Flashboys return: the transatlantic war for milliseconds

Express, a superfast data cable between the US and Europe, has just gone live at a cost of €270m. By getting buy and sell orders to stock exchanges first, the Irish-based firm behind it is giving high-frequency traders the opportunity to earn vast profits

 

Prof Pierre Aronnax and his servant Conseil, the heroes of Twenty Thousand Leagues Under the Sea, spotted one of the first telegraph cables laid across the bed of the Atlantic during their captivity on the submarine Nautilus.

“It was on the 17th of May, about 500 miles from Heart’s Content, at a depth of more than 1,400 fathoms, that I saw the electric cable lying on the bottom. Conseil . . . thought at first that it was a gigantic sea serpent,” the professor recounted in Jules Verne’s classic adventure novel, from 1870.

The first message carried by cable from the Old World to the New, in 1858, read: “Europe and America are united by telegraphy. Glory to God in the highest; on earth, peace and good will toward men.”

It took 17 hours to transmit, and within a matter of weeks the line had broken down. A second cable, laid a decade later, proved more efficient. It was the forerunner of a communications system that allowed information to be transmitted between continents in a matter of minutes, and later seconds, instead of the minimum of 10 days it had previously taken a ship to deliver a message.

A few days ago a new transatlantic cable, Express, went into service. Hibernia Networks, the Irish-based company behind the €270 million venture, says it will deliver messages in less than 59.5 milliseconds. That is six milliseconds faster than the previous record. Those six milliseconds are of little interest to most cable users. But they are of enormous significance to the so-called high-frequency trading firms whose activity makes up about half of all trade on the United States’ multitrillion-dollar equity markets, and up to 40 per cent on European markets.

These firms will pay a fortune to use Express, betting – pretty safely – that the minuscule time advantage will enable them to reel in hundreds of millions of dollars in extra profits.

“The product they are buying is called 59.5,” says Bjarni Thorvardarson, chief executive of Hibernia. And if he can’t deliver, the customers get their money back, the Icelander says.

High-frequency trading has been decried as a scam that uses algorithms to fleece regular – human – investors on a grand scale, and regulators across the world are scurrying to catch up with the technology.

Spawning headlines

Hibernia’s chief rival, Level 3 Communications, runs what was previously the fastest connection across the Atlantic – and claims that upgrades will permit its cable to return to pole position.

But none of that appears to bother Thorvardarson, who says that Express will soon emerge as the new champion in the war for milliseconds.

Earlier this year, in relatively calm spring weather, ships loaded with 4,000km of fibre-optic cable set sail from a harbour near Halifax in Canada and from Brean, near Bristol in England.

Their route had been carefully planned by specialists using a research vessel. Progress was slow to begin with, with only about 15km laid each day. The cable had to be buried under the seabed as it began its journey from its landing stations on either side of the Atlantic.

Initially it needed to be buried in shallower water – less than a kilometre deep – to prevent damage by fishing lines or nets, and to avoid the possibility of the line’s being attacked by sharks.

The cable-laying ships pulled a plough along the ocean floor that dug a furrow into which the cable, fortified with metal and about as thick as a forearm, was lowered from enormous drums. The plough then filled in the furrow as it moved on.

The operation speeded up considerably, to about 150km a day, once the ships got into areas where the ocean is between 3,000m and 6,000m deep. There, metal protection was no longer necessary, and a thinner version of the cable – in thickness somewhere between a finger and a garden hosepipe – was simply laid on the ocean floor.

The two ends of the transatlantic cable were spliced together on September 1st.

In August the Resolute cable-laying shop carried a branching line to Ireland, pulling it through a duct along the seabed to a landing station at Garretstown beach, near Ballinspittle, in Co Cork.

It was then linked to the country’s existing fibre-optic network, and hailed by business leaders and Government Ministers as another big building block in what Hibernia calls “Ireland’s pre-eminent position in the global cloud-infrastructure marketplace.”

Express is now part of the sprawling network of cables under the world’s oceans and seas that collectively run for nearly 900,000km. Some have poetic names, such as Amerigo Vespucci, a snip of a cable at just 85km, linking the Dutch West Indian islands of Bonaire and Curaçao. But most have functional titles, such as SEA-ME-WE 3, the longest line in the world, at 39,000km, which links western Europe to Japan, stopping off in a few dozen countries on the way.

These cables are the veins and arteries of our connected world, carrying more than 90 per cent of international internet traffic and phone calls. What the vast majority of companies using the cables want is the ability to send huge amounts of data at a decent speed.

But the high-frequency trading firms desperately need to gain milliseconds. The traders who will use Express cable are no different from their historical predecessors. Brokers have always wanted to be the first to place their orders, so that they can capitalise on new information that affects the price of shares or bonds. And they have always had their detractors.

In the 1790s a US congressman lambasted an early form of the high-speed trader. He called them “rapacious wolves seeking whom they may devour” after they boarded ships from New York to the southern states to buy up debt from unsuspecting bondholders who had not yet received news of changes in the law affecting the price of the bonds.

Financiers have also used carrier pigeons and couriers on horseback, and in early 19th-century France the so-called Chappe telegraph, a precursor to the modern telegraph, used a system of towers, built every 12km to 25km, whose operators passed on messages via semaphore.

But now high-frequency traders have taken the desire to be first to the extreme, and are engaged in what Jeff Sprecher, chairman of the New York Stock Exchange, in March called an “arms race for speed”. Companies like Hibernia are also participants in this race.

High-frequency traders have dispensed with humans. They use algorithms, which the companies that develop them typically keep secret, to place orders that travel near the speed of light.

The algorithms make money in various ways. One method is to buy or sell stock a fraction of a second faster than other players, which are often mutual or pension funds handling the money of ordinary savers and workers with pensions.

The price of a stock will often rise by a small amount for a short time, then fall again. If a trader’s algorithm buys a batch of shares a few milliseconds before the price rise, then sells them milliseconds later, it can net thousands of dollars. Repeating that process throughout the day can generate considerable profits.

Humans who rely on making a phone call or clicking on a mouse to execute an order don’t stand a chance against the algorithms, which are programmed to search for information about price movements and then, in far less time than it takes an eye to blink (which is about 300 milliseconds), act on that information.

Human oversight

Navinder Sarao, the British trader accused of triggering that crash using a computer in his parent’s home in London, is currently facing extradition to the US. After being arrested in April, Sarao faces 22 charges, including wire fraud, commodities fraud and market manipulation between 2009 and last year

“Now the world’s money is traded by computer code, inside black boxes in heavily guarded buildings,” writes Michael Lewis in Flashboys: Cracking the Money Code. His bestselling book last year was credited with finally revealing to the general public the opaque workings of high-frequency trading.

“Even the experts entrusted with your money don’t know what’s happening to it. And the very few who do aren’t about to tell, because they’re making a killing,” says Lewis in a book that reads like a thriller, with villains who profit from the alleged scam, and heroes who seek to curb it.

Lewis argued that after the subprime crisis of 2008, which threw the global economy into turmoil, the financial world was yet again taking the public for a ride. His was one of many voices condemning high-frequency trading as its allegedly predatory nature slowly became apparent.

Warren Buffett’s right-hand man, Charlie Munger, said in 2012 that high-frequency traders “have all the social utility of a bunch of rats admitted to a granary”.

Regulatory authorities across the world have slowly been tightening up the rules about high-frequency trading, and more legislation is on the way. Several firms or individuals have been fined in the US and in Britain over high-frequency trading strategies.

But regulators struggle to keep up with the sophisticated algorithms devised by some of the world’s brightest minds. Companies such as Hibernia, meanwhile, continue to cash in on the ravenous demand for more speed.

High-frequency trading also has many advocates, particularly those who engage in it and who mounted a fierce campaign to defend the sector in the wake of Lewis’s book. They argue that it makes markets more efficient by lowering trading costs and adding liquidity.

And they note that throughout history many financial innovations have generated the same sorts of fears and heated reactions.

The high-frequency trading cause got a boost in February of this year from the Bank of England. Its survey of trading in a section of the FTSE 100 concluded that electronic traders made markets more efficient rather than fomenting instability.

But Lewis, and many others, insist that high-frequency trading continues to rig the market. And firms such as KCG Holdings, Sun Trading, Tower Research Capital and Virtu, along with major banks across the world, continue to profit handsomely.

Lewis begins Flashboys with the story of a cable completed in 2010, which partly inspired Hibernia to embark on its Express project. The 1,330km line was quietly laid by a firm called Spread Networks, by employees who were not told what they were working on.

It started at a building across the street from Nasdaq’s servers in New Jersey, bored its way through the Allegheny Mountains of Pennsylvania, and arrived next to the futures market of Chicago. The route cut more than 100km off the existing cables’ path between the cities and shaved three milliseconds off the time it took traders to send their orders.

Spread Networks, when its cable was finally unveiled, was reportedly able to charge high-frequency traders a multiple of their previous fee to use this link.

Race for speed

Microwave transmission is faster than fibre-optic cables. But, as Bjarni Thorvardarson of Hibernia is quick to point out, the technology cannot be used over oceans, because it relies on having a network of antennas within a relatively short distance of each other.

Hibernia has applied Spread Networks’ idea of reducing distance to its Express project. It is also hoping to extract large sums from the high-frequency traders who have signed up to use the new cable.

Bloomberg has quoted an anonymous trader as saying that Hibernia told him the fastest service on Express would cost up to $20 million for five years of access, or $333,333 a month. A slower option, which takes 62ms to make the round-trip transmission, costs about $35,000 a month.

Thorvardarson refuses to be drawn on the fees. “It’s a very significant premium. I wish it was 50 times, but it’s not quite there,” he says. He refuses to name the customers who will rent space on the cable, but he says they include French, Dutch, British, Canadian, US and German firms.

When he and his colleagues heard rumours of Spread Networks’ secret venture, it set them thinking about how they might capitalise on the need for speed.

The rule of thumb for lowering latency – industry terminology for the time it takes information to pass along fibre-optic lines – is that every 100km saved means a gain of about 1ms. Hibernia says that Express, which follows a 4,600km straight line from Halifax to Brean and then goes overland from there to servers around London, is 500km shorter than any of the existing transatlantic cables, many of which were built during the dotcom bubble at the turn of the century.

The current fastest cable is believed to be a line called AC1, run by Level 3 Communications. The US firm has been quoted as saying that that upgrades to its cable mean it will maintain its market position by the time Project Express comes online.

Express will likely win many accolades if it emerges as the transatlantic high-speed cable champion.

But few are likely to go quite as far as James Buchanan, the 19th-century US president, did in his praise for the first cable across the ocean. He hailed it as “a bond of perpetual peace and friendship between the kindred nations, and an instrument destined by Divine Providence to diffuse religion, civilisation, liberty, and law throughout the world”.

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