Rapid changes in electronic trading have created both business opportunities and technology risks in the trading environment. Firms can mitigate the risk of adopting new technologies with methodical testing.

The Issue - Good News and Bad News.

Changes bring good news/bad news for technology managers: As trading costs drop, revenue for transaction fees also decline for those executing the trades. This puts pressure on technology managers to deliver higher performing systems at a lower cost. Rapid changes in strategies, new order types and new connectivity give Technology Officers the real chance to impact the business for better or worse.

Adopting better test procedures and quality controls early in the project life cycle will result in better trading systems at fixed costs. Investment in testing is further justified by reduced total cost of ownership; from faster implementation, reduced software maintenance and lower network-operating costs.

New trading techniques like electronic price discovery have amplified the volume of orders and market data as trading systems probe the market for price depth or pools of liquidity. More and more, response time is critical. Algorithmic trading also leads to high frequency executions as traders attempt to obtain the best prices without disclosing intent or moving the market. Now, systems must be built to handle the volumes of market data that result from all the orders and cancellations. For example, consumers of the Options Price Reporting Authority "OPRA" feeds can expect rates of 173,000 messages per second - roughly 98.6 megabits of data per second! According to OPRA (http://www.opradata.com/specs/projections_2005_2006.pdf).

Reliance on electronic trading increases the need for technology managers to mitigate the risks of both implementation and operations. Business drivers important to financial firms are -

Regulation reduce, maintain and measure transaction speed.

Competition meet customer demands before the competition

Stability avoid impact of "brownouts"; electronic trading has redefined disaster to just a few seconds.

Cost control capital and manpower costs in the face of reduced budgets.

Your response - New Solutions and Mitigating the Risk.

To address the requirements for processing speed in the face of increasing data volumes and sheer network traffic, financial firms are adopting a number of new strategies - Direct Market Access (DMA), specialized trading networks, 10 Gigabit Metro Area Networks (MANs), blade servers, integration of commoditized software components for Order Management Systems (OMS) and Execution Management Systems (EMS), cluster computing and additional fire walling for outsourced solutions. Yet the "bleeding edge" is aptly named; there are substantial project risks in adopting new technologies.

Firms need to mitigate these project risks with thorough testing at all stages of the project lifecycle.

IT managers must understand new networking technologies in a laboratory environment before production deployment. There are millions of lines of code embedded in a network of routers, switches and content devices - the interaction between different vendors' devices is complex and will have an impact on both stability and application response time. Testing this interaction provides engineering and operations staff a full picture of how things work - and how they break. Some advanced customers use testing to 'war game' their response to outages or security attacks!

Successful firms are turning Quality Assurance (QA) into a competitive advantage. For software developers, QA is often seen as a bottleneck. Firms that have adopted automated testing have realized substantial gains. In one case, an exchange reported a 70% improvement in testing cycles through automated testing - resulting in faster deployment of new systems. At the same time, automated testing mitigates the risk of change and reduces QA costs, while accelerating time to market for new features.

Automated regression testing has both competitive and regulatory advantages. Reg. ATS, Rule 301 speaks to the necessity of testing trading systems. In particular it states that an Alternative Trading System:

"Develop and implement reasonable procedures to review and keep current its system development and testing methodology" [Reg. ATS can be found at http://www.sec.gov/rules/final/34-40760.txt]

It is likely that government regulators increasingly will mandate Service Level Agreements (SLAs) for the buy and sell sides as well. While business continuity was a first consideration, over time regulators are looking at response time. Similarly 'immediacy' was mentioned in Reg NMS (National Market System) and industry comments prior to release of the final rule. The competitive advantage of quality was noted in the summary regarding Rule 611:

"...trading centers that offer poor services, such as slow response times, will likely rank near the bottom in order-routing preferences of market participants..." [Reg NMS can be found at http://www.sec.gov/rules/final/34-51808fr.pdf]

The performance impact of innovative services from Service Providers (SPs) and trading networks must be carefully understood, not just by a 'ping test' but by full characterization of their throughput and performance with real application data. Customers and SPs are negotiating SLAs measured in milliseconds. For success, financial technology professionals and technology vendors should share test plans and results that back up product specifications, solution designs and SLAs. Next, adopt best practices suggested by the Reg's to implement thorough procedures for pre-deployment testing.

Conclusion

To fully realize the benefits of electronic trading, firms must test carefully to achieve maximum benefits at the lowest cost of ownership. Early adopters of structured testing throughout the development, deployment and operational lifecycle have successfully demonstrated they can mitigate technology risks and manage technology costs.

Robert LeClair is a Product Manager for Spirent Communications. Spirent provides tools and consulting services to the Financial Services industry to test and understand the performance of trading systems and technologies underlying corporate networks. Email: robert.leclair@spirentcom.com; web: www.spirentcom.com.