Managed connectivity the better way to access Emerging Market FX

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1 Managed connectivity the better way to access Emerging Market FX Dan Barnes reports on how market volatility has made flexibility and control of connectivity key for FX trading firms looking to access and leverage opportunities in emerging markets. The Swiss franc and Russian rouble are benchmark events for FX trading firms weighing up their technology and infrastructure partners. Not only do currency shake-downs as the rouble and franc have seen drive home the importance of reliable connectivity and speed, to survive the subsequent fallout and bankruptcies requires a universe of counterparties. As macro events hit larger currencies, the developing economies who are exposed to larger markets are also at risk of volatility. That can impact both local and international traders says Aleksey Larichev, head of business development at telco Avelacom. We see many companies in Russia, Europe and the US trying to move into emerging markets because the profits on common markets, such as the US and Asia, are shrinking, he says. They are exploring new venues. Dubai is growing pretty fast, Mumbai, Singapore and Johannesburg too. These markets are pretty new and while traders have technique they are not fully familiar with connectivity issues, connectivity possibilities and co-location things in those markets. Their main challenge is they don t know how to set out the infrastructure so it stays reliable and so it fulfils their needs. As firms branch out into new currencies they look for a range of counterparties with which to trade in order to access different liquidity flows whether retail, corporate and investment fund or single dealer platform (SDP). A widening of trading partners creates a challenge for the trader, who is facing more data, more counterparty information and potentially more currency pairs. INCREASING FRAGMENTATION Alexandra Foster, global head of strategy & business development at BT Financial Technology Services says, Over the last few years new players have come into the market; it is less dominated by the interdealer brokers (IDB), and there are more local players to balance the larger international players. Consequently there is increasing fragmentation and technology has a part to play in aggregating liquidity. The interplay of technology with algorithms in the FX world helps that interconnectivity between the hubs, creating an aggregated view of what is happening across the market. Technology is also bringing increased sophistication into markets. A report entitled FX Trading platforms models converge and competition heats up published in Q by analyst house Celent, noted that [A] growing number of servers [are being located] closer to local clients, especially in emerging markets. NETWORKS, HOSTING & CONNECTIVITY There is no alpha in running infrastructure. Jake Loveless The historical model of locating servers in the main datacentres of London, Frankfurt, New Jersey, Chicago and Tokyo is being expanded out into markets such as Sao Paulo for CME and Reuters, Kuala Lumpur for CME and Singapore for 360T. The FX platforms expanding their geographical coverage are increasingly offering co-location services in these new areas, although Celent found the majority (56%) of platforms do not yet offer co-location at all. However traders should not automatically assume that their hosting providers need to be hardwired to a currency s national bank smart connectivity providers know that local markets are only one source of liquidity. Jake Loveless, CEO at ondemand infrastructure provider Lucera, says, The South African Rand is my favourite currency, if for no other reason than it has such volatility. Now, you would think if you want to trade the Rand you really need to get a circuit in Johannesburg. But that turns out not to be the case. That client base is actually centred in London, you just have to find them inside those data centres, because they are trading the G10. Large liquidity providers have moved to where liquidity sources are. If you take NY4 for example, a single data centre in the New York metro region, there are more than 190 liquidity sources for spot FX. LOCAL MARKETS In some instances local markets have less electronic trading, in others they might not offer the right sort of counterparty to a particular trading strategy. Jubin Pejman, managing director of hosting and connectivity specialist FCM360, says, Liquidity is still coming out of New York and London and while liquidity is coming out of Singapore, it s not the kind of liquidity that our clients are looking at. I think it s more of a commercial business as opposed to a retail business or single dealer platform (SDP) business. There may be a lot of business going on between Singapore and Hong Kong but it s not the kind suited for algo traders and 138 july 2015 e-forex july 2015 e-forex 139

2 FX Brokers quite yet. The uneven level of services and accessibility to emerging market currency trading directly affects the strategies that can be run successfully from any given location. To ensure the right level of market access, a broad enough range of counterparties and reliability, traders must choose their connectivity partner wisely. A broker, for example, will have literally thousands of customers between Indonesia, Australia and mainland China, and it really wants to be in the right location so then it can start showing its customers that they don t have to leave Asia to access the broker and its liquidity sources, says Pejman. FEET ON THE GROUND When talking to a connectivity A widening of trading partners creates a challenge for the trader While some developed markets have very much gone to a co-location model that s not necessarily feasible in other locations just basic communications and reach can be challenging. provider about accessing a developing market directly, a trading firm should be sure they have feet on the ground, in order to avoid any unwelcome surprises, says Amar Vadher, head of technology at outsourced connectivity provider FXecosystem. When we have looked at regions around the Mediterranean such as Turkey and Cyprus, we send consultants to conduct due diligence in order to make sure that we are choosing the right locations for our customers, he says. That has instilled a lot of value for our customers. We have to account for geographical issues, any seismic risks for example, and power supply as well as taking into account how clients are going to be hosting with us. We need to ensure that we have got all of the connectivity and all of the power that is possible, with local hands ready to support in these regions. A range of factors can impact trading into emerging markets, the Michael Cooper most obvious issue being a lack of consistency in the physical infrastructure and technology that might be encountered. Michael Cooper, chief technology officer at Radianz, BT Global Banking and Financial Markets says, You have got variance at an infrastructure level the physical attributes around it and also at an IT and a market level, all the way through to regulatory variation. There are different points in terms of maturity, sophistication and the standard of delivery across markets. While some developed markets have very much gone to a co-location model that s not necessarily feasible in other locations just basic communications and reach can be challenging. What you should expect from a provider is an understanding of: what 140 july 2015 e-forex

3 is feasible; what the limitations are; any restrictions in the infrastructure layer; awareness of different regulatory positions; and the way the local environment operates. TECHNICAL HURDLES Vadher observes that in some developing regions it can be very technically difficult to get connectivity from offices to a datacentre and then on to metropolitan areas in developed markets. We have had to redefine how to allow these clients to connect into the marketplace by providing a very small step of internet connectivity over a couple of feeds to their buildings, and then utilising low latency connectivity back to New York, for example, he says. The interaction between local market rules or laws and technology can also be a hurdle says Pejman, giving the example of mainland China, from where traders can find otherwise accessible corporate websites are blocked, preventing access to a trading interface. The breadth of information and understanding needed can make the use of multiple suppliers for different aspects of connectivity, or development of connectivity in-house, more risky. Any gap in understanding, whether for a single provider or from a lack of coordinated information exchange, can create risks Tokyo is the best place in Asia to have your primary hub from a technology perspective, Jubin Pejman for the trader. A more holistic approach, using a managed or hosted connectivity provision, can overcome those gaps. Pejman says, You can go to NTT or PCCW Global, someone that owns a good proportion of all the cable in Asia. You can go and talk to someone who specialises in low latency. However that stuff doesn t matter as much anymore. It s more about whether your partner actually helps you provide the service to your customer and gets the service right. You need a lot of moving parts brought together in order to actually execute the project. THE SET-UP The options available to a trading house using a hosted connectivity service can be tailored to fit their specific needs. The simplest set-up only provides connectivity with the trading firm placing its own equipment at trading venues and manages technology on its own. Proprietary trading firms that lack resources may prefer a slightly more complex structure. Larichev says that a second option is for the provider to manage their equipment at the venues, however it is run by the trading companies. He says, For newcomers, like small high-frequency trading (HFT) companies we offer the trading package which includes connectivity, equipment and network management. For example if an HFT company wants to go to a new market, they might want to have connectivity to a local circuit, servers installed and to have it by the end of the month with no investment. We do it on our own, sign a contract for an agreed period and we just leave everything for you to run as you need. If business doesn t go well we just disconnect everything and move to a new trading venue with you. This way small companies can expand their geographical presence without any significant initial investment. Time is of the essence to traders and while low latency and speed of hardware installation are crucial, so is the ability to go live and hit the ground running 142 july 2015 e-forex

4 We have to account for geographical issues, any seismic risks for example, and power supply as well taking into account how clients are going to be hosting with us. Amar Vadher with a consolidated set of services says Vadher. You need a single point of contact to liaise between all the different parties that are involved when it comes to setting up a platform to receive liquidity, he says. For example, when setting up a retail broker we provide them with fine monitoring of latency and more importantly flow. This gives a more detailed view of how we add value via our reporting mechanisms to these clients. They want to know when there is liquidity from two or three providers, who is turning their trades around more quickly and where geographically are the prices going to be coming from? Those sorts of services are really key benefits to using FXecosystem. COST Cost is of course a major concern the increased regulation of sell-side firms is driving up their costs and is being reflected in charges for buy-side firms. A variety of factors can drive up trading costs. Increasing the grade of certain qualities such as resiliency and redundancy is more expensive, along with capacity and volume. However the cost of a suboptimal model in an emergency can be far more expensive. Cooper says, One of the advantages of our model would be that clients are able to access multiple providers and move between them relatively simply. Clearly if you have got discrete communications to multiple providers then you have got an aggregated cost as a consequence of that and operational complexity as well. That is where there are unforeseen costs and where we do contribute to a better solution. Loveless adds, You want to drive that cost of connectivity down as low as you possibly can. There is no alpha in running an infrastructure. Our clients legacy infrastructure were world class. But if you looking for bottom line impacts today you are looking at operations, at risk reduction and most importantly time to market and flexibility - and to do that you need scale and breadth. REGIONAL RECEPTION The optimal geographical positioning of infrastructure will depend on the markets Just basic communications and reach can be challenging. 144 july 2015 e-forex

5 being traded. Asia represents an enormous geography with enormous variation in the regulations and infrastructure available. There are variants in the transparency of rule interpretation; the clarity of what you are able to do in some locations is better than others, but it also creates a volatility of sorts, says Cooper. The way some countries operate, is to go away and think about a question then come back with an answer and make quite dramatic changes. They also provide quite a local answer. It can be quite an intelligent response but it is likely to be different from place to place which means you need to be flexible in how you respond. Pejman notes that the TY3 datacentre in Tokyo will allow Alexandra Foster FX brokers to offer services closer to their clients without compromising on the quality of infrastructure, but also to reach markets such as China from which it can be difficult to directly access markets such as the US. Tokyo is the best place in Asia to have your primary hub from a technology perspective, he says. It s the best place to be in Asia because it s the best way to get to the US west coast where the fibre drops are and major data centres with a lot of banking activity. Where clients are not able to get into a broker s servers in NY4, the solution is to provide a better service. Put some of your equipment into Tokyo so that the snappiness or the optical experience the customer has is positive. Once they are in that hub in Asia we can take a client with a private line back to New York or back to London. Equally, if a trader wants to access certain currencies from a developed market, they may be better to look at local cross connects says Loveless. Tokyo, Singapore and Hong Kong are already priced well into London, he says. That liquidity is readily available The interplay of technology with algorithms in the FX world helps that interconnectivity between the hubs, creating an aggregated view of what is happening across the market. there. A similar thing has happened with access to some Latin American markets such as Mexico. It used to be best to have a point-of-presence (POP) there but increasingly both liquidity providers and liquidity takers have decided it s better to come to New York. For places like Colombia and Brazil, those players have tended to come to Chicago. CONCLUSION Whether operating from within or without the emerging market in question, there is no doubt that the fear of sudden volatility has created greater interest in the capacity and reliability of trading infrastructure. Recent currency fluctuations have demonstrated the value that a managed service can offer in both flexibility and rigour, says Foster. During the Swiss franc incident earlier in the year we were able to support our clients and help them to manage unprecedented volume spikes, she says. Having a managed service with BT meant that we were able to select the right infrastructure in order to flex up and down and meet the demand of those unprecedented volumes with our clients so that business continuity was maintained. That is something we can do in all geographies, and is an example of the importance of working with a strategic partner who has local capabilities but on a global basis. 146 july 2015 e-forex