Recalling the years around the financial crisis may still bring a shudder to many on Wall Street, but for high-speed traders 2008-2009 were pay dirt.
The high-frequency trading industry was still in an early stage. Recent regulatory change, opening the way for competition, and computing advances had paved the way for its rapid development. As markets took fright through the crisis, there was plenty of price volatility and high volumes of asset dealings — the raw materials for any trader to make money.
A decade on, the environment could not be more different. The business of high-speed trading has matured, making it harder to compete in a sector where keeping up with technological change is expensive and volatility has languished near all-time lows.
“It is classic supply and demand,” says Ari Rubenstein, chief executive of Global Trading Systems, a high-speed trader.
“A lot of firms are sophisticated and are now mature at building innovative technology that enables them to supply liquidity to the marketplace . . . So profit margins are suffering.”
According to research by investment bank Sandler O’Neill, the total volume of equity trading is down 12 per cent in the year to date compared with the same period a year ago, while over the same time intraday volatility is down by 49 per cent.
This trend has hit high-frequency trading, which relies on sophisticated algorithms and high-speed computers to effectively make markets on multiple venues and in securities concurrently. As margins in the sector are squeezed, the cost of cutting-edge technology and market data that are necessary for staying competitive has continued to rise. This has forced high-speed traders to rethink how they operate.
Some of that has come in the form of consolidation. Virtu Financial this year paid $1.4bn for rival KCG Holdings, a previous tie-up of Knight Trading and Getco that never managed to thrive. The deal gives the group 20 per cent of the US market.
Others have decided to give up. Teza Technologies, a pioneer of electronic markets, was founded by Misha Malyshev, who made more than $1bn in 2008 for hedge fund Citadel while head of high-frequency trading. Last year, the company decided to abandon its proprietary trading business.
You have a lot of supply and not much demand. So profit margins are suffering
Another group is teaming up. Through a venture known as Go West, top traders including DRW, IMC, Jump Trading and XR Trading have opted to pool resources to build an ultrafast wireless and cable route between the financial centres of Chicago and Tokyo rather than each paying for its own network.
“The market continues at low volatility and fairly low volumes and the industry is trying to do its best,” says Larry Tabb, founder of the Tabb Group, a capital markets consultancy. “There is still cost cutting going on and consolidation happening.”
The challenging backdrop coincides with what many participants see as the natural progression of an industry segment that is no longer the young, maverick part of its market. Rather, high-speed traders have become the establishment. They dominate, for example, the ranks of market makers on the floor of the New York Stock Exchange and have usurped a role traditionally held by banks.
“As electronic market makers continue to mature, we are observing a degree of consolidation in the industry,” says Remco Lenterman, head of global business development at Citadel Securities. “This process is being somewhat accelerated by a competitive trading environment.”
Mr Rubenstein, meanwhile, predicts more partnerships, not just among traders but also among trading companies and banks. “In an environment where margins aren’t expanding . . . it brings people together to come up with interesting solutions . . . The vast majority of firms are talking to each other about opportunities,” he says. “It is not just prop [proprietary trading] firms. Divisions in banks are assessing what their growth plan is given low volumes and volatility.”
Last year, JPMorgan and Virtu agreed a partnership in the US Treasuries market: Virtu will provide technology to the bank to trade in the dealer-to-dealer markets for Treasuries. Citadel, for its part, bought an automated market maker called Automated Trading Desk from Citigroup. Such deals with banks are expected to continue.
Another issue for traders in financial markets is Mifid II, the EU’s trading rule reforms which come into force next year. Among the changes, banks can no longer bundle the cost of research into trading fees, a move that some believe will increase the pressure on US banks to follow suit. That could in turn lead banks to improve their trade execution, since research may no longer be part of a package investors normally receive.
In the meantime, participants and observers are still focused on what could finally snap the financial markets out of this period of becalmed stability and prompt a rise in volatility.
Some hopes are pinned on central banks lifting interest rates after the long post-crisis period of accommodative monetary policy and stimulus.
“What everyone is trying to understand is what is driving the persistent low volatility? Are low interest rates a factor and to what degree?” says Richard Repetto, an analyst at Sandler O’Neill. “Investors are trying to figure if the low volatility environment is here to stay. Actions of the central banks are one area that is being closely watched.”