up and ongoing maintenance, any colocation decision needs to fit with the overall business strategy of the firm. Firms are increasingly considering colocation because it is being accepted as the only way to give certain trading strategies a fighting chance of being successful. Speed of access is no longer a specialised requirement; firms realize that unless they adopt low-latency infrastructures they are likely to trade at a disadvantage, as those with faster systems beat them to available liquidity. As such, the decision is increasingly how and where to distribute trading systems? rather than whether to colocate. And here its imperative for practitioners to select a colocation set-up that fits their overall business strategy. This involves assessing to which markets its important to maintain low-latency connectivity. While high frequency traders may operate across a wide range of execution venues, they need to understand those for which a connection measured in milliseconds is no longer acceptable. Trading firms need to understand which of their markets they need to access within microsecond timeframes, so that they can identify which they need to consider for colocation.

colocate Any firm looking toits trading needs to understand how systems will receive market data, both from the colocated marketplace and from other sources that may impact order generation.

Beyond the obvious costs of rack rental, local server equipment, and telecommunications connections, there are a number of other functions that need to be assessed for consideration. Any firm looking to colocate needs to understand how its trading systems will receive market data, both from the colocated marketplace and from other sources that may impact order generation. To meet new and emerging regulations, firms 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 facility needs to be ascertained, and the cost of implementing such systems needs to be considered in the cost-benefit analysis of the overall colocation set-up. For example, is it important to your strategy that the colocation provider offers a low-latency multi-market data feed for your trading system. Practitioners may also need access to order-routing systems to handle away trades, unfilled orders that could be routed to alternative markets, execution venues or dark pools. Again, the availability and cost of these systems must be incorporated into the colocation decision-making process.

An industry briefing prepAred by a-team gRoUP for nyse technologies

Demystifying exchange colocation

A firm considering colocation must analyse all of these factors before taking infrastructure decisions. Not only can they impact direct costs, but their provision and operation or otherwise can be instrumental to the success or failure of the overall colocation strategy. Indeed, many firms today are able to calculate the business benefit based on the milliseconds or indeed microseconds of latency they are saving. This opportunity benefit also applies to an additional set of more indirect factors. These might be described as the community aspect of any given colocation facility, 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 factor in the colocation decision. The ability to switch between venues at high speed could open up a range of trading options that otherwise may not be possible.

trading firms must explore the afforded possibilities for additional benefit
by the facilities on offer at the colocation site in question.

Whats clear from this emerging picture is that the colocation decision-making process extends beyond the direct costs of infrastructure and maintenance. Firms must ensure the set-up fits their overall business strategy. But they also must explore the possibilities for additional benefit afforded by the facilities on offer at the colocation site in question, since these may have a material impact on the profitability of the trading strategy.

An industry briefing prepAred by a-team gRoUP for nyse technologies

Demystifying exchange colocation

a check list for colocation

The colocation question is perhaps not quite as simple as it at first appears. Practitioners need to do their homework, and business and technology heads considering a colocation approach should bear in mind the following key questions: a) Which locations fit your business strategy? When deciding which markets to colocate in, the trading firm must decide where it will get the greatest return on its investment. One factor in this is access to the liquidity required to successfully deliver in the trading strategy. While this is straightforward in the case of 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 offer at your target markets colocation facilities? No two colocation sites are equal. Innovative execution venues are branching out to offer their colocation customers additional services. These can include feedhandlers and data feeds to offer access to third-party market data, pre-trade risk management capabilities and order-routing systems. By packaging these services, these innovators can offer them to colocation clients on a shared-cost basis, dramatically reducing the cost of entry and of ongoing maintenance. c) What community services are available? As they expand their colocation facilities, innovators are attracting a raft of 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, often in related asset classes like futures, options and foreign exchange, all of which markets are seeing a proliferation of new, electronic trading platforms. The presence of a trading facility for, say, derivatives within the same facility as the underlying instrument can offer lucrative trading opportunities. d) What level of service and support do I receive? Its imperative to understand what levels of service to expect from a colocation venue. This clearly applies to the local equipment and connectivity, and any additional services of offer. But colocation sites housing multiple markets may yield service savings when it comes to upgrades. With most major venues conducting significant technology upgrades every 18 months or so, the ability to deal with multiple markets through a single infrastructure 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 fix an issue if your trading infrastructure goes down, and how much they would charge for such a service. If the data center facility is custom built for financial services with the requisite focus on up-time, flexibility and security that can often be a compelling factor in the decision process. Exchange operators are focusing their attention on making it easier and cheaper for firms previously precluded from colocation to participate. Colocation specialists like NYSE Technologies, whose traditional colocation customer base is comprised of sell-side firms and large market makers, have developed new models for providing entry-level colocation services typically geared towards the buy-side, smaller firms with less IT resource and foreign firms with no local IT. Checking all the boxes on the list above, these offerings can take either a managed services or menu-driven approach, reflecting the fact that there is no one-size-fits-all solution for colocation services.

An industry briefing prepAred by a-team gRoUP for nyse technologies

Demystifying exchange colocation

new entry-level Possibilities

NYSE Technologies is pioneering the managed trading Applications services approach with its Compute On Demand offering Multi-Market trading that gives smaller and distant firms access to the facilities Multi-Market data they need to take advantage of NYSE Euronexts global risk Management colocation facilities such as their data centers in Mahwah, New Jersey and in Basildon, Community ser vices just outside London. The service enables firms to Hosting either rent a physical blade within a shared colocation environment, or a virtual Connectivity server within a colocated cloud. The service attempts to simplify the commercial charges for a package of technology services, highly customisable to fit the specific client requirements.

service elements available from an innovative colocation facility

The model allows the colocation client to lease the hardware preconfigured with market data, 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 facility. Various levels of service and support are available, again to fit the needs and budget of the client. Similarly, Compute On Demand supports a range of connectivity options, ranging from dedicated line to virtual private network and cloud. This is a significant break from the traditionally inflexible world of exchange colocation and connectivity. For those who prefer a more menu-driven offering, NYSE Technologies has developed an unmanaged entry-level colocation model that also keeps costs low while offering the kind of latency performance enjoyed by major players. Using this approach, clients are able to select from a range of options: Rack/hardware provisioning Connectivity between the colocation hall and production environment Connectivity to additional venues/trading platforms VPN/virtual control circuit access to external services By opening up its entry-level offerings, NYSE Technologies is attempting to demonstrate that its easier to colocate than many practitioners think. New Compute On Demand models and underlying exchange systems are taking away the complexity and lowering the cost.

An industry briefing prepAred by a-team gRoUP for nyse technologies

Demystifying exchange colocation

introducing nyse technologies compute on Demand

Trading firms need a fast and reliable low-latency infrastructure to support their trading strategies and meet the demands of clients. They dont need the capital expenses, inflexibility and maintenance burden of traditional colocated solutions. Compute On Demand is a new managed solution being initially launched in the US with a progressive global roll-out optimized for colocated trading environments, built by people who understand the dynamics of the markets. Connected to the Secure Financial Transactions Infrastructure (SFTI) network, it provides you with ultra-low latency access to hundreds of buy-side and sell-side traders around the world, as well as to hundreds of trading services. Compute On Demand allows you to focus your time and energy on the efforts that drive the success of your firm.

customer challenges
cutting the cost of a low-latency infrastructure. Building your own low-latency trading infrastructure requires large capital investments. Reducing time to market. It can take a long time to work through your firms procurement systems to get equipment purchased and installed. Adding new services can then take weeks. adapting to rapidly changing needs. Building and maintaining your own infrastructure requires long-term commitments to a set amount of capacity. Adding, or subtracting, servers is neither cheap nor easy. Keeping hardware and software up to date. It takes a lot of time and technical expertise to research and build out low-latency trading environment. Keeping that infrastructure current may then involve negotiating a lengthy internal procurement process. Retaining the expertise to maintain infrastructure. A large and dedicated operational group is required to maintain and monitor all aspects of trading solution, at all hours of the day and night. maintaining a secure platform. Making sure that your infrastructure supports a safe and secure trading platform requires a significant expertise and constant vigilance.

solution Benefits
no capital expense required. With Compute On Demand, NYSE Technologies owns the infrastructure. You simply lease as much of it as you need. Rapid start-up and expansion. All equipment is pre-provisioned, reducing startup times from a few months to a few weeks. New SFTI services can be added in days. scalable dedicated hardware. Packages start from a single server and scale to fit a customers requirements. Each server is allocated a local disk drive for fast I/O. Additional storage is available through the Storage-On Demand solution. state-ofthe-art equipment. NYSE Technologies takes full responsibility for building, upgrading and maintaining a state-of-the-art trading infrastructure. 24/7 maintenance and monitoring. NYSE Technologies provides management and monitoring of the hardware, network, operating system stack, and storage backed by our 24x7 Service Desk. Our market data and order entry expertise provides unrivaled support. World class security. 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. 10

An industry briefing prepAred by a-team gRoUP for nyse technologies

Demystifying exchange colocation

about nyse technologies

A division of NYSE Euronext (NYX), NYSE Technologies provides broadly accessible, comprehensive connectivity and transaction capabilities, data and infrastructure services, and managed solutions for a range of customers requiring next-generation performance and expertise for mission critical and value-added trading services. NYSE Technologies offers a diverse array of products, services and solutions to: the Buy Side, including order routing, liquidity discovery and access to a community of over 630 BrokerDealers and execution destinations globally; the Sell Side, including high performance, end-to-end messaging software and innovative market data products delivered on the worlds largest, most reliable financial transaction network; and Market Venues and Exchanges, including multi-asset exchange platform services, managed services and expert consultancy. With offices across the U.S., Europe, and Asia, NYSE Technologies offers advanced integrated solutions for the global capital markets community, earning the ability to power trading operations for many of the worlds best financial institutions and exchanges. For additional information visit: nysetechnologies.nyx.com

www.a-teamgroup.com
A-Team Group, founded in 2001, provides a range of global online news, in-depth research reports, and events focused on the business of financial information technology. A-Team Group serves its global client base of IT and data professionals within financial institutions, technology and information suppliers, consultants and industry utilities with insight into the business of electronic trading, market data, low latency, reference data, risk management and the impact of regulation upon these industry segments. Our flagship news service is A-Team Insight, with the best of A-Teams coverage of the Electronic Trading, Low-Latency Connectivity, Market Data, Reference Data and Risk Management Technology segments. With in-depth features and interviews with key newsmakers, A-Team Insight gives busy financial IT executives all they need to know to stay on top of our fast-moving industry via regular updates on our website and a monthly PDF digest format. Find out if you qualify for a complimentary subscription and sign up for a free 30-day trial at: www.A-TeamGroup.com/complimentary-access. A-Team Groups research division provides industry professionals with focused and in-depth research offerings to better understand the specific uses of data and technology in todays trading and investment processes across the financial enterprise from front to back office. These include a series of topical white papers, survey-based research reports and focused directories (eg: algorithmic trading, valuations and alternative trading systems directories). Many of A-Teams research publications are available for free at: www.A-TeamGroup.com/ site/research. A-Team offers custom research solutions, commissioned by clients seeking answers to specific questions for in-house product development or marketing, or looking to support their marketing activities, promote thought leadership and generate sales leads. Find out how our custom research solutions can boost your marketing campaigns by contacting A-Team Group. A-Team Groups events division produces a series of Insight events annually. These events combine A-Teams expertise in financial markets IT with thought leadership from world-class technology innovators and practical experience from financial market practitioners. For a schedule and more information, visit: www.A-TeamGroup.com/ Insighevents. A-Team also partners with customers to produce custom physical and webinar events. For more information about A-Team Group, visit www.A-TeamGroup.com.

The information contained herein is not intended to constitute legal, regulatory or financial advice and should not be relied upon in lieu of consultation with independent advisors. Any opinions expressed herein are those of the author and are not necessarily shared by NYSE Technologies or its affiliates

An industry briefing prepAred by a-team gRoUP for nyse technologies

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