Competition, Less Volatility Drives Consolidation in High-Frequency
January 25, 2010
Chicago's Essex Radez, a self-clearing broker-dealer specializing in high-speed algorithmic trading, has slashed operating costs, such as what it pays for market data and the clearing of transactions, to a bare minimum.
But lower volatility and trade volumes are biting into profits. That trend over the last six months conflicts precariously with competitive needs for custom technology to speed up orders and for capital to pursue trading involving longer-term positions, prompting the firm to consider mergers or partnerships.
Lower profits mixed with the ever-pressing need among trading shops relying on faster and more sophisticated technology to outdo competitors has already prompted a trickle of mergers and acquisitions that some anticipate turning into a steady stream, if not a flood.
John Muehlhausen, chief technology officer at Essex, says the proprietary trading firm became a self-clearing broker-dealer in 2004, to cut out the fee it paid to a correspondent clearing house. Since clearers tend to pass along the cost of trade-related technology, asset custody and other services, their clearing fees tend to be high compared to Essex's costs to self-clear, after it peels away unnecessary services.
"We clear all of our business with a couple of computers, some software we wrote, and a very small staff," Muehlhausen says.
Essex's streamlined clearing costs amount to little more than the Depository Trust & Clearing Corp.'s small per-trade settlement fee that all self-clearing broker-dealers pay or pass on to customers as a part of the clearing process, he said. DTCC says it charges its members an average of three-tenths of a cent per transaction.
The firm also developed its own low-latency market-data subsidiary that connects directly to the major exchanges' data centers and ECNs. Essex defrays its costs by charging modest market data fees to its customers. "We think that unless you trade for practically nothing, it's going to be hard to make any money," Muehlhausen says, adding Essex provides a "near-zero cost basis" for automated equity traders.
In addition to trading for its own account, Essex houses a few dozen clients that trade independently through the firm. The need to cut costs has been exacerbated by the plunge in price volatility and trade volumes-the fuel driving many active-trading strategies-over the last six months.
The Chicago Board Options Exchange Volatility Index has plunged to under 18 this year from above 80 at the peak of the credit shock in October 2008. That's reduced the securities price discrepancies and high volumes many high-frequency trading strategies require to capture tiny profits per trade.
Self-clearing and generating market data take significant time and resources to implement, which leads HFT firms-and especially exchange members catering to HFT traders-to increasingly consider consolidation.
"The consolidation is really to spread fixed costs over a broader base" of trading activity, says Bruce Mumford, who heads up Mumford Capital Services, a Chicago-based consultancy that advised trading firms in recent mergers.
Mumford advised two Chicago-headquartered proprietary shops trading futures, fixed-income, options and currencies-GH Traders and Harrison Trading Group-last summer when they united to form HTG Capital, headquartered in Chicago. Mumford also advised HTG in its December acquisition of Chicago-based Kingstree Trading's equity index and energy trading groups, which brought additional trading activity under its roof.
