By Paul Rowady
There is massive change afoot in the capital markets. Coupled with the evolving nature of market interconnectedness and an exploding diversity of data flows, unprecedented global regulatory drivers are forcing the OTC swaps market into a more exchange-like environment, complete with more-automated workflows. These new levels of complexity lead to myriad connectivity requirements among trading platforms, clearing brokers, clearinghouses and the buy side. As a result, market participants are faced with the increasing need to immerse themselves (and their trading systems) within increasingly complex trading ecosystems.
A discussion about interconnectivity and co-location is sure to conjure up visions of highly automated trading strategies for listed markets in most of the world’s developed and active regions. The name of the game is high-speed decision making aimed at cash equities, listed futures and options, and, to a growing extent, at FX and certain fixed income markets. To remain tied to this notion, however, would be to ignore exactly how pervasive the need for co-location and interconnectivity has become.
Allowing for a broader lens, it is quickly apparent that these topics are no longer limited only to the highest-speed trading strategies managed by the secretive, quantitative skunk-works embedded in select firms. Over the recent past, and as a result of democratized functionality that is cheaper and easier to use, a much broader array of market participants -- with the potential to include almost everyone -- can access (nearly) the speed, performance and other interconnectivity benefits of the algo pioneers.
That said -- and because the clash between performance needs and resource constraints has recently emerged as one of the industry’s most precarious balancing acts -- the increasing need for optimized co-location and interconnectivity has given birth to the concept of capital markets “eco-centers.” No longer just a data center, an eco-center delivers on the promise of concentrated and comprehensive access to a region’s various matching engines and vendor-supplied workflow solutions, all with an eye toward optimizing interconnectivity relative to specific performance and operating cost requirements. In other words, market evolution has arrived at the point where market participants can now plug themselves into a comprehensive array of functionality under one roof, like a supermarket for high-performance trading and analysis.
With those movements as a backdrop, now enters the post-credit crisis hangover and all the mass transformation that it entails for the swaps and other OTC derivatives markets. Whereas the cash equity and listed derivatives markets started off with a relatively centralized framework, the OTC derivative (OTCD) markets are leap-frogging directly into an uncertain yet highly fragmented and complex market structure. As such, trading institutions have to negotiate a far broader menu of connectivity options and requirements to an expanded array of trading platforms, exchanges, matching engines, risk engines, brokers and other solutions.
As the new rulebook forged by the Dodd-Frank Act (DFA), the European Market Infrastructure Regulation (EMIR), and other regulatory efforts around the globe kicks in, the former bilateral paradigm for swaps will be replaced, in large part with a multi-lateral framework, much like the operational and regulatory attributes of the listed derivatives world. Taking these moves a step further, and particularly in an era seemingly starved for new sources of performance, accessing the emerging “futurized” swaps markets within this eco-center concept offers potential for alpha discovery and harvesting at an accelerated pace.
We don’t yet know all that can be found by approaching these new product segments from a high-performance perspective; it is a journey into the unknown that we will all take together. But the insight that can be gained from accessing and managing each of the growing list of hedging products -- including futurized and cleared OTC swaps -- in a highly-automated manner is hard to refute. Computational prowess is and will continue to be a requirement here. Moreover, there is always opportunity in mass transformative events, particularly when the framework allows for new tactics and an evolving diversity of demographics. It is conceivable, if not highly probable, therefore, that optimized co-location and interconnectivity will quickly become just as important in the new swaps market as it is in any other highly-automated market structure.
So where will this eco-center concept first take root? Even though cleared OTC swaps and the new product launches aimed at mimicking them are still very much in their formative stages, it doesn’t take a crystal ball to make a reasonable guess. The major clearinghouses already have a solid presence in the Chicago market, as do the major clearing brokers (aka: futures commission merchants, or FCMs) and much of the futures trading infrastructure, analytics and support solutions. On top of this, new players in the reformed swaps market, such as Javelin (a swap execution facility, or SEF) and other enhanced trading platforms, have already seen the benefits of proximity tactics by establishing their matching engine at the address of the world’s largest datacenter (and the new heart of the Chicago trading community): 350 E. Cermak. Need we say more?