U.S. market could benefit if exchanges exit New Jersey in tax spat

By John McCrank

NEW YORK (Reuters) - U.S. stock exchanges have put New Jersey on notice: Pass a financial transaction tax and they will relocate their primary data centers, where billions of dollars of trades are executed daily - possibly to Chicago.

A move to the Windy City wouldn't just save millions in annual tax dollars. It could also help level the playing field for market participants by making lightning-fast price changes harder to exploit by high-speed traders and promote deeper liquidity, industry members said.

That's because all 16 U.S. stock exchanges have their disaster recovery sites in the same building at 350 East Cermak Road in Chicago, as opposed to their main sites, which currently reside in three data centers spread across a 50-mile swath of northern New Jersey.

In the electronic trading world, the physical distance a signal must travel is a key factor in how long it takes to get an order filled, and the race to get the best prices is one in which nanoseconds matter.

Moving to the Chicago site would reduce the possibility for latency arbitrage, where firms detect a trade on one exchange and then use microwave or laser technology and sophisticated algorithms to race to the other exchanges, executing trades and booking profits before those exchanges can update their prices.

"A lot of investments in fast infrastructure would become obsolete and a lot of trading strategies on that side would be eliminated," said Jack Miller, head of trading at Robert W. Baird & Co.

Reducing latency arbitrage would make it easier for market participants to complete trades at their desired price, said a senior exchange executive who was not authorized to speak publicly on the matter. That would encourage larger displayed trade sizes with tighter spreads between the price at which an asset is being offered and the price for which it is being sold, improving overall liquidity, the person added.

"Having all exchanges in one geographic location would be healthier for liquidity in our markets," said another senior industry executive.

SHOT ACROSS THE BOW

The backup to the U.S. stock market is in an eight-story English gothic-style building just off Lake Michigan, in the shadow of Chicago's sprawling McCormick Place Convention Center, that hosts several data centers.

This week, Intercontinental Exchange Inc's <ICE.N> New York Stock Exchange unit is running the smallest of its five exchanges, NYSE Chicago, live from the location to show its readiness to move. Nasdaq Inc <NDAQ.O> plans to do the same with its smallest exchange for a week in late October.

All 16 exchanges were also in Chicago this past weekend for an industry-wide exercise simulating a regular trading day, in part to show they could operate from their disaster recovery sites in an emergency.

But the exchanges also wanted to send a message to New Jersey, which is considering a state tax of a quarter of a cent per financial transaction for firms that make more than 10,000 such transactions per year.

"The tests are a first step toward demonstrating industry preparedness to move data centers out of New Jersey and protect millions of market participants across the U.S. from New Jersey's invasive proposed tax," said the Coalition to Prevent the Taxing of Retirement Savings.

The tax is under review by the state's Senate, Assembly and its governor, said Richard McGrath, a spokesperson for New Jersey's Senate president, Stephen Sweeney, who introduced one of two bills proposing the levy.

The coalition represents exchange operators NYSE, Nasdaq, Cboe Global Markets <CBOE.Z>, IEX Group and the Members Exchange, as well as financial firms TD Ameritrade <AMTD.O>, UBS <UBSG.S>, Credit Suisse <CSGN.S>, Citadel Securities, Virtu Financial <VIRT.O> and data center operator Equinix <EQIX.O>.

"They're basically firing a very strong shot across the bow of the people trying to impose a local transaction tax, by signaling, we can literally move everything out of state overnight," said James Angel, a finance professor at Georgetown University.

(Reporting by John McCrank; editing by Ira Iosebashvili and Leslie Adler)