Networking Solutions for the Financial Trading Industry 1
Table of contents The financial markets ecosystem 1 Challenges facing financial companies involved in market trading 4 How a communications service provider powers financial trading networks 5 Why Allstream 7
The last three decades have witnessed a continued rise in the size of financial markets as a portion of the global economy. Coupled with the general phenomenon of globalization, technological advances and a favorable political climate, this trend stems from the creation of an ever-expanding range of financial services tailored to serve growing needs for economic development. The primary role of such services has been to mobilize existing financial resources such as savings and pension contributions and redirect them in the most efficient way toward productive projects and investments. Many studies show a positive correlation between the existence of a strong and sophisticated financial market and the level of prosperity achieved by a particular country or region. The United States, Canada and others owe their economic vitality to the continued availability of a wide array of financial products and instruments delivered through a network of diversified markets and financial services institutions. This document intends to examine the types of institutions that participate in financial markets, focus on the technological challenges that confront them and show how a communications service provider can assist financial institutions in meeting those challenges. The financial markets ecosystem Financial markets and the institutions involved in trading securities on those markets are an important component of a well-developed economy. For example, in Canada this sector generates about 6% of the GDP while in the UK it amounts to about 12%. Financial services institutions actively participate in the market and trade among themselves, with other businesses and with the general public. Depending on the role they are playing, they compete in the marketplace while complementing each other s activities. In ideal market conditions, their interactions create a financial trading ecosystem that will result in the most efficient allocation of funds and the optimum matching between lenders and borrowers or between investors and businesses seeking capital to power their growth. Figure 1 shows a simplified diagram of this ecosystem. The set of market participants included in the diagram is by no means exhaustive and, in most cases, only one institution is shown for each role. The retail investing participants are not included in the diagram as the focus of this document is on financial institutions. 1
Figure 1 Figure 1 Trading Venues Alternative trading systems (ATS) Over The Counter Market (OTC) Electronic Communication Network Crossing Network Exchange Dealer Bank Call Market Investment Bank Market Analytics Company Financial Services Provider Direct Market Data Access (DMA) Dealer Inter - Dealer Broker Broker Broker Trading Data flow Market Data flow The Trading Venues are at the centre of the financial services ecosystem. Among the most important: Exchanges are the institutions that can and are authorized to list stocks (equities). To have its stock listed on an exchange, a stock-issuing corporation must meet a set of stringent criteria set by the exchange and will be regulated by governments or authorized agencies (eg. the Securities Exchange Commission.) In addition to stocks, exchanges allow trading in other securities such as bonds and derivatives. Most exchanges today trade only electronically and very few still have some brick and mortar trading facilities. Exchanges and Alternative Trading Systems (ATS) operate complex market data storages and distribution networks that deliver current market data to local points of presence and to individual brokers or traders. Alternative Trading Systems (ATS) do not list stocks and are not as tightly regulated as exchanges. However, they are effective in facilitating trades and in matching sellers with buyers. A few examples of ATSs: k Electronic Communications Networks (ECN) are automatic systems that match buy and sell orders for securities. Using an ECN, brokers and individual dealers can trade among themselves without going through a middleman. Permitting after hours trading, ECNs allow for automated trading, passive order matching and speedy execution. Examples: Instinet, SelectNet, NYSE Arca, etc. k Crossing Networks execute automatic trades without routing them through an exchange or other public display market (like ECNs do). That allows traders to conduct transactions without revealing their identity. Examples: LiquidNet, Pipeline, Goldman Sachs, SIGMA X, etc. k Call Markets are markets where transactions take place at a predetermined time rather than at any time a seller is matched with a buyer, as is the case with regular trading. The transaction price is established through an aggregation of the various bid and ask orders. 2
In Canada the only type of ATS are the ECNs and, as a consequence of that, they are generically called ATSs. Those ATSs can be lit (publishing information about their transactions) or dark (not disseminating information about their transactions in any way). Over The Counter (OTC) are venues outside formal exchanges, used generally for trading stocks or other instruments that have falled dramatically in value or have been decertified from the main exchanges. Derivatives are often traded on OTC. Stocks on OTC do not have to meet the stringent requirement of exchanges and transaction prices are not made public. Example: OTCBB (Over the Counter Bulletin Board). In Canada, OTC trading in equities is not allowed although other types of investment instruments (fixed income, etc.) can be traded. Financial Services/Market Data Providers are companies that collect, aggregate and distribute market data to market participants. In fact, this is the most common way in which brokers, traders and investors get access to market data. Examples: Reuters, Bloomberg, etc. Broker, Inter-Dealer Broker, Trader Companies that perform one or more of the following functions: direct trading, advice for investors, trading on behalf of investors, facilitating trades between other brokers. Most brokers have access to market data through the services of a market provider. Some arrange to have direct market access (DMA) to exchanges as shown for one broker in Figure 1. This may add cost but has the potential of further reducing the latency involved in executing trades. Investment bank A bank that works with governments or corporations for the purpose of raising capital on the market through issuing of stocks, bonds or other securities. Investment banks are involved in trading securities either on their own account or on behalf of others. Examples: Goldman Sachs, Morgan Stanley, Wells Fargo, etc. Dealer bank A bank that has been authorized by a government or a government agency to offer on the market government backed bonds or other securities. Examples: BMO Capital Markets, Barclays Capital Inc. The division between the above roles is not clear cut in many cases. There are investor banks acting as brokers, brokers acting as market data providers, etc. Further, the brief descriptions refer to market participants that deal in stocks or bonds. The currency and commodity markets are different in many respects including their regulatory framework or the way in which trades are executed. However the roles of those involved in the trades are very similar and so are their business and communication challenges. It is important to notice that the flow of data between market participants can be divided into two categories: market data and trade data. Market data is unidirectional and always flows from the trading venues toward dealers and investors. Trading data is bidirectional as it reflects all communication involved in the execution of trades. The brief descriptions above refer to market participants that deal in stocks or bonds. The currency and commodity markets are different in many aspects including their regulatory framework or the way in which trades are executed. However the roles of those involved in the trades are very similar and so are their business and communication challenges. 3
Challenges facing financial companies involved in market trading Despite their increased prominence and growing weight in the national GDP of many countries (US, Canada, etc.), the road ahead for financial institutions and the financial trading ecosystem that surrounds them is not without challenges. We will focus on three main areas of concern. First, governments and regulatory agencies keep introducing stricter regulations designed to prevent financial instability in the markets. This trend has accelerated significantly after the events of 2008 when the market collapse and the subsequent economic crisis were perceived to be effects of unrestrained behaviour on the part of the financial industry. Financial services institutions will have to ensure compliance to the new rules by overhauling their structure, policies, asset mix, technology and governance. Second, there is the commoditization of trading triggered by the proliferation of so many online trading possibilities. Financial institutions will have a harder time making the case for the value they can add to trading through their traditional advice and intermediation services. This reality requires flexibility and creativity in order to come up with adequate products and strategies that will ensure their viability in the market place. Last but not least, technology continues to advance. To stay competitive, financial services institutions need to adapt to the changes brought by new technological trends, tools and methods of doing business. That means finding ways to take advantage of social media interactions, aligning to the requirements of a computerized world where even money becomes a digital abstraction (see Bitcoin), profitably mining the depth of huge information pools organized as big data and ensuring that business continuity is never an issue with a global customer base that never sleeps. Foremost among the technological challenges is the need for very high speed and very low latency in many trading and financial decision making activities. Many participants in the financial markets are throwing a great deal of resources and talent at attempting to shorten their reaction time by even the tiniest fractions of a second. A few extra milliseconds can make the difference between a successful trade and a failed one. In particular, this problem will impact high frequency traders. This is why new trading platforms feature algorithm resolving engines embedded in chips connected directly to computers hardware buses or Ethernet NIC cards. However, many such innovations will amount for very little if the underlying network infrastructure is not able to support speed and latency objectives that are specific to this sector. Building a quality network infrastructure and deploying the right networking services becomes a clear objective for all financial services companies. The networking services they select need to feature high performance combined with superior reliability and must be delivered by leading communication providers with the breadth of products and experience to address the demanding requirements of the industry. 4
How a communications service provider powers financial trading networks The following example shows how carrier network services can be deployed to support market data flows from a stock market exchange. A simplified diagram is shown in Figure 2. This diagram illustrates the network used to store and transmit market data Figure from 2 the exchange to local points of presence (POP) from where brokers and investors can access it. Figure 2 Data Storage Facility WDM Switch Data Centre A SPL SPL SPL Data Centre B Allstream Wavelength Network (DWDM) A - Feed B - Feed Allstream Business IP (MPLS based) Multicast Support 6 x QoS levels Point of Presence 1 Point of Presence 2 Point of Presence 3 Point of Presence 4 The connectivity between the two redundant data centres that process the market data and the storage facility that stores the data is implemented using Allstream Storage Private Line (SPL) service links at 10 Gbps. Allstream SPL is a DWDM (Dense Wavelength Division Multiplexing) based service that uses native Storage Area Network (SAN) connections to deliver high speed, low latency data transmission for data storage environments. For redundancy purposes market data from the data centres is directed through two separate feeds (A & B) to the distribution network that ensures the delivery of data to the POPs. The distribution network is deployed through the Allstream Business SwE network that provides superior connectivity and very low data latency. 5
Brokers and market data providers are another example of trading companies benefiting from Allstream network services. Figure 3 illustrates the network of a broker that receives market data through a financial services provider institution and operates two business locations. Figure 3 Figure 3 NYSE POP TSX POP NASDAQ POP Paris CAC POP Allstream Business IP Financial Services / Market Data provider (e.g. Bloomberg) Allstream Wavelength EPL (1 Gbps) Order Routing Networks Data Centre Execution Engines Broker s LAN Allstream SwE 1 Gbps Analytics and Algorithmic Engines Traders Broker Main Location Broker Remote Location The figure shows a simplified depiction of the way market data is collected from stock exchanges POPs by the market data provider and then passed on to the broker network for analysis and trade execution decisions. To effectively collect data, the market data provider subscribes to the Allstream Business IP service that supports VPN multicast transmissions and features Class of Service (CoS) parameters that help prioritize traffic. Market data reaches the broker s network through one or more feeds implemented by Allstream Ethernet Private Line (EPL) service at 1 Gbps. EPL is a point-to-point, high speed, non-congestion low latency service that is delivered through the Allstream Wavelength fibre network. The broker s two business locations are connected through Allstream s Switched Ethernet (SwE) network that provides connections at up to 1 Gbps in speed and transparently joins the network elements at the two locations in one effective LAN structure. For improved flexibility Allstream SwE service offers VLAN ID and QoS transparency between the two sites. 6
The two examples examined do not include all Allstream services that can be leveraged by financial services providers in order to increase productivity, reduce cost and improve the overall performance of their operations. Several other solutions can be leveraged: k WAN Optimization devices that speed up critical applications execution over the WAN between different business locations k SIP Trunking service that provides reliable, low-cost voice channels between office turrets and the phone lines of each trader on the floor k Replication and disaster recovery services that ensure essential business continuity of trading offices through power outages and natural disasters Why Allstream Allstream is a Canadian communication services provider that has been supporting the needs of Canadian businesses for more than 100 years. Its customers include major banks and financial trading companies in both Canada and the United States. Allstream provides highly available, highly secure connectivity services across the US-Canada border and partners with communication providers in more than 70 countries. Financial institutions use Allstream s IP connectivity, Unified Communications, Security and Cloud services to communicate faster, be more agile in the marketplace and achieve their business objectives. To learn more about Allstream s IP Network services and solutions, as well as the Allstream Service Guarantee please visit www.allstream.com or contact your Allstream sales representative. Allstream 200 Wellington Street West Toronto, Ontario M5V 3G2 Call or visit or follow us at: 1 855 299-7050 www.allstream.com blog.allstream.com WP_22330 02/14 Allstream Inc. 7