Sixteen microseconds. That is how long it takes for a share trade to be completed using a system built by Algo Technologies, a US-based trading technology company.
To get an idea of how fast this is, the blink of a human eye takes 300 milliseconds – and one millisecond is made up of 1,000 microseconds.
That trading in shares – and indeed other asset classes such as options and foreign exchange – can take place this fast may seem bewildering to those not deeply involved in the world of technology and markets.
Many still think of share trading as an activity that takes place on the floor of the stock exchange, with human intervention; images of traders punching in orders on screens on the floor of the New York Stock Exchange are part of the daily diet of business television viewers.
But these out-of-date images are there largely for marketing reasons. The NYSE ensures that its trading floor is on television every day as much to maintain the visibility of its brand in the minds of investors as anything else. Today, the vast bulk of share trading happens out of the public eye and is carried out through computer systems that grow ever more complex.
Technology has thus transformed the way markets function without the public really knowing. Trading takes place through underground fibre-optic networks that carry messages between computer systems at banks and trading firms, into vast data centres hosting an exchange’s trading engine. These centres do not make for exciting visuals, but they are where most of the world’s share trading is now taking place.
Speed is only part of the story. Regulation that has allowed competition to emerge for established exchanges has led to the creation of rival trading venues, some operated by broker-dealers and others by independent operators with ambitions to be the exchanges of the future – such as BATS Global Markets and Direct Edge in the US, both of which are less than 10 years old.
Then there are “dark pools”, special platforms that allow the trading of shares away from exchanges with prices posted publicly only after deals are done.
This has split trading in the US among 14 public exchanges, more than 30 dark pools and more than 200 broker-dealer networks. The NYSE only handles 26 per cent of volume in NYSE-listed stocks, for example.
Navigating all this requires technology. Companies that used to represent a small corner of the technology business are becoming household names as market participants hire them to build high-speed trading connections and risk-management systems.
Regulators are now acutely attuned to how this technology revolution has transformed market structures. Mary Schapiro, chairman of the US Securities and Exchange Commission, the markets regulator, said last month that advances in technology had “opened the door for entirely new types of market professionals” – such as certain breeds of “high-frequency trading” that use computer algorithms to trade in and out of assets in microseconds – and warned these market structure changes had “raised serious questions and concerns”.
Essentially, regulators are starting to question whether technology – and how it has changed markets – is still working to advance orderly markets and price formation, or whether it has run so far ahead that it has created imbalances in markets that need to be addressed.
This month, the European Commission held a review into the Markets in Financial Instruments Directive, which broke the monopolies of national exchanges and allowed competition in share trading.
Michel Barnier, the commission’s internal markets commissioner, told a conference: “Technical complexity or technological developments cannot be used as an excuse to derogate from the fundamental principles of transparency, responsibility and appropriate regulation.”
What, then, do regulators do? Clearly regulating technology is hard. It would be difficult to justify any regulator telling Algo Technologies, for example, that 16 microseconds is fast enough – and no more.
In any case, it is not necessarily speed that is the issue. And at some point – perhaps soon – the race in trading speed has to end with everyone getting to the same point, which may be light speed – especially with the development of new “photonic chips” that pave the way for the production of ultra-fast quantum computers with capabilities far beyond those of today’s devices.
Instead, regulators are looking at upgrading their own systems to narrow the gap between the technology being used by players in the markets and that employed by watchdogs to monitor markets for potential abusive behaviour.
The SEC has also proposed measures to help improve risk management around technology, such as rules that would prohibit broker-dealers from providing third parties with unfettered access to markets without appropriate risk-control systems in place. The idea is to ensure that traders using a broker-dealer’s exchange membership to access an exchange are subject to the same risk-management controls as an exchange member.
In addition, the SEC has proposed establishing an electronic “audit trail” of trades, so that whatever a trader does can be seen quickly by regulators. In effect, the commission is acting to limit certain trading behaviours that have been enabled by technology. That is consistent with its congressional mandate to protect investors and the integrity of markets.
Regulatory authorities in Brussels lack that mandate, and are driven more by a desire to ensure effective competition. Thus tackling the challenge of the rise of machines in Europe will be a much harder task.