(This article originally appeared in Finance Magnates)
An application for a patent was published by the U.S. Patent and Trademark Office in February. The document, as reported by Bloomberg originally, described an innovative way for executing synchronised trades in multiple exchanges, consisting of sophisticated algorithms, a host of computer servers and atomic clocks meticulously calibrated to vibrations of irradiated cesium atoms to sync orders to within a few billionths of a second.
If the invention fulfills its promises, one of the most renowned names in the hedge-fund business could gain exclusive U.S. rights to a tool capable of foiling the most predatory of high-speed traders.
Renaissance Technologies is the brainchild behind the application – a secretive and highly profitable $32 billion firm founded by mathematician and former code breaker Jim Simons.
The lengths the company has been willing to go to build and patent its own computer-driven technology at a potential cost of tens of millions of dollars illustrates just how big a threat high-frequency traders have become to the industry’s largest and savviest players.
Routing
These days, hedge funds, especially those with a high turnover, are focusing much more on doing their own routing and have started to employ ‘high-frequency trading technologies’.
Most money managers route their orders to brokers, who then send them onto various exchanges or dark pools, depending on which has the best price.
However, with the U.S. stock market becoming more fragmented, high-speed firms have exploited the minuscule differences in time for trades to reach various exchanges to step in front of large investor orders. For their part, high-speed firms say that they lower transaction costs by taking the other side of hundreds, if not thousands, of trades each day on various exchanges.
The Technology
Renaissance has therefore decided to take matters into its own hands. Its invention, developed by the firm’s co-chief executive officers Robert Mercer and Peter Brown, first sends an order to a central server, which breaks it up into multiple smaller orders. Those are then routed to venues that offer the best prices and most liquidity, much the same as brokers do now.
Before that happens, the smaller orders are sent to servers located as close to the exchanges as possible, along with instructions on the precise times that they should be executed. The co-located servers sync their transactions so that HFT firms won’t have enough time to identify an order on one exchange and then race to another to trade against it.
A crucial part of the system is the optical, atomic or GPS clocks that will be used synchronise those orders. Renaissance says in its application that GPS clocks are accurate to within nanoseconds and any time differences between them are “too small to be perceived” by HFT firms.
Renaissance is not the first firm to seek a patent for its anti-HFT technology. In 2013, the Royal Bank of Canada obtained one for a order-routing system that Brad Katsuyama and his team created for the firm. After starting IEX Group Inc., Katsuyama went on to develop the “magic shoebox”, which uses 38 miles of fiber-optic cable coiled in a small box to slow orders by 350 microseconds. IEX, which uses the system as its centerpiece, will become a full-fledged exchange in August.
Renaissance, however, has said its own invention provides “a much simpler and more cost-efficient way to achieve accurate and repeatable synchronised trades compared to the prior art.”
