A group of high-frequency traders, market makers and service providers calling themselves the Shortwave Modernization Coalition has asked the Federal Communications Commission for access to the shortwave band of the radio spectrum, seeking to shave crucial milliseconds off the transmission of data between major financial sectors.
I’m no expert in FCC deliberations, but reading the public comments shows a well-financed, professional application by the SCM. The band the SCM wants is currently used by amateur transmitters such as citizens-band radio and ham radio, and Federal agencies including the US Coast Guard and Federal Aviation Administration, as well as having a number of niche technical applications. While many current users don’t like the idea of letting high-frequency traders in their domain, they do not appear organized or well-financed, and their objections seem speculative compared to the slick professional study claiming HFTs will not interfere with current users. My amateur guess is this will pass FCC muster, which has led me to ponder the market implications.
The detailed technical analysis of the radio spectrum in the SCM petition stands in contrast to the few casual words slipped in to assert a public interest. SCM says using shortwaves will make markets more liquid and efficient. This is a controversial claim. Shortwaves will speed transmission of data between exchanges, which will make the global financial system more “tightly coupled”. Rick Bookstaber in his best-selling A Demon of Our Own Design argued that tight coupling is precisely what causes financial disasters.
Today, for example, it might take a tenth of a second for trading in Chicago to affect trading in London. That’s not just transmission delays but time taken for information to be decrypted and integrated into the databases that drive trading. The contagion from a flash crash or system failure or credit collapse or other problem in Chicago is not immediate. A tenth of a second isn’t much for humans, but computers can do a lot of processing in that time and circuit breakers, fail-safes and other precautions can kick in to stop local problems from causing global collapses. If the SCM cuts that from a tenth to a twentieth of a second, that could make things worse, not better.
On the other hand, tight couplings are more efficient. It’s also possible to have problems that arise because places are out-of-sync. The SCM might be right that speedier data flows will be better. They just don’t seem to have studied the question carefully.
I promise there are some important considerations for all investors here, but I must slip in a tiny bit of basic physics. Radio frequencies are measured in hertz, or cycles per second, and frequencies from 3 to 3 trillion hertz are used commercially. Low frequency waves require less power and travel farther before attenuating, but they carry less bandwidth. So low frequencies are good for sending a little data a long distance, and high frequencies are good for sending a lot of data a short distance.
The Pentagon can use 3 hertz to make sure its worldwide network of submarines is okay, a medical imaging device might use 3 trillion hertz to get a 3D image of your body inches away from transmitters.
The SCM has its eye on a medium band from 2 to 25 million hertz. This has the property that it can bounce off the ionosphere above and the surface below to send information far over the horizon. Radio signals in this band can connect Chicago with Shanghai without the relay stations needed for higher-frequency signals or the delays caused by the glass in fiber optic cables or satellite transmission systems. This can mean savings on the order of 50 milliseconds — or one-twentieth of a second — over transcontinental transmissions.
In the first decade of HFTs, from the mid-1990s to the mid-2000s, people fought over microseconds —millionths of a second. In those days, HFTs operated on single exchanges, and co-located their servers with exchange servers. Having your cable a few feet shorter than the adjoining server’s cable could mean you got the trade and the other HFT didn’t, even with signals at the speed of light.
After 2008, however, market-making HFTs increasingly got interested in cross-exchange trading — using data from Chicago to make trades in Frankfurt and Shanghai. The struggle in this domain — chronicled in Michael Lewis’s book Flash Boys — is in milliseconds, not microseconds. Enormous expense has been undertaken to shorten transmission times and the SCM is the latest chapter in that effort.
Shortwave transmission comes with disadvantages. First is low bandwidth, you cannot transmit complete order books, only simple signals like, “The Fed raised rates 0.25 basis points,” or “Apple stock just dropped 3 points.” Second is unreliability. There’s a lot of noise in the spectrum from natural radio sources, so signals get lost and you have to keep shifting frequencies to find a clear path.
Commercial vendors claim 85% reliability, but my personal experience suggests that’s optimistic. Finally, security is an issue since it’s cheap and easy to intercept the signal, and the low bandwidth makes sophisticated encryption impractical. Nevertheless, service providers have been working under an experimental authorization by the FCC since 2020, and claim to have solved these issues, and their customers seem to agree.
The benign view is some HFTs will pay for shortwave transmission and grab some money from firms that don’t make the investment, leaving markets basically unchanged but slightly more efficient and faster. A middling view is shortwave transmission will increase liquidity in the sense of faster execution for end-investors at smaller stated bid/ask spreads, but actually high total transaction costs due to unfavorable market movements. The sky-is-falling view is that tighter coupling of financial markets will cause the next financial meltdown.
I have no strong opinions on the subject, but it would be nice if the people asking for this change, and the regulators considering it, had such opinions and told us why.
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