Opening Cross: Got a Beef? Maybe You Need ‘Protection’

Home to Inside Market Data Chicago and some fine, hot Italian beef sandwich joints, one of Chicago’s nicknames is The City of Broad Shoulders, described in Carl Sandburg’s poem as “stormy, husky, brawling,” perhaps because if someone picks a beef with you in the Windy City, people are prepared to barge in and stand up for you—not in the sense of Al Capone’s protection rackets of old, but out of a genuine sense of fair play.

While I doubt this sentiment had any influence in the Illinois Supreme Court’s rejection last week of the International Securities Exchange’s appeal in a long-running dispute with the Chicago Board Options Exchange over the right to list and trade options on the S&P 500 index and Dow Jones Industrial Average, it was a sentiment I heard numerous times last week in Chicago. Instead of complaining about clients being less willing to spend money, vendors instead spoke of how they are helping those clients rally against other suppliers seeking to impose what they see as unfair fees. Of course, there is always self-interest in play when trying to become a client’s chief ally. But just as in some parts of the US, people are protective of their guns and bibles, many vendors and sell-side firms in Chicago seem religiously protective of their clients.

Perhaps being closer to the producers of the commodities on which its markets are built—in the form of farmers and wholesalers—gives Chicago’s markets a more human face. Perhaps it’s the recognition that those using its markets for hedging are often farmers rather than speculators, who can’t afford the same costs as proprietary trading firms or hedge funds—or that the city’s philosophy is more “People, people, money,” than the “Money, money, money” focus its inhabitants attribute to New York. “The difference is, New York is about finance, Chicago is about trading,” said a conference panelist.

However, this approach has not insulated Chicago from the financial crisis, or from regulators’ scrutiny and calls to protect the public from high-frequency trading—a topic that came up frequently during last week’s event. Carol Clark, senior policy specialist at the Federal Reserve Bank of Chicago, outlined research conducted by the Fed into the role of high-frequency trading in the current landscape, and described how firms confessed to the problems they experience implementing high-frequency strategies, and their concerns about potential mishaps arising from newer, less experienced entrants. (For more, I recommend reading the entire October issue of the Chicago Fed Letter). Clark also outlined how pre-trade risk management practices are haphazard and fragmented, with thorough checks sacrificed for speed, and that there is no way to identify manipulative practices in real time without a view of firms’ trading and positions across all markets.

Certain of these aspects may become moot points as firms back away from making big investments in low-latency infrastructures—though regulatory scrutiny may have been an additional factor for some—as the cost of implementation encroaches on the potential returns of eking out diminishing incremental speed advantages. Speakers at the event (a full report on which will appear in next week’s issue) described how spend must be carefully justified and its returns measured, and suggested firms analyze their needs to find a level that is “good enough,” rather than chasing ever-moving goalposts.

But Level 3 Communications’ acquisition of AlgoSpan’s FibreSpan, and Equinix’s efforts in its new LD5 space will not be wasted: There are still many inefficiencies outside the US and the most liquid asset classes, panelists said. There is also opportunity to apply latency’s lessons to new areas, but increasingly firms will turn to new types of analytics—such as those in the works by Appleton Group Wealth Management, Credit Benchmark and SuperDerivatives, as well as techniques outlined in this week’s Analytics report—to gain an edge. After all, as one panelist said, speed itself is not alpha, but it does amplify the alpha you gain elsewhere.