I have been pondering the influence high frequency trading has had on the bandwidth market over the past few years, and whether the recent second look it is getting from regulators might be something worth keeping closer tabs on. Low latency demand from the HFT wing of the financial industry has created some of the most profitable opportunities for both new and existing infrastructure since the bubble. Hence, shifts in that industry’s structure may have reprecussions.
The pressure to slow down HFT somehow has been building for a while now following the high profile Knight Capital disaster and several other cases that have highlighted the risks. Traders take risks as a matter of course, but when those risks balloon to economy-damaging levels someone usually steps in. Regulators overseas are already beginning to increase oversight and add restrictions and the SEC here may be moving slower but it is moving in the same direction.
Now, I have always been of two minds when it comes to HFT and its promises of turning microseconds into uncounted dollars. On the one hand, bandwidth differentiation has meant a lot to the fiber industry after a decade of commoditization. Seeing fiber operators compete to provide the best network rather than the lowest price has been a very welcome shift. It’s been like being an weapons supplier to a rapidly escalating arms race after decades of peace.
But on the other hand, market liquidity is a bit like engine lubrication. You definitely need enough of the right quality in the right places to make it work right, but beyond that you’re begging for trouble unless you’re a NASCAR driver – in which case there are reasons why you aren’t driving on public roads. Besides, the HFT guys aren’t in it for the liquidity, it’s really about finding better ways to pick each others’ pockets and nothing else. It doesn’t increase the size of the pie materially, and thus in the end the financial industry makes basically the same money in aggregate that it used to make while paying more for bandwidth for the privilege. Well, the finance guys may deserve what they get in those terms, but how sustainable is it for network operators if regulators find a way to end the game and the need for those low latency circuits dries up.
So the question is, has the rest of the market for low latency connectivity evolved to the point that any regulatory-induced shift in HFT-related demand will be negligible? Or does the equation shift meaningfully for those fiber operators that have worked the hardest to win this segment of the market? I think the financial vertical is still the primary driver here despite growing need from other parts of the economy for low latency options, e.g. healthcare, gaming, and cloud. None of those have the same financial payoff that has driven the HFT community to pay top dollar for an extra few microseconds.
But perhaps it’s important not to overestimate the ability of regulators to stuff the toothpaste back in the tube. Whatever rules they pass to protect markets from perceived HFT risks, there will still be automated trading of some type and those that have a latency advantage will have the upper hand in whatever that is. Even if today’s HFT trading systems vanish, others built for the new regulatory regime will simply replace them.
Put another way, today’s HFT systems strike me as the first brute force way to take advantage of a new idea, to be followed by more sophisticated approaches when it stops working. There are more subtle ways to use speed than to give a computer the authority to trade a hundred thousand times per second without supervision and hope you didn’t fat-finger the settings like Knight Capital did in August. The next generation won’t be this clumsy.
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