Technology's Role in Finance Is Now Dominant

Tech not only makes trades but analyzes them for risk. The question is at what point do humans and the institutions they serve become too dependent on machines and lose their own ability to make judgements? JL


Telis Demos and Alexander Osipovich report in the Wall Street Journal:

Every day, 10% of all orders sent to the U.S. stock market first pass through black boxes created by a 50-person technology company, whose boxes do risk checks on the trade orders. Devices the size of a pizza box in data centers connect to exchanges where trade orders are analyzed before they are sent into the market. The devices need 360 nanoseconds, billionths of a second, to perform 65 risk checks. In a fraction of the time it takes for an eye to blink, the devices check whether a client is allowed to buy or sell short a stock; that a client won’t exceed its bank credit limit; and that the order wasn’t a “fat finger” error. If the boxes detect a problem, they kill it.
Every day, about 10% of all orders sent to the U.S. stock market first pass through black boxes created by a 50-person technology company, Hyannis Port Research Inc. in Needham, Mass.
HPR, whose boxes do risk checks on the trade orders, is little known outside Wall Street technology departments. But it is at the center of a high-stakes contest among big banks to keep their trading arms relevant and profitable.

Wall Street stock trading has faced pressure from all sides in recent years. Clients are paying smaller fees to trade, driven by increased automation and a broad shift toward passive investing strategies that require fewer high-margin services such as research, which used to juice banks’ trading returns.
At the same time, banks’ need to invest in trading-related technology hasn’t slowed. Years since Wall Street began its shift from the old-fashioned business of brokering trades by phone, the speed and complexity required of trading desks is only increasing.
Last year the dozen biggest banks globally generated $9.2 billion in core stock-trading revenue, a third less than they did in 2009, according to the industry data tracker Coalition. But much more of that revenue is generated by electronic trading than in the past.
Some big banks, including Deutsche Bank AG, are exiting equities trading. Others are staying in largely so they can service their trading clients in more-lucrative businesses, such as lending.
While HPR’s major competitors are the in-house systems of major financial institutions, many banks are managing the rising technology needs of their trading operations by turning to HPR or other outside partners such as Pico, which connects banks to trading venues, or Cloud9 Technologies LLC, which provides voice-communication software.
HPR builds computer devices about the size of a pizza box. Banks such as UBS Group AG UBS 0.19% place them in data centers connecting to exchanges and other trading venues, and trade orders are analyzed before they are sent into the market.
Using the same chips that power hyperrealistic videogames, HPR’s Omnibot devices need just 360 nanoseconds, or billionths of a second, to perform more than 65 risk checks.In a fraction of the time it takes for an eye to blink, the devices check whether a client is allowed to buy or sell short a particular stock; that a client won’t exceed its bank credit limit; and that the order wasn’t a “fat finger” error. If the boxes detect a problem with an order, they can kill it without stopping others from going through.
The consequences of a botched trade can be severe. Traders still wince at the memory of the 2010 “flash crash,” in which a blizzard of erroneous trades caused the Dow Jones Industrial Average to plunge close to 1,000 points, only to rebound, within minutes. In 2012, the former Knight Capital Group lost more than $400 million from trading software gone haywire.
Banks’ focus on this area sharpened when the Securities and Exchange Commission adopted a 2010 rule requiring banks or brokers to do risk checks on trades before they are sent to the market. Some banks have been penalized for violating the rule.
Big banks have historically built such systems themselves. But several banks have decided that the cost and time needed to match the fastest speeds is too much.
“Clients have become more sophisticated and gained access to more electronic trading tools,” said Joanna Fields of consulting firm Aplomb Strategies. “It’s a struggle for firms aiming to service these clients to maintain the technology expertise required to keep up.”
When banks’ technology partnerships work, banks are able to deploy the latest technology at much lower costs. But outsourcing key functions can sometimes go wrong, and such relationships require banks to do extensive diligence on partners. Regulators typically hold the bank, not the vendor, responsible for any slip-ups.
UBS has extended its use of HPR from the U.S. and Europe to Asia as well. Bank of America Corp. BAC 0.66% has worked with HPR and is planning to expand globally, and Credit Suisse Group AG CS 1.30% is starting to work with HPR, said people familiar with those two relationships. And people familiar with the situation said Goldman Sachs Group Inc. GS 0.23% has had discussions to potentially work with HPR.
HPR’s chief executive and co-founder, Anthony Amicangioli, began his career designing switches used to route telecommunications network traffic. An engineer by training, Mr. Amicangioli moved into finance in the 2000s, working with a high-frequency trading firm.
In 2011, he and a partner raised $2 million from UBS to start HPR, with the Swiss bank becoming his first customer.
“We are standing in front of the Hoover Dam,” Mr. Amicangioli said. “It only takes a few microseconds for something to blow up.”