Is there a profitable future in the co-location business?
Turn the clock back almost a decade and the exchanges were busy trying to find newer ways and places to conduct trading operations. Sure, thered still be traders, algorithms and data but not in Manhattan – rather theyd all interact across the Hudson River and in a suburb of New Jersey. Think the exchange located in the Concrete Jungle goes to the home of the mall and backyard.
Say it isnt so, Joe.
But it was. And other exchanges and companies created data centers and co-location facilities in other Garden State locales, such as Secaucus, Edison and Piscataway. Still other centers popped up in outside the New York/New Jersey metro area in Virginia, Illinois and Denver to name a few.
According to CBOEs website, there are 2,424 colocation facilities nationwide. Is there room for more? And moreover, has the proliferation of these hubs been a worthwhile endeavor?
Co-location was the first wave in a move from firms owning their own infrastructure. From a cost perspective it has been well worth the effort, said Brad Bailey, Research Director, Securities and Investments Group at Celent. Co-location has offered advantages in availability, disaster recovery, physical security, shared services. Some of the third-party data centers have become key locations in trading across asset classes.
Is the co-lo business still booming?
Data growth has accelerated and the move away from on-premise infrastructure continues, Bailey continued. Demand is very high for data centers strategically located near major trading centers globally.
If 2010 was the first wave of co-location, then Bailey dubbed the present as the second wave of innovation and construction. The move into the cloud marks a delineation from physical spaces to the cyber realm.
Firms are continuing to strategize on what infrastructure should be in house, collocated, and moved to the cloud, he said.
The following article originally appeared in the May 2010 edition of Traders Magazine
A Buttonwood Tree Grows in Mahwah
By Peter Chapman
It wasn’t simply a landscaping flourish or a nod to history that prompted NYSE Euronext executives to plant a group of buttonwood trees outside their massive new data center in Mahwah, N.J. this spring.
According to Wall Street lore, it was under a buttonwood tree–better known as the sycamore–that 24 brokers formed the New York Stock Exchange in 1792. By planting six of the trees in Mahwah, the exchange operator was, of course, paying its respects to its heritage. But also, and more significantly, it was signaling that a new type of market center was being born.
For more than 200 years, the building at 30 Broad and its predecessors were the center of trading, where brokers swarmed around specialists’ posts shouting out their buy and sell orders. But for the next 200, NYSE executives hope the building at 1600 MacArthur Blvd. in Mahwah will fill that role, with traders’ algorithms noiselessly interacting with the matching engines of its five equities and options exchanges.
For NYSE Euronext, the future is in co-location and being a “liquidity hub.”
The New York has always been a manager of liquidity hubs, of course. At 30 Broad, it provides four walls within which brokers can conduct their business. It provides the doors that let them onto the trading floor. It provides a specialist who controls the action. It provides booths, telephones, market data, order routing and order management systems. And, of course, it provides the electricity, heat, running water, food and bathrooms necessary to keep everyone comfortable.
Center of Universe
The building in Mahwah is just one more facility. But instead of a specialist, it has a matching engine. Instead of doors, there are FIX gateways. Instead of brokers, there are algorithms. Instead of booths, there are racks. There is still market data. There is still order-routing connectivity. There are even order management systems, in case traders need them.
For NYSE Euronext, Mahwah is the new center of the universe. There will still be traders on the floor at 30 Broad, but they will be interacting with a server in Mahwah.
To make the dream a reality, the company has charged its commercial technologies division, NYSE Technologies, with the task of bringing in the traders and their algorithms. As the NYSE did (and still does) at 30 Broad, NYSE Technologies will do in Mahwah: supply traders with market data, order routing and a place to hang their (digital) hats.
The group has responsibility for the 400,000-square-foot facility in Mahwah and an equally large one in Basildon, England. They cost $600 million.
“Our data centers are the trading floors of the future,” Stanley Young, chief executive of NYSE Technologies, told Traders Magazine. “The network electronically replicates the physical floor where people used to walk and talk.”
NYSE Technologies was put together last year by combining several disparate pieces of the NYSE Euronext global empire. Its mandate is to commercialize the parent company’s trading infrastructure properties in service of sellside, buyside and exchange customers. The group is essentially a rebranded NYSE Euronext Advanced Trading Solutions, a smaller in-house organization launched two years ago with a similar goal.
Behind the creation of these enterprises was management’s concern that NYSE Euronext’s traditional trading operations were under threat and the firm needed to diversify. NYSE Euronext had to invest in the technology to support its own markets, the thinking went, so why not market the technology to others? If NYSE Euronext was not going to be able to execute every trade, it should at least try to touch as many orders as possible. That philosophy underlies NYSE Euronext chief executive Duncan Niederauer’s vision for the future of his company.
“We are going to redefine what it means to be an exchange in the 21st century,” Niederauer told analysts recently. “It’s not just about the matching engine. The matching engine is a commodity.”
The bet is that many of those brokers who opt to outsource their data feeds and connectivity to NYSE Technologies will do so by co-locating their trading servers in Mahwah. That will give them the fastest access to NYSE Euronext exchanges. Orders earmarked for competitor exchanges will be routed via extranet.
Moving to the big data center is not a requirement, however. NYSE Technologies’ executives assert that they will manage infrastructure wherever the customer sees fit. That’s even if they want to co-locate in the data centers of NYSE competitors.
Young was previously chief executive of an NYSE Euronext joint venture called Atos Euronext Market Solutions (AEMS). The vendor provided technology services to NYSE Euronext’s European operations. Young joined NYSE Euronext when it acquired AEMS in summer 2008.
To make NYSE Technologies a viable competitor, Young must mold a grab bag of tech companies NYSE Euronext acquired in recent years into a cohesive whole.
In the U.S., that includes the old Securities Industry Automation Corporation (SIAC); the high-speed market data company Wombat Financial Software; FIX engine supplier TransactTools; order router NYFIX and AEMS. About 300 people work for NYSE Technologies in the U.S., Europe, Asia and Latin America.
Despite two years of effort, the organization is still in its infancy and the molding process is ongoing. There has been some flux in the executive suite, and the two data centers aren’t slated to come on line until later this year.
“It’s a work in progress,” Niederauer said at a recent conference for analysts. “We’ve acquired a few assets. We haven’t put them together yet as we would like.” Young expects the group to be in fighting shape by the end of the year. “The message is still embryonic,” he said. “But the trajectory is the right one. We have to get our data centers up and running. By the end of the year we will be in such a strong position, I will be comfortable taking on all comers.”
Predecessor group NYSE Euronext Advanced Trading Solutions was launched in 2008 shortly after the firm bought Wombat. ATS was co-headed by Wombat CEO Danny Moore and TransactTools CEO Sam Johnson. Both men have since left the firm, Johnson in 2008 and Moore just last month. Moore acted as NYSE Technologies’ chief operating officer for the last year or so.
Supporting Young is a mixture of old NYSE hands and new hires. His chief technology officer is Don Henderson from NYFIX. His head of research and development is Conor Allen, from Wombat. Young also works closely with NYSE Euronext CTO Steve Rubinow, whose main focus is the Mahwah data center.
As for the three business units, Young looks to longtime NYSE employee Mark Schaedel to run market data. Market data sales is by far the biggest contributor to NYSE Technologies’ revenues. It accounted for nearly half of the group’s total revenues of $368 million in 2009. Most of that came from the distribution of NYSE Euronext data. The plan is to bring all the market data from about 150 exchanges worldwide into its data centers for onward distribution to traders’ algorithms or black boxes.
Key U.S. employees for infrastructure include Ken Barnes from Wombat and Don Brook from Radianz, who jointly run the co-location business. Tony McManus, formerly in charge of algorithmic trading software at Wombat, runs enterprise solutions. Key services include a large extranet known as SFTI (pronounced “safety”) that was the centerpiece of SIAC, and co-location.
The breadwinner for now is SFTI. The nine-year-old network shuttles market data, orders and trade reports between brokers and exchanges and, with last year’s acquisition of NYFIX, brokers and money managers. The group brought in $136 million last year, or 37 percent of the total.
Finally, Bob Moitoso runs the transaction solutions division. Industry veteran Moitoso has spent much of his career facilitating communication between the sellside and the buyside. He joined with the NYFIX deal. Bruce Boytim and Dan Romanelli, formerly of Merrill Lynch, are responsible for the risk management gateway. The group is the smallest of the three, contributing only 14 percent of revenues, but includes at least two valuable trading products: a risk management gateway-now an imperative with new SEC rules surrounding risk management likely–and NYFIX.
The $368 million NYSE Technologies took in last year was 15 percent of total NYSE Euronext net revenues. The division is the least profitable of NYSE Euronext’s three divisions–the other two are cash equities and listings and derivatives–accounting for only 5 percent of the firm’s operating profits.
“There is no revenue flow yet,” Dominique Cerutti said at NYSE Euronext’s Investor Day conference in March. Cerutti is the head of all technology at NYSE Euronext-and Young’s boss. “We are still building the company. That’s the reason for the margins.”
Still, NYSE executives predict the group will be the fastest growing of the three businesses, reaching $1 billion in sales in four to five years. Cerutti expects operating margins to grow from 13 percent presently to 30 percent over that period.
Underlying these projections are expectations that brokerages will pull back from their commitments to trading infrastructure. Due to the expense and time-consuming nature of managing infrastructure, NYSE Technologies is predicting a wholesale switch to outsourcing.
Rather than maintain potentially hundreds of data feeds and networks connecting them to market centers and their customers, brokers will pay NYSE Technologies to do it for them.
The sellside wants to focus on where they can add value to their clients,” Young explained, “which is in trading advice and the quality of their algorithms. They don’t want to have to provide that costly infrastructure anymore.”
Young is not the only infrastructure player saying this. Several of NYSE Technologies’ competitors share his view. “We are in challenging economic times where tough decisions have to be made,” said Jeff Wecker, chief executive of Lime Brokerage. “A broker-dealer can come to Lime and get best-in-class infrastructure for a fraction of what it would cost to do it themselves. More and more brokers have decided that infrastructure is not where they want to differentiate themselves.” Lime was originally a provider of trading infrastructure services to hedge funds and is now moving aggressively into the broker-dealer space.
The hard financial times following the turmoil of 2008 drove brokers to look to outsourcing as a way to reduce expenses, Young said. Now that the fog is lifting and budgets are returning, however, they are still interested in shedding what they consider to be “non-core” assets.
So while demand may be there, supply most certainly is. Several players are offering “broker-in-a-box” infrastructure services. Some offer soup-to-nuts; others offer pieces. Lime, for instance, offers proprietary connectivity, data and transactions gateways. Vendor SR Labs offers proprietary connectivity and market data. Vendors FTEN and Options IT offer proprietary connectivity and partner with suppliers of data and gateways. Still others, such as SpryWare and Exegy, just offer the data.
None, however, offers proprietary connectivity, data and transactions software–plus own and operate a co-located data center and operate their own marketplaces. It is with this all-encompassing package that NYSE Technologies hopes to make its mark. And, as a supermarket of services, the vendor could offer more competitive pricing, NYSE Technologies executives contend.
The vendor’s competitors note, however, that soup-to-nuts doesn’t appeal to everyone. It may work for those broker-dealers unwilling to get their hands dirty with their “under-the-hood” technology, but not for those who consider an optimal infrastructure an important part of their offering. These brokers shop for “best of breed” solutions.
Nigel Kneafsey is chief executive of infrastructure supplier Options IT. He also sees strong demand from financial service firms for outsourcing, but says they may not want to be tied to a single supplier. Options IT, for example, works with various vendors for market data feedhandling applications. That means “clients can use whichever software platform or hardware accelerator they want,” Kneafsey said. “So if they want to move from one to the other or test several, they can. One feed handler, for instance, can be preferable to another for different strategies executed on the same market.”
NYSE Technologies execs counter that they have assembled a collection of “best-of-breed” components and therefore offer the best of both worlds.
In any event, despite the breadth of its offering and the efforts it is making to become a recognized name in the vendor space–through an onslaught of news releases and public appearances–NYSE Technologies must still overcome certain institutional hurdles if it is to succeed.
Perhaps the biggest hurdle is the perception it is merely an appendage to NYSE Euronext’s primary exchange business. The fear is that NYSE Technologies is merely a stalking horse for the exchange operator-that it will bias its services to favor the parent company’s main business.
Young is admittedly happy with the cachet lent by the NYSE Euronext brand, but he also wants his organization to be considered a stand-alone, neutral vendor of trading and connectivity services.
To help bolster its image as an independent entity, NYSE Euronext recently reorganized itself into three groups, one being NYSE Technologies. The move gave the division responsibility for its own profit-and-loss statements, making it more prominent, at least in the eyes of investors.
Still, separation between the vendor arm and the exchange operator can only go so far. NYSE Euronext is still the vendor’s largest customer–although none of the $368 million in reported revenues includes sales to the parent–and nearly half its revenue comes from sales of NYSE Euronext market data. In addition, co-location at Mahwah is intended to benefit exchange operations as much as the vendor arm.
Indeed, the perception is that NYSE Technologies was established to a large extent to benefit the market share of the exchange operator. “They are partnering with the mother ship to make sure that their listed market will be a destination of choice,” said Paul Zubulake, a senior analyst with Aite Group. “Part of the reason is to maintain market share and liquidity. It’s not a bad strategy.”
NYSE Euronext executives do not dispute there are synergies between the two groups, pointing to co-location as a key intersection. “The payoff from the data centers will come in the form of revenues down the road,” Joe Mecane, an NYSE Euronext executive vice president and chief administrative officer for U.S. markets, said at this year’s NYSE Investor Day conference. “But [co-location] is primarily to make order flow more sticky to our markets. You will be able to access both NYSE Arca and NYSE Classic from one place. Now you must go to two.” Co-location causes “stickiness” because it makes for speedier interaction between trader and exchange, NYSE Euronext execs explain. As access to NYSE Euronext markets will always be faster, the trader will do more of his business on those markets.
Back in 2008, when NYSE Euronext execs commissioned the facilities in Mahwah and Basildon–which should be ready this summer, building the trading floor of the future wasn’t on their minds. The purpose was more mundane: to consolidate several aging data centers accumulated in the course of creating the global exchange operator. In the U.S., for instance, the company operates eight data centers. These will be mostly decommissioned when the Mahwah facility opens.
“We built these data centers to consolidate our old ones that were at the end of their lives,” NYSE Euronext chief operating officer Larry Leibowitz said at NYSE Investor Day. “It was to save money and use new technologies. It wasn’t for co-location. We were lucky, not smart.”
In 2008, co-location, or proximity hosting, was not a household word. High-frequency trading firms were starting to locate their trading servers next to exchange matching engines, but the practice was not widespread.
Yet, almost overnight, co-location exploded, becoming the talk of the industry. Last year was the tipping point as firms rushed to co-locate and the supply of rack space dried up. Now, it is expected that all brokers will eventually co-locate their trading servers so they are not slower than their rivals.
Today, co-location is expensive and largely the province of high-frequency traders and big brokerage houses. Costs can reach $400,000 per year.
Cost should not be a barrier, NYSE Technologies execs argue. “The costs of connecting to us and using our managed services such as co-location will be very affordable and available to players of all sizes,” Young said.
NYSE Technologies has at least three large deals in the works. Jefferies Execution Services, the NYSE member agency broker arm of Jefferies & Co., is one of them. The firm, which is providing sponsored access for high-frequency traders, is taking the risk management gateway to start. It is also “taking a hard look” at NYSE Technologies’ market data and co-location services, according to Al Petrillo, president of Jefferies Execution Services.The brokerage’s HFT customers currently access the markets via Jefferies’ infrastructure. The deal with NYSE Technologies will give Jefferies high-speed access as well as risk-checking. “Look at the evolution of the market,” Petrillo says. “Risk-controlled speed to market liquidity is key.”
Beyond the Trade
Cost savings is also key, an NYSE executive noted, and can stretch into the several millions of dollars. On the transactions side alone–FIX gateways and risk management gateways–brokers can achieve savings of upwards of $2 million if they opt to outsource rather than build.
Brokers saving money translates into NYSE Technologies making money. Competition may have gutted NYSE Euronext’s share of the exchange business, but there is still money to be made in its role as a facilities manager.
“Our model is changing to account for the way trading has changed,” Young said. “Long gone are the days of monopoly exchanges. We are now part of the industry fabric. We have to be able to provide services irrespective of where the trade ultimately executes.”