Max Bowie: How Mifid II Will Drive Co-Lo Growth

US regulators are scrutinizing high-frequency trading, including supporting services and technologies, such as co-location. But, says Max, the US’s regulatory drive to move OTC assets onto exchange-style platforms—and the expansion of the Markets in Financial Instruments Directive in Europe—will actually contribute to more demand for co-location services.

When the European Commission unveiled the Markets in Financial Instruments Directive (Mifid) in 2007, it transformed European equities trading, spawned multilateral trading facilities, and caused trading to fragment, creating a wealth of new data and demands for a US-style consolidated tape to re-aggregate this fragmented data.

Now, Mifid II includes proposals for consolidated tapes. However, while the Consolidated Tape Association provides consolidated quote and trade data from fragmented US markets, any European tapes will provide trade data only, still requiring firms to source quote data in the same manner as before to meet many of Mifid’s requirements.

Mifid II will also extend the regulation to asset classes beyond equities, and contribute to the forces driving bonds and derivatives onto exchanges or centrally-cleared, exchange-like platforms, such as European bond trading platform Galaxy MTF, and the swap execution facilities (SEFs) being created in the US to move OTC asset classes onto centrally-cleared venues. And there’s certainly evidence of demand to trade assets like fixed income on exchanges: Third quarter turnover in Börse Berlin’s bonds trading segment increased by 183 percent over Q3 last year.

Participants in Inside Market Data’s recent Fixed Income report agree that more fixed-income trading will move onto centrally-cleared electronic platforms, which will reduce the risk of OTC trading and increase trading and data volumes—but are not necessarily convinced that moving assets onto exchange platforms will automatically create more demand or better-quality data especially if clearing costs make it prohibitive for firms to trade OTC assets and liquidity moves elsewhere.

However, such a move is expected to create more demand for market and historical data, which Celent senior analyst Anshuman Jaswal says has been a barrier to adoption of algorithmic trading in the fixed-income markets, along with a lack of streaming prices, since most fixed-income platforms use a request-for-quote model, rather than an order-driven marketplace—though European bond-trading platform MTS is launching a platform for corporate bonds trading that will operate on a transparent, order-driven model.

As such platforms come to market, we can expect to see a frenzy of activity among providers of co-location centers where these new venues will host their trading engines. Many equity and derivative markets have already moved their core technology out of their main buildings into large datacenters—either their own or third-party-operated—and in June, FiberMedia SVP of sales John Panzica told me that the hosting provider will specifically target the growing SEF market.

But like Mifid, the datacenter marketplace is also undergoing a period of major change and expansion. Private equity firm Abry Partners’ recent acquisition of datacenter and infrastructure provider Xand Corp. is the latest in a string of deals—including Century­Link’s purchase of Savvis for $2.5 billion in April and the buyout of co-location and hosting center provider Telx by Abry and Berkshire Partners—that reflect how valuable these facilities have become to the modern data industry and markets as the world grows increasingly globalized and interconnected.

Access to Liquidity
As trading congeals around these massive co-location centers—either third-party or exchange-owned—these intermediaries will play a key role in providing access between the fragmented liquidity pools.

And now, providers who have had success in low-latency co-location and infrastructure markets in North America and Europe are looking for new sources of revenue, and are turning their attention to the Asia-Pacific region, which is still largely dominated by a few local players and domestic exchange groups. However, as new venues such as Chi-X Australia enter the fray and threaten to fragment trading in individual markets and the region as a whole, demand is likely to increase for more co-location and proximity hosting centers to provide intermediate points between multiple venues to support cross-market strategies—just as the regulatory moves in Europe and the US will stimulate datacenter growth of their own.