Trading from the Front: A CEP Hedge Fund

In terms of technology, the software and architecture around the platform is completely different. When we first started, we built prototypes that were back-testable and able to migrate into trading strategies directly. In a lot of our strategies, however, we were surprised at how different market data was when we moved from a historical environment to a live environment. Architecture has changed immensely in the last few years, especially when we switch asset classes and add exchanges. When we first started, most of the strategies and architectures between counterparties were a blue sky implementation, yet the system we put into production and what we have now are completely different.

FG: How have regulatory changes affected you?
CY: When you do a ten-year backtest, you do not factor in a lot of the compliance changes from year to year. An easy example is the Reg SHO short sell compliance rules which have evolved in the last few years. When we first started, we knew about Reg SHO and factored it in, but obviously that changed again in the last year. The strategies themselves did change a little, but Reg SHO mostly affected our models in terms of factoring in the locates, the liquidity of locates from broker dealers, sourcing stock loans,the rates for the pricing model, transaction costs, etc. Obviously you cannot do that end in the backtest or it would take years to run. In terms of other compliance changes, the only changes futures strategies were in terms of the margin requirements, leverage and the loss or exchange of credit. All our models run on one-time or two-times leverage to be as conservative as possible, and we try to build our new models assuming relatively low leverage.

FG: Has your latency been affected by adding newcompliance or risk layers?
CY: We use Lime Brokerage for their risk layers, which are surprisingly fast for us. We have not made many changes in the risk layer other than to change the models to incorporate fat finger checks, buying power checks and short sell checks. Although it slows us down slightly, we have also established a redundant check on our side. We found that the broker-level checks worked for compliance, but they were not detailed enough for a strategy-by-strategy risk check. As an agency broker dealer, they are doing their best to cover themselves and their clients, but because their clients are broad, the actual compliance check is going to be equally broad. We insert our own risk checks, not to circumvent Lime, but as an additional layer. Investors want as many checks as possible. In this environment, it has always been ‘trust, but verify’, and if you do not or cannot really verify, you
need to put your own check in.

FG: What is important toyou in executing broker?
CY: We are really focused on the quality of the technology and the infrastructure, but we are not that concerned about customer service. We tell all our brokers the same thing, ‘if I never call you, that means you are doing a great job.’ I am not actually going to call someone to make a trade, so there is no point to picking up the phone. Even if something goes wrong, it is already too late to intervene. Depending on the issue, we will stop trading and reduce risk while we assess or trade through the problem and then go through a large endeavor to clean it all up. That is why we emphasize the technology to prevent a situation like that. We look for strong, redundant infrastructure, actual co-location, with the real cross-connected DMA. A solid testing platform is also helpful, and good access to market data is an important requirement for us. Their latency model does not even have to be top of the line, but at least within our specs. It is a cold war now, everyone cannot be the fastest. For us the second and third fastest is acceptable as long as they have a strong infrastructure backing trading strategies we believe in. For instance, Lime’s co-location is actual co-location in the NJ2 data center, using the Savvis and direct Mahwah feeds.
Many broker-dealers claim to have DMA, but actually offer a smart order router that mimics DMA. We are looking for a robust model and a certain pedigree of users on that infrastructure.