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August 1, 2010

So Not Fast!

By By John D'antona Jr. and Peter Chapman

But the question of a potential conflict of interest arises now as the exchanges, who operate the marketplaces, have entered the co-location business by building their own data centers and selling space. This began when exchanges shifted from a nonprofit to for-profit operating model, an evolution many believe started with implementation of Regulation NMS. As electronic trading grew after passage of Reg NMS, exchange revenues fell, leaving venues to search for new revenue. One solution the exchanges devised to deal with revenue loss was offer clients co-location services.

Exchanges Speak Up

The exchanges, aware many are pointing fingers at them for the problems surrounding May 6 and for catering to select groups of customers, fired back. They argue that all clients are treated fairly and equally. Not to do so, they contend, would be a direct violation of public trust and hurt confidence in the markets.

"If we gave any client or investor any type of preferential treatment over another, we'd be run out of business quickly," said Randy Williams, spokesman at Kansas City, Mo.-based BATS Trading. All of BATS's 450 clients or investors, which range from Getco to Lime Brokerage to Tradebot, receive the same services, such as free basic data feeds, and pay the same for trades, he added.

Joe Mecane, executive vice president at NYSE Euronext, said his exchange offers co-location to almost anyone who wants it. He dismissed the arguments of those who say co-location is only available or limited to high-frequency traders.

"The reality is, co-located equipment is used by people who deploy high-frequency trading algorithms-but it is also used by almost every bulge bracket investment bank, every wholesaler who is executing on behalf of retail orders and virtually every algorithmic trading firm," Mecane said.

However Arnuk begged to differ on the firms that co-locate. He said firms that aren't co-located are placed at a distinct disadvantage. He compared trading and co-location to the type of car one drives on a freeway and that one shouldn't be obligated to buy an expensive sports car in order to compete on a level playing field.

"The exchanges will always retort that co-location is available to all, and so it is fair," Arnuk said. "Of course it is available to all, as is a $1.7 million Bugatti Veyron, which does zero to 60 in 2.6 seconds. But should that class of car be the minimum required to play? If I only need a Civic, or more realistically the V6 Camaro, should I be forced to buy the Bugatti to drive on the freeway?"

Retail brokers also worried that while exchanges tout fair and open access to co-location, they've implemented very low barriers of entry. Thus, the subsequent amount of message traffic moving to and from the exchanges and data centers has risen tremendously.

Bandwidth, a precious commodity, they say, is being monopolized by co-located HFTS who can send millions of orders and cancellations during a single trading session. In the end, it pushes out the average retail investor's order, a point the SEC is making.

While acknowledging spread costs have come down because of co-located HFTs, retail brokers like TD Ameritrade note that these firms enjoy a time and place advantage. Their advantage in getting news and quotes before everyone else won't last forever.