High Frequency FX: The benefits of incubation for proven performers
The financial crisis of the past two years has led to dramatic changes in the competitive and regulatory landscape of Wall Street. Negative perception, more stringent capital requirements as well as new regulation, such as the Dodd-Frank Wall Street Reform Act, has made proprietary trading less attractive to banks. Several banks have scaled back on proprietary trading while others have announced that they are exploring moving their proprietary trading into a separate hedge fund structure. Furthermore, changes to bank compensation schemes, such as a higher proportion in deferred compensation and the introduction of claw back mechanisms have made it less attractive to work at a major bank. As a result, we have seen an exodus of high frequency trading (HFT) teams out of banks. Some teams are joining hedge funds or proprietary trading firms while others are choosing to go out on their own and create their own high frequency trading firm. In a previous article1 we described the challenges of starting a HFT firm. Here we will focus on incubators and the benefits they provide to start-up HFT firms.
In the last couple of years, as observed by the Aite Group2,3, a few firms have been established specifically to incubate HFT firms. The traditional role of an incubator is to identify profitable opportunities within an industry and to provide the necessary resources to help start-up firms develop and grow into successful businesses that exploit these opportunities. Incubators within the FX HFT space are no different. Incubators are often confused with the traditional hedge fund seeder. A seeder typically only provides trading/investment capital and is not involved in company set-up or in the management of the company.
An incubator’s approach is to create a true partnership with the start-up firm and to provide a high level of support in order to guide the new firm during its early days. An incubator will typically take an ownership stake in the new firm in exchange for its services. An incubator will ideally assume responsibility for a significant portion of...continued