11.16.2011
By Terry Flanagan

MiFID Drives Middle-Office Outsourcing

HFT market-making obligations will cause firms to ‘externalize’ risk management.

New market-making obligations under Markets in Financial Instruments directive (MiFID) will compel firms that employ high-frequency trading strategies to outsource some or all of their key risk-management functions by co-locating with providers of such services.

“While the original MiFID accelerated the trend of trading firms and brokers to co-locate trading apps, we believe MiFID 2 will act as a catalyst for banks to externalize their middle-office risk applications,” Patrick Lastennet, director of financial services marketing and business development at Interxion, told Markets Media.

Taking note of the growth in the use of algorithmic and high-frequency trading strategies, MiFID II includes a controversial market-making obligation.

The directive requires that “an algorithmic trading strategy shall be in continuous operation during the trading hours of the trading venue to which it sends orders or through the systems of which it executes transactions. The trading parameters or limits of an algorithmic trading strategy shall ensure that the strategy posts firm quotes at competitive prices with the result of providing liquidity on a regular and ongoing basis to these trading venues at all times, regardless of prevailing market conditions.”

“The most concrete impact of MiFID 2 on HFT is the requirement for firms engaged in HFT to act as liquidity providers and post quotes throughout the day regardless of market conditions,” said Lastennet.

“The net effect is that we might see smaller HFT players disappear, or, on the other hand, the footprint of major players will increase and there will be a trend for shifting middle office risk management apps in co-location,” he said.

In addition, MiFID II will force firms to manage their positions and risk in near real-time on a global scale. From one central location/system, the firm will need to compute an increasing amount of calculations.

“This is likely to be achieved through virtualized server farms, necessitating high density power,” said Lastennet. “Carrier-neutral data centers such as Interxion are uniquely positions to offer scalable high-density power and high-bandwidth connectivity to serve those needs.

MiFID II will force a number of OTC derivatives contracts like CDS to be traded with pre-trade transparency on designated OTFs (organized trading facilities) and cleared via a CCP.

This, in turn, will create an increase in market data for trading and firms to process.  Some CCPs are preparing themselves to be able to scale from the number a few thousands of transactions a day to several millions, fragmented across tons of new platforms.

Firms co-locating with carrier neutral data centers will be able to benefit from their initial set up and leverage on choice of connectivity and access to specialized market data providers, Lastennet said.

“If the OTFs turn up to be adequate venues for HFT strategies, carrier-neutral data centers will also bring proximity benefits,” he said.

Both BATS Europe and the London Metal Exchange have opened access points in Interxion’s City of London data center, allowing market participants to take advantage of low-latency access, as well as reduced complexity and connectivity costs.

“When all such services are provided in a single location, they are extremely advantageous for market participants, as a one-stop-shop is created within the data center,” he said. “This model is a collaborative effort that provides choice and flexibility for the customers.”

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