On 12th February 2016 the UK’s Financial Conduct Authority closed a consultation on the use of cloud technologies by financial services firms. The initiative, reflects a growing awareness amongst authorities that technology innovation needs to be provided with a regulatory framework, as its use increases – the Monetary Authority of Singapore has also made amendments to its rules to ensure cloud servicing is captured.
These moves are positive for the FX trading environment, in which the adoption rate of cloud components in an end-to-end model has become increasingly common. Until recently, individual components and elements of a system that made up an FX trading environment tended to be discrete and developed in a privately engineered fashion. A firm would often select the component pieces, the systems, the storage, the application of the services, the networks, and the location to engineer it in accordance with the trading demands.
“The availability of cloud components have become more widespread and the ability to utilise them has become more prevalent and more feasible,” says Michael Cooper, Chief Technology Officer for Radianz, BT Global Banking and Financial Markets at BT. “That’s come off the back of an underlying trend around IT provision towards cloud models, from people like ourselves at BT providing more mature cloud capabilities with location sensitivity.”
Increasing adoption rate
The trend is towards an ever-increasing rate of adoption of cloud, assisted by the formalisation of a framework by regulators and the increasing comfort of traders and institutions with the level of service that cloud can offer.
The way that market participant are interacting with one another is changing, which in turn has an impact on their need for technology to support and connect with clients. For example, mid-sized players are starting to use direct application programming interfaces (APIs) for customer engagement rather than going through multi bank platforms or publishing through third parties.
“We are starting to see some of the smaller players develop a niche strategy which means they want to directly interact with their end customers and not go via one of the top tiers guys or multi-bank platforms,” says Jay Hibbin, technology strategist, Financial Services for CenturyLink. “So I think we saw the rise of the multi-bank platforms a few years ago and their ubiquitous use for that market, but now we are seeing the smaller banks who are not in the top five, six or even top 10 looking to establish themselves with a niche strategy focused on a handful of clients who they want to directly interact with. There is some disintermediation.”
The virtualisation of compute power also creates the potential for smaller firms to access major processing resources which can allow them to develop technology more quickly and cheaply than ever before, creating testing environments that can expand and contract in terms of resources as they are needed.
“When you hear about the fintech incubator strategies of pretty much all the major banks now, you know that this roughly translates into small tech firms being given a combination of resource at the banks which helps the products they are developing to be better for the banks,” Robin Manicom, head of financial enterprise at data centre provider Equinix. “Banks don’t want to become disintermediated by the fintechs so the banks are just a back office. But it also means the banks gets to build the technology really that they need and the fintech gets to sell some pretty good business to the banks.”
Both exchanges and banks are moving into FX which gives them a requirement for flexible resource as they establish themselves; where previously they may have been a derivatives market before or a fixed income market they are now becoming a fixed income/FX market.
“That’s really interesting for us because we are seeing that happen only really for FX not the other way around,” says Manicom.
When considering the use of cloud-based technologies in the FX space firms have to weigh up the key things that will enable or inhibit the model to work effectively in the FX market, particularly assessing latency, location and the capacity to reach multiple counterparties or data sources. Traders who were not traditionally interested in low-latency, high-frequency access to liquidity are finding that it is more accessible and therefore interested in that trading model is expanding.
“Previously conversations around cloud were quite disjointed; potentially if you went cloud you almost admitting that you weren’t latency sensitive,” says Hibbin. “It was a business to consumer (B2C) play really. Now actually it’s not a B2C play it’s potentially a more mainstream activity because maturity on the cloud side means that platforms are available in proximity to liquidity data centres and so the latency trade-off for going cloud is not necessarily a significant one anymore.”
The maturity of cloud platforms also means that provision is not based upon public cloud alone, it is possible to get isolated or dedicated instances of cloud.
“I have got bare metal services that offer cloud economics but on a physical rather than a virtual kit and I have got private cloud and managed services as well,” says Hibbin. “So I can actually deploy a platform where maybe my trading engine is still in a traditional dedicated model, co-located next to the FX liquidity pools in the market.”
Gordon McArthur, CEO at Beeks FX, a leading provider of virtual private servers, notes that the capacity for provision offers the flexibility to cater for traders at every level.
“Many people using virtual servers are more the retail-type traders who are just starting out and don’t need the resources of a dedicated machine,” he says. “We have a plethora of those users along with many institutional clients who use our dedicated servers; we have brokerage firms who use us to offer servers to their clients and to host their infrastructure. A lot of our clients are using the Metatrader MT4 platform and often NinjaTrader; there are multiple different softwares, but MT4 is the most common,” says McArthur. “The number of instances they are using and the number of products they are trading will determine the resources they need. The smallest virtual server can handle an MT4 platform and trading while a dedicated server can handle 20 instances and trading across eight connections to multiple firms.”
As it considers the technology that will support an FX trading operation, a firm has to look at IT, models and processes that complement the existing system and are consistent with it as well. In the current market environment for many businesses, this must include an awareness that the specific role they play may change as a consequence of regulation. Specifically, where liquidity is becoming shallower – even in what have been considered highly liquid currency pairs – and the sell-side is withdrawing from liquidity provision, there is the potential for market infrastructure providers, buy-side firms and non-traditional liquidity providers to offer new ways of working.
“In traditional capital markets margins are really being squeezed, markets have completely fragmented over the past eight years, which will be furthered exacerbated by regulation such as MiFID II,” says Manicom. “We also know that all of the market operators are trying to cover each other’s markets; domestic exchanges trying to compete with other exchanges in their own market. So you have got the exchanges and the banks who are obviously happy to support that type of cross regional and global trading, on one hand, while at the other end of the scale you have got the new MiFID and Basel regulations coming downstream that require firms to report on everything, driving more investment into being compliant.”
This perfect storm of crushed margins and rising costs creates a real challenge for firms seeking to be competitive. The potential exists for global growth yet that requires investment in technology to support that global presence. With the bottom line is rising higher while the top line is coming down, profitability is compressed making the economics for the usual models for supporting growth harder to operate.
“With cloud technology we can’t create liquidity, we can’t create more trades, but what we can do is we can help drop the bottom line therefore bring in some more profitability into every transaction,” says Manicom.
He asserts that Equinix, along with other technology providers are doing just that with the promise of what cloud is able to deliver. The maturity of the technology, its proven resilience, and the development of new models that allow data to be run across applications without crossing borders are all increasing the confidence that regulators have in supporting its use.
“The year before last the Monetary Authority of Singapore (MAS) had really been against cloud technology for banks, because it was mainly concerned with data security going offshore,” he notes. “There was sovereignty in Singapore and it more or less decided it didn’t want to see any of the Singapore banking customers’ businesses venturing off with third party cloud providers.”
Then in late 2014 MAS published a set of rules around the inclusion of software as a service (SaaS) within the outsourcing arrangement guidelines, making cloud acceptable as long as it adhered to the existing outsourcing rules; it also addressed the concept of ‘multi-tenancy’ technology provision which specifically referred to a single platform that serviced multiple tenants.
“Some firms have helped MAS basically understand that data can move around in a highly-encrypted more or less unbreakable fashion and I think that made MAS a little bit more comfortable and understanding of the benefits of cloud coming into financial services,” says Manicom. “That acted as a beacon for the industry as if it managed to convince one of the biggest doubters of cloud that must be seen as a positive step to move forward.”
Resilience is crucial in order to maintain the confidence of traders and regulators; crucially this includes defence against cyber-attacks as well as a sturdy infrastructure. Where clients are not in direct control of the systems that manage data, concerns can be higher.
“I personally am not of the belief that the organisations and service providers specifically servicing financial markets did not providing that level of security,” says Cooper. “Arguably security has become more critical than it’s ever been before. My personal view is that a segment specific service provider like BT, and others, have been best placed to implement,incorporate and maintain best practice security policy.”
As MiFID II will require institutional investors to record the personal details of traders that execute specific orders, even greater defences need to be put in place.
“We have put all of the security measures in place for clients,” says McArthur. “We have got multiple layers of network, a security layer, a front end layer and we give clients multiple ways to access their infrastructure. Our engineers see people have tried to attack our infrastructure before, and you learn more about those attacks every time.”
To be confident that the cloud capability a trading firms is selecting will be suitable for purpose, it should be made available in a suitable location, which may mean being physically resident in a particular data centre.
“Then your ability to use cloud as part of your system depends on availability in that location,” says Cooper. “If you want to use cloud —either compute or network — in your trading system, then you have to consider whether it’s has an appropriate level of security, the correct levels of availability and a suitable performance profile.”
With FX becoming more regulated as a market, a framework of rules is a useful assist when onboarding new technologies. In the selection process for a third-party provider, certain best practices need to be considered. Among those are the commitment to the provision of cloud services in finance and the extent to which they are underwritten from a regulatory perspective.
“Financial services firms need to ask if they have the sort of infrastructure, the elasticity, and the operational flexibility to respond to dramatic changes in the market” says Cooper. “And as service providers, we need to offer a service with these attributes and the ability to anticipate and adapt to evolving market requirements”.
All about cost
The effect of reduced liquidity and tighter regulation also changes the priorities of trading firms, so that performance has to be balanced against cost, to mitigate reduced capacity to generate alpha.
“Dial back a few years there would have been FX players, buy and sell side, who would have told you that it wasn’t about cost it was about latency, access to liquidity and about speed to market,” says Hibbin. “Cost was a fourth or fifth consideration and if it meant spending a bit more money to get access to the right datacentre, the right compute, the fastest possible switch, the fastest access network or the right liquidity platforms they would throw everything at it.”
That attitude reflected the high volumes and the huge potential returns relative to the costs, which meant that firms did not need to focus on element of expense as much. Now there is a more granular focus on cost because the volumes are not as high.
“Returns are not necessarily as great and the level of compliance and focus on FX as an asset class means that actually there are other considerations that you have got to weigh into the balance, in terms of the cost of being compliant, and best execution obligations which are coming down the road for FX,” says Hibbin. “All of that is adding to the cost, meaning that people are going to take a much more pragmatic mature approach. Can they afford to have the lowest latency access to 15 liquidity pools for a given currency pair? Do they need to focus more on a certain specialism, on key customers?”
Latency can often be critical in one or two areas, or particular markets and the traditional FX vendor conversation which would involve a trader wanting to be in all of the points in Tokyo, and in London and in New York, at very low latency, where cost is not an issue are fading away according to the vendors.
“I think those type of opportunities certainly from a supplier side are dwindling because clients are taking a more cost focus pragmatic approach,” says Hibbin.