Trading Infrastructure – The Trend Toward Outsourcing 29 November 2017:
When it comes to technology solutions for trading infrastructure, the build-versus-buy debate is one that never seems to go away. In the past, it was fairly common practice for banks and electronic trading firms to want to build and to run everything themselves. But more recently, there seems to be a definite trend away from that philosophy and toward buying, or even outsourcing, critical infrastructure. The Realization Group’s Mike O’Hara speaks with James Laming, Head of Infrastructure R&D, Options; Bill Fenick, Vice President of Enterprise, Interxion; Mike Powell, Founder and Director, InkBlue; and Stéphane Tyč,Co -Founder, McKay Brothers and Quincy Data, about the drivers of the trend and the related challenges.
Mike O’Hara: Hello and welcome to Financial Markets Insights.
When it comes to technology solutions for trading infrastructure, the build versus buy debate is one that never seems to go away. In the past, it was fairly common practice for banks and electronic trading firms to want to build and to run everything themselves. But more recently, there seems to be a definite trend away from that philosophy and more towards buying, or even outsourcing critical infrastructure.
James Laming: There is a huge amount of people now looking to outsource even the lowest end, into the lowest latency markets, where you wouldn’t necessarily have seen it before.
We have people who just want to spin out to use new and faster technologies than their incumbent companies would have forced them down the route for, and people want to just move quicker.
There is a lot more than just low latency play, of course, there are systematic traders, there are quants, and a whole world or a whole color of different people who are also outsourcing.
Bill Fenick: Particularly, the prop shops and the hedge funds, thought they had a secret source by building their own, but what they’ve realized is that, relatively speaking, the specific, or the standard, vendors who deal in this space, let’s just talk of low latency feeds, for example, are just as good.
There’s a consistency of the outsourcing in data feeds. Whereas, perhaps 5, 10 years ago, 5 years ago, people were building their own data feeds, today, it’s almost exclusively outsourced. I see very little advantage in a proprietary data feed. We’re seeing that.
We’re seeing that also in trading systems, in FIX implementations. We’re seeing that quite a bit in, if you will, things that have become standard over the past 5 to 10 years, where that’s your playing field now.
You need to have this type of basic requirement to even play in this game.
O’Hara: So what’s driving this trend for trading firms – and banks – to take a more open-minded approach to outsourcing?
Mike Powell: There’s been quite a big mind shift, I would say, post the global credit crisis and if you look over this over the last 10 years. I think prior to that, when algo trading, for instance, was in its infancy, the prevalence of high-performance trading infrastructure wasn’t there, so it was more for competitive advantage. Also, I think generally there was an attitude of banks of, “If it’s business critical, we’ll do it ourselves. We’ll do it in-house.”
I think a couple of things have changed quite significantly since then. One is high-performance trading infrastructure is much more prevalent in the market. There’s a whole raft of very good vendors out there providing excellent solutions, and it’s much more mainstream as algo trading. Everyone does algo trading these days, so it’s not the competitive advantage it was; it’s more a table stake.
I think, secondly, the big realisation across certainly on the sell side on the banks has been not so much now is it business critical, but actually is something they’re doing a process of doing whatever technology they’re using? Is it differentiating? Is it a competitive advantage?
When you add on top of that the shrinking margins that you’ve seen in equities and other and exchange-traded instruments, cost has become much more of a factor.
I think managed-service outsourcing, buying rather than building, is potentially a tool that they can leverage to, maybe, bring some of those costs down, be a bit more efficient, be a bit more agile. I think that’s been the big shift that we’re seeing, and this more open appetite to taking a managed service rather than building in-house, and that whole mind shift around that space.
O’Hara: Bringing down costs may be one factor in the equation, but are there other reasons why firms are looking more towards outsourcing?
Stéphane Tyč: Outsourcing in general is mostly about cost, but in our particular case it’s not about cost. It’s about accessing something that’s unique. We’re very different, I would say, in most of our offerings in that you cannot build, in-house, what we have and what we offer. We’re seeing a part of the equation, if you will, which is those that want to stay in a particular game will come and outsource to us. It’s not because it’s a cost question. It’s really because they cannot do it in-house.
Fenick: There are other drivers. I would say some of them are technology driven, being that they know that they have to, if you will, exploit and leverage some of the newest and latest technologies, which their companies are just not capable of doing, not capable of keeping up with.
It seems that we’re running in almost six-month cycles. For example, for a large bank, it might take them anywhere between 12 and 18 months to do a proper rollout. They’re just not capturing the cycles of technology innovation, if you will. They’re looking to outsource that and bolthole plug it in, in many respects. They’re looking at it from an advantage point of view, of engaging and embracing technology simply versus just cutting costs.
James Laming: What we’re also seeing is people wanting to use more new technologies, which just doesn’t fit within the current environment. There are certainly systems out there that want to use much larger data sets than they would be able to manage within their current infrastructure, so there’s a big push away from the old SAN environments.
There are people who want to collect a lot more data than they’ve ever had to before. There are people doing much greater or larger, systematic builds, and similar, and we’re seeing huge growths in those areas on our platform.
O’Hara: It could be argued that another factor that’s driving this outsourcing trend is regulation. In MiFID II for example, can the best execution requirements be interpreted is such a way that pushes firms towards more of an outsourced model?
Tyč: Well, it’s really interesting, the best execution, because now the obligation and the standard is much higher. You have to procure the best tools to do your best execution. What that means is unclear because you have to factor in cost, you have to factor in other objectives. Still, there’s some obligation to procure the best tools. Does it mean that you have to have the best for every component of your system? If taken to that extreme – and that sounds a little extreme – then it would mean that you have to procure the fastest, lowest-latency service, computers, networks, market data, everything.
It’s hard to know where the obligation stops. Obviously, you cannot do best execution by reading yesterday’s quotes at the New York Times. Maybe you’re not obliged to buy the fastest market data. Somewhere in between it stops, and where it’s reasonable is probably going to shake out in the future. We don’t know, but maybe it’s being pushed towards, “You have to buy more.”
O’Hara: For firms who are looking to outsource more of their trading infrastructure, what are some of the key considerations to keep in mind?
Powell: I think the vendors or third parties offering this type of service, it’s inherent on them that they have to be able to demonstrate that they could do as good a job, if not better, than the bank, for instance, themselves.
In general, it has to be better because we all know that there are technology issues from time to time, there’s an outage, there’s a failed server and so on. It’s never great. If it’s an in-house problem, yes, you kind of fix it and you move on. If you’re a vendor providing that service, that noise reverberates a lot more loudly, so you kind of have to be better, really, than the client doing it themselves.
The whole SLA – and I’d include in that things like business continuity, change management processes, monitoring and notification tools, the whole transparency – are really key around that. That’s perhaps the barrier that’s incumbent upon the vendors to help demonstrate, preferably quantifiably, that they can meet those challenges. Therefore, perhaps, a bank is better off outsourcing rather than trying to do that themselves.
O’Hara: There’s no doubt that the whole build versus buy debate will continue to rage on, even though more and more firms are now happy to outsource critical trading infrastructure to third parties. The benefits of doing this seem pretty clear.
The question is whether outsourced technology can also provide the differentiated factor that can really give some firms a competitive edge over others.
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