The Financial Conduct Authority (FCA) is investigating the practice of trading firms putting their IT equipment in the same buildings or near the systems used by stock exchanges to match buyers with sellers.
Trading companies, known as high-frequency traders, that trade massive volumes in a matter of microseconds can benefit from having their systems alongside the systems at a stock exchange.
This cuts the time it takes for messages to reach their systems, which are automated to trade, using software algorithms, when prices reach a certain point.
Messages travelling over a fibre link can only go as fast as the speed of light. To reduce this, suppliers and finance firms offer colocation services to reduce latency.
Price fluctuations can occur between an order being made and completed, but exchanges can compete end-to-end trades in microsecond the journey time from the trader is just under 300,000 meters per second, so colocation trims vital microseconds. It takes about one millisecond for every 200km travelled on fibre.
But the FCA is set to investigate whether the practice of colocation is competitive or if it is unfair for some companies, such as new market entrants. It is asking for comments from the industry to be in by 9 October 2014.
The FSA said: “Colocation provides a market access advantage for colocated participants over those that are not colocated. Such market developments could be viewed as a natural consequence of innovation and evolution of the markets.
"Competition issues may not arise when such services are made available in a fair and non-discriminatory manner. However, competition concerns could arise, for example, if the availability or cost of the colocation creates a barrier to entry for new market participants.”
Since 2008, the London Stock Exchange has had a service where trading companies can put their systems in its datacentre to reduce the message latency. And suppliers such as Colt offers alternatives.