The MTTLR Blog » network management

Will Co-location Kill the Stock Exchange* or, Is Too Much Tech Bad for Business?

admin — Wed, 29 Oct 2008 16:30:00 +0000

by: Elina Druker, Associate Editor, MTTLR

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Used under a Creative Commons BY-SA 2.0 license.

A Brief Introduction to Relevant Developments

Technology is changing the course of investing. According to Ivy Schmerken of Advanced Trading, about 85% of all trading on U.S. exchanges is automated.² Computer algorithms (algorithmic trading) are entering trading orders for over 30% of trades on traditional stock exchanges and possibly as high as 80% on American and equity markets.³ Trading algorithms are “a series of calculated steps strung together to … buy and sell large blocks of stock… [which] can be tuned to execute almost any strategy” in order to take advantageof momentary opportunities.⁴

The success of an algorithm depends, not only on the formula’s strategy, but on the speed at which information is input and the trade executed. Algorithmic traders are constantly pushing trading systems to be faster. The cost of speed is astounding. According to Joel Clark, of Waters, a recent Tabb Group study “estimates that reducing the latency of transaction processing to gain a microsecond of improvement costs a firm approximately $250. Reducing latency by 6 milliseconds, then, equates to 6,000 microseconds and a possible cost of $1.5 million.”⁵

As a result of this ‘need-for-speed’ exchanges are in competition, not only with each other,⁶ but with other, faster trading methods such as Alternative Trading System (ATS). Unlike exchanges, which have been around long enough to have outdated infrastructures, new ATSs have the newest technology available, enabling them to “complete trades at up to ten times the speed of older rivals.”⁷ Popular ATSs, such as Electronic Communication Networks (ECNs) and most recently, Crossing Networks and Dark Pools, have numerous additional advantages over exchanges, including minimized market impact of bulk trades and anonymity. “What’s troubling overall for exchanges is how much market share they are losing to the other … innovative technology venues,” says Brad Bailey, senior analyst with the consulting firm Aite Group.⁸ Traditional exchanges’ market-share dropped from 86% to 73% in 2007-2008, and is expected to keep falling. Alternative Trading Systems now process 13% of all matched trades.⁹ ATS may be open to gaming, through pinging and front-running, and may fragment the market, but possible legal implications (and the S.E.C.) haven’t gotten in the way.¹⁰ One method of eliminating latency is called proximity hosting.

Telecommunication companies, such as Savvis, place their hardware in or near an exchange’s data center. They then sell rack space close to the trading venue, or access to trading servers, the venue’s gateway or software.¹¹ Subscribers of proximity hosting receive low latency connections to one or multiple closely located trading venues.¹²

Implications of Automated Trading

To stay competitive, exchanges have had to develop their own technologies. They have had to update physical infrastructure, develop technology to move trades from the floor to electronic trading, disseminate market data faster and create “low touch/ no touch trading strategies.”¹³ They have also changed the nature of the exchange business. Hundreds of independent exchanges have begun a mass consolidation. BNY ConvergEx’s Managing Director, Joe Cangemi expects much more consolidation, predicting that “there will be three or five survivors.”¹⁴

Exchanges already wear many hats and charge for their services every step of the way. They charge traded companies “listing fees” and commission fees, and investors pay member and admission fees¹⁵, fees for physical seats on the floor¹⁶, fees per transaction¹⁷ for executing and updating trades, and market data providers also pay for publishing online and for subscriptions¹⁸ to real-time information.

Recently, exchanges have entered the telecommunications business. They have started selling physical co-location of investor servers at the exchange’s data center, competing with those technology firms who offer low-latency proximity hosting. Co-location is like proximity hosting, except that the exchange hosts the subscriber’s box in its data center. It is closer to the information feed, thus faster, than proximity hosting. Co-location can diminish latency between a client and the exchange to below 64 microseconds.¹⁹ The London Stock Exchange’s co-location service, TradElect will double to 20,000 continuous messages per second, with end-to-end execution latency reduced to three milliseconds in October 2008.²⁰

Co-location, however, is a dangerous strategy for all parties.

First, it’s expensive for subscribers. That means that institutional investors, nearly all of whom are using algorithms, can buy an advantage. Larger, well established investor groups can afford to co-locate while smaller boutiques²¹ cannot. This could create a barrier to market entry for small institutional investors. A few weeks ago, there were 6 major investment banks. Suddenly, the landscape has changed and co-location systems may prevent new market players from filling the spots left by the crisis.

Second, exchanges do not have the infrastructure to prevent jitters in latency. ²² Jitters and fluctuations in information can create unpredictable results. Unlike third party telecommunication companies, who can maintain some minimal amount of technology risk management, algorithms co-located with an exchange may act on unfiltered, possibly flawed data. Technology companies are in the business of keeping their software and hardware up-to-date. Exchanges wear too many hats to keep ahead of the technology curve. They simply are not in the best position to manage the flow of information.

So, there are risks. So what? Well, if large institutional investors can block small investors from entering the modern algorithmic trading market, and can make risky decisions instantly, maybe someone should revive risk management and competition. Regulations need to prevent exchanges from wearing the technology-provider hat. Algorithmic trading already creates plenty of room for error and there is no room for additional error on the exchange side. Besides, should access to the best information really be the factor separating large and small investors?

* The Buggles, Video Killed the Radio Star, 1979.
2 Ivy Schmerken, Exchange Consolidation Wave Is Expected to Continue in 2008, Advanced Trading, Nov. 1, 2007.
3 Wikipedia, Algorithmic Trading.
4 Mara Der Hovanesian, Cracking The Street’s New Math, Businessweek.com, Apr. 18, 2005.
5 Joel Clark, Still the Need for Speed, Waters, Apr. 1, 2008.
6 Wikipedia, Algorithmic Trading.
7 The battle of the bourses, The Economist, May 29 2008.
8 Schmerken, supra note 2, at page 4.
9 The Economist, supra note 7.
10 Video game? Dark pools battle pingers, gamers in unregulated markets, Financial Week, Apr. 22, 2008.
11 Proximity Hosting: Plug’n’Trade or Pay’n’Wait?, Automated Trader, 2008.
12 Check your speed, The Trade News, Oct. 16, 2007.
13 Id.
14 Schmerken, supra note 2, at page 4.
15 Fees Calculator, London Stock Exchange, 2008.
16 Hillary Wicai, The Marketplace Report: Pricey Seats on the NYSE, National Public Radio, Jul. 26, 2005.
17 NYSE to cut back trading floor, costs, LA Times, September 13, 2007, at print edition C-4.
18 Nasdaq OMX launches free real-time market data service, Finextra.com, Jun. 2, 2008.
19 Rich Miller, Proximity Hosting: When Microseconds Matter, Data Center Knowledge, Dec. 3, 2007.
20 Penny Crosman, London Stock Exchange Offers Collocation, Wall Street &Technology, September 2, 2008.
21 Admittedly, some small investors may gain access to co-location though their brokers, but at a high cost far exceeding what they would have had to pay for data in the past as emerging market players.
22 Sun Microsystems, Inc., Low Latency: Eliminating Application Jitter with Solaris™, May, 2007.

The Impact of Comcast’s BitTorrent Policy on Network Neutrality

admin — Tue, 04 Dec 2007 12:42:00 +0000

by: Brian Pascal (bhpascal [at] umich [dot] edu), Associate Editor, MTTLR

Imagine buying a train ticket from Ann Arbor to Chicago. Imagine, also, that, upon arriving at the train station, an attendant notices that you are carrying a wheeled suitcase, well within normal size limits. Without examining the contents of the bag, the station attendant politely informs you that your trip to Chicago has a new stopover — in Texas. He apologizes for the inconvenience, but, in order to ensure a smoother trip for other customers (whom, he claims, dislike walking behind people dragging wheeled suitcases), your trip will be substantially delayed. Worse, this action is not pursuant to any rules or regulations published by the railroad — it simply happens, and you, without any choice, find yourself on a train heading towards Dallas.

This incongruous situation, absurd in the real world, is all too real on the Internet. A few weeks ago, the Associated Press discovered that Comcast is playing the role of station attendant, targeting a specific type of internet traffic and delaying its delivery.¹ The type of traffic targeted is that which is mediated by the BitTorrent protocol, a method originally designed for the efficient distribution of large files via the Internet while simultaneously distributing the costs of bandwidth and hosting among a multitude of users.² While there exist numerous legitimate uses for BitTorrent, and while it was not specifically created to assist in copyright infringement, the very capabilities that make BitTorrent a powerful tool for creating a robust, self-sustaining network for the distribution of legitimate large files also make it widely used to enable copyright infringement, allowing for the rapid distribution of movies, television shows, and music. For these reasons, legal and illegal BitTorrent traffic accounts for a large percentage of the overall traffic on the Internet (though specific usage data has proven difficult to measure). ³

When the Associated Press published their findings, Comcast’s initial response was to flatly deny the allegations, stating that “Comcast does not block access to any applications, including BitTorrent.”⁴ Several days later, however, Comcast admitted that it was, in fact, delaying BitTorrent traffic, stating that “[d]uring periods of heavy peer-to-peer congestion, which can degrade the experience for all customers, we use several network management technologies that, when necessary, enable us to delay — not block — some peer-to-peer traffic. However, the peer-to-peer transaction will eventually be completed as requested.”⁵

This type of action, that of altering the flow of Internet traffic based on content, is merely the latest chapter in the ongoing debate over network neutrality. Tim Wu, a leading scholar in the field, states that “network neutrality is best defined as a network design principle. The idea is that a maximally useful public information network aspires to treat all content, sites, and platforms equally.”⁶ Comcast’s delaying of BitTorrent traffic is a clear deviation from that ideal, especially considering that it does not even specifically target the illicit uses of BitTorrent, but rather the protocol as a whole. Further, the means by which Comcast accomplishes this is by “impersonating” one of the users connected to the network, sending a signal that is interpreted as a request to stop transmission by TCP/IP, internet communication protocol.⁷

While there are strong normative and economic arguments to be made in favor of network neutrality,⁸ there is another theory, less often raised, that may serve to answer many of these questions under a legal framework — the doctrine of common carriage. The idea of a “common carrier” dates back to the common law of the 1800’s (or perhaps earlier). Generally, “common carriers were 1) required to serve upon reasonable demand, any and all who sought out their services; 2) held to a high standard of care for the property entrusted to them; and 3) limited to incidental damages for breach of duty.”⁹ This was not limited strictly to railroad services and shipping conglomerates. “In 1901, following many state courts, the U.S. Supreme Court held that at common law — i.e., even without a specific statute — a telegraph company is a common carrier and owes a duty of non-discrimination.”¹⁰ This commonlaw theory was instantiated in the United States Code, requiring communications carriers “to interconnect directly or indirectly with the facilities and equipment of other telecommunications carriers,”¹¹ and, moreover, to “ensure the ability of users and information providers to seamlessly and transparently transmit and receive information between and across telecommunications networks.”¹²

Read broadly, it seems that ISPs should be included in the set of telecommunications carriers regulated by these laws, and, moreover, to stand as a Congressional mandate of network neutrality; however, they are, generally speaking, not applied to internet connectivity.¹³ Further, current ISPs rely upon a host of economic and non-economic arguments to promote “network diversity,” arguing, for example, that the ideal of network neutrality is dependent upon a myth of “infinite bandwidth,” and that the application of a truly content-agnostic network is inefficient in practice.¹⁴ Additionally, since the ISPs claim ownership over their own networks, they argue that it is fully within their rights to regulate and optimize their available bandwidth as they see fit.¹⁵ Comcast’s recent throttling of BitTorrent connections is in keeping with this side of the argument. Given the economic concerns of of providing the best possible experience to its users, coupled with the very real fact that BitTorrent is responsible for a large percentage of its available bandwidth, Comcast made the decision to sacrifice the optimistic ideal of neutral network upon the altar of perceived practicality.

The debate over network neutrality is far from finished. Between the widespread, mainstream coverage of Comcast’s shaping of their network, and Barack Obama’s announcement of his intention to fight for network neutrality,¹⁶ the conversation has never been more prominent nor more relevant.

But conversations depend upon open channels of communication. Instead of fostering free and open communication, ISPs appear to hope for a return to the more centralized broadcast model, in which content providers are the main source and users are little more than passive receivers.¹⁷ In so doing, those in favor of network diversity short-circuit the very ideals originally embodied in the law of common carriage, the ideals that should, given the directness of the analogy, live on in modern Internet regulation. The alternative is a future in which speech not supported by big business is at risk for routing through Texas, and that situation, under any other circumstances, has never been allowed to stand.

¹  Peter Svensson, Comcast Blocks Some Internet Traffic, Wash. Post, Oct. 19, 2007.
²  See, e.g., Wikipedia, BitTorrent (last visited Nov. 12, 2007).
³  Id.
⁴  Svensson, supra note 1.
⁵  Peter Svensson, Comcast Admits Delaying Some Traffic, USA Today, Oct. 23, 2007.
⁶  Tim Wu, Network Neutrality FAQ (last visited Nov. 12, 2007).
⁷  See, e.g., Susan Crawford, Comcast is Pretending to be You, Susan Crawford Blog (last visited Nov. 12, 2007).
⁸  See, e.g., Wu, supra note 6.
⁹  Eli M. Noam, Beyond Liberalization II: The Impending Doom of Common Carriage, 18 Telecomm. Pol’y 435. Sec. II (1994).
¹⁰  Cybertelecom, Common Carriers, (citing Noam, supra note 9).
¹¹  47 U.S.C. § 251(a)(1) (2000).
¹²  47 U.S.C. § 256(a)(2) (2000).
¹³  See Noam, supra note 9.
¹⁴  See generally, Christopher S. Yoo, Beyond Network Neutrality, 19 Harv. J. Law & Tech. 2 (2005).
¹⁵  Id.
¹⁶  Barack Obama – U.S. Senator for Illinois, Network Neutrality, June 8, 2006.
¹⁷  Susan Crawford, The Radio and the Internet (working draft).