AsiaEtrader Issue 2 | Volume 1
HEADInG
I 2012 Q2
The Electronic Trading Resource for Asia
Competition is Coming To Korea OTC Reform in Asia
LEADER
AsiaEtrader Issue 2 | Volume 1
HEADING
I 2012 Q2
The Electronic Trading Resource for Asia
Competition is Coming To Korea OTC Reform in Asia
CREDITS Chief Editor Stephen Edge support@asiaetrading.com Contributing Writers Dan Barnes dan@icorp.co.uk Paul Egan paul.egan@regan-associates.net Dr. Jayaram Muthuswamy jmuthusw@kent.edu Frederic Stephan fredericstephan@yahoo.com Cover Design Nadia P. nad3e9@gmail.com Graphic Design Mariel Closa dc.works.group@gmail.com Magazine Design The Magazine Production Company, Adur Business Centre, Little High Street, Shoreham-by-Sea, West Sussex, BN43 5EG Printer Century View Printing Limited Units B3, B4 & A1; 10/F Ko Fai Industrial Building 7 Ko Fai Road Yau Tong Kowloon Hong Kong Advertising Enquiries support@asiaetrading.com Subscription Enquiries support@asiaetrading.com
Spring Has Sprung Our Second Edition Springtime is always an occasion for renewal and change. Dreary winter is cast off and replaced with warming sunshine and cleansing rain. Heavy clothes are put aside for lighter, brighter outfits and open-toed shoes. Grounds dun with undergrowth can finally be manicured back to life. I myself have two blisters to show for having recently restored our garden in preparation for the season of growth ahead. The theme of renewal and change is not only limited to springtime of course. Korea’s capital markets are themselves sweeping away undergrowth and renovating its own house. The government is proposing to cast off its old and outdated regulatory policies and bring about some much needed change to their underutilized capital markets. Reform and competition seem to be a recurring theme not only in Korea but across Asia as it enters the springtime of its progress. Our first cover story looks in depth at the changes taking place as competition inevitably seizes another further transforming this part of the world. More widely felt and harboring much greater repercussions to the fabric of the financial industry is the over-the-counter derivatives space undergoing transformation in every corner of the globe. Asia while only just 8% of global OTC business has an opportunity to implement a rigorous and far reaching OTC policy before becoming too unwieldy to oversee and manage. What’s more are the changes underway putting us on the path to a unifying global regulatory policy for the first time. We held two forums in Hong Kong and Singapore this past quarter that addressed concerns and raised pressing issues relevant to Asia in what is more of a commodity market than an interest rate one found typically in the West. Our OTC edition here’s voice from the ISDA and our OTC opinion poll offers us further insight into views from the industry. A great deal else is budding up all over Asia and we have done our best to bring you our second edition of the Asia Etrader Magazine. We hope you enjoy it.
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Stephen J. Edge Wild Wild Web Ltd. GPO Box 11108 Hong Kong
Editor
www.asiaetrading.com ©2012
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Contents 4
Cover Story:
Competition Is Coming To Korea, Well Almost
9
Cover Story
OTC Reform: The View From Asia
16
Opinion & Analysis
High Frequency Trading And Market Efficiency
18
Buy-Side:
QFII Update
The Cost Of Central Clearing
20
Derivatives:
In Case Of Default, Break Glass
Asia Futures Trading Recap Q1 2012
Volatility In Asia Q1 2012
26
Exchange Spotlight:
Stock Exchange Of Thailand – Punching Above Their Weight
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Risk:
ISDA Views On Hong Kong OTC Reform
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Who’s Who:
Tony Mackay – Founder Of Chi-X Europe And Chi-X Global
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Equities:
A Bargain At Half The Price
Asia’s Fragmentation Footprint Q1 2012
Asia Equity Trading Recap Q1 2012
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Opinion Poll:
Should Standardised OTC Derivatives Trading
Be Mandated To Clear Through CCPs?
Who Should Pay ASICs Inflated Regulatory Costs?
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Post Trade:
Cutting The Post Trade Drag on Broking
50
Regulatory:
Australia’s Invisible Transaction Tax?
52
Technology:
Compliance System: How Can The IT Department Help?
Latency In Asia
54
Back Page:
Careers
Dates Directory
Social Media
In the Zone...
In THE ZOnE
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The first quarter of 2012 is already behind us and not surprisingly Asia’s electronic trading industry was a hive of activity. Let’s take a very brief look at what happened In The Zone. Australia
Hong Kong
Exchange competition and the impact on Australia’s electronic trading market structure will be the On-going news for some time to come. Despite almost four years in the making Australia’s regulator, ASIC, without warning unilaterally imposed a “cost recovery” tax on ASX and Chi-X. The cost of regulating a multimarket environment ballooned from AU5million to AU25million when the ASX handed supervisory powers to the regulator last year. It is in effect a transaction tax set to quash high frequency trading a key customer-type of Chi-X. How this will affect Chi-X remains to be seen. ASIC was busy working with Canadian regulators last quarter ensuring that regulated entities that operate both in Australia and Canada were adequately supervised. ASIC finalized its investigation into Saxo Bank’s risk management policies over the collapse of Sonray Capital Markets. Goldman Sachs was fined AU50,000 for breach of client money. After 15 years Jeff Olsson the group executive for technology left the ASX and David Mitchell joined Chi-X Australia as business development manager. The ASX Australian Liquidity Centre (ALC) saw both Fidessa and FFastfill occupy some rack space too. ICAP entered the Aussie agriculture and soft commodity markets.
The HKEx was busy this quarter with several developments. The most noteworthy was the launch of the data center and a US380 million technology initiative. The HKEx also implemented its second phase of reduced trading hours in March where lunch will only be one hour and the trading day extended to 6 hours. The exchange also signed an MOU with the CFFEX and was tipped as one of the bidders for the London Metal Exchange. Hong Kong continues to establish itself as the destination for offshore Renminbi trading where it has agreed with the UK Treasury to launch a private-sector forum to enhance cooperation between the two cities. Joe Meyer, the CAO, departed after only 6 months at the exchange. Hong Kong also fell victim to several job cuts in the broking industry with Daiwa, among others, announcing a 10 percent cut to its workforce. The HKMEx saw Green Futures and Newedge join its ranks as members and the bourse also surpassed 1 million contracts in less than one year of operation. The SFC completed its short position reporting consultation where net positions greater than 0.02% or HK30 million must be reported. The regulator also set up a risk management unit and announced support for the HKEx risk management reforms at the exchange groups 3 clearing houses.
India China Asia’s biggest economy and highly sought after financial industry heard news from the regulator the China Securities Regulatory Commission (CSRC) as that country pushes reform in its financial industry. Of note was the expansion of the QFII program that saw a record 15 firms granted a license for US2.1 billion of quota. The pension system received a boost when the regulator moved to allow investment in the securities market. Pension funds can only invest in government bonds or park cash in the bank. The CSRC also announced a plan to curb excessive speculation in its capital markets. The Shanghai Futures Exchange announced the launch of bond futures, the Bank of China cleared another hurdle to earn its LME membership and Citi Orient Securities was approved to begin its joint venture in China.
Regulators were busy all across Asia reforming capital markets under the yoke of competition and SEBI was no different. The United Stock Exchange came under pressure from SEBI regarding its ownership restrictions. Direct investment in India’s exchanges is limited to 5 percent. The regulator gave the nod for exchange listing of 2 and 5-year cash settled futures underlying a 7 percent government bond. High frequency trading in India which has taken off in the last 2 years is under a lot scrutiny and SEBI is considering whether or not to put the brakes on these kinds of trades by increasing latency. Market-to-market requirements for liquid funds is expected to be made compulsory within the year as well. The Reserve Bank of India allowed QFIs to increase investment up to 5 percent of paid up capital for India companies, the Multi Commodity Exchange finally had its IPO and the BRICS interlisted index derivatives began trading on
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the BSE as well as South Africa, Hong Kong, BM&F Bovespa and RTS in Russia.
Japan It was the merger of the OSE and TSE that continued to play out in Japan highlighting developments in that countries market structure. Concerns from OSE shareholders arose on whether or not they were getting a good enough deal. Also, the TSE filed a notification to the Japan Fair Trade Commission in accordance with the Anti-Monopoly Act. The Japan FSA submitted proposals for OTC derivatives trading and also submitted its concerns to the US regarding the impact of the Volcker Rule. The OSE launched a new volatility index derivative, the Tokyo Grain Exchange announced it may have to close its doors and SBI Japannext saw PTS turnover reaches 4.5 percent of TSE. Lastly, the oneyear anniversary of the Japan earthquake was observed.
Singapore The SGX announced that its co-president Gan Seow Ann would step down after 11 years and Glenn Seah was hired as head of compliance. The exchange also welcomed as new members Polaris Futures and HSBC. The CFTC approved the Stoxx 50 Index Future to trade in the US. Dual currency trading came to the SGX as well. The securities will be fully fungible and consolidated at CDP. Hutchison Port Holdings Trust was the first dual currency listed. The Monetary Authority of Singapore (MAS) began public consultation on OTC trading and introduced a framework for credit rating agencies. Citi decided to sue a Singaporean fund manager for US1 million for a bad gold trade.
Thailand The Stock Exchange of Thailand announced that new trading rules would be forthcoming in anticipation of its new technology upgrade provide by Cinnober. The Thailand Clearing House announced it was accepting new members and allowing trading members to upgrade to clearing members as that country continues to develop its market structure. Lastly, RTS Realtime Trading Systems announced that it has connected to the Thailand Futures Exchange.
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Competition Is Coming To Korea, Well Almost
C
ompetition contagion is sweeping across Asia and has now afflicted the Republic of Korea. It all started before the Global Financial Crisis (GFC) in 2007 when Korea’s capital markets regulator the Financial Services Commission (FSC) established the Financial Investment Services and Capital Markets Act (FSCMA). The FSCMA brings together 6 capital markets related laws to invigorate and innovate South Korea’s somewhat benign and restrictive capital markets. The Act, having taken effect in February 2009, was stalled in the wake of the GFC as both Korea and the world were focused elsewhere and hasn’t had the impact it was intended to have. Now, in the aftermath, with the G20 intent on reform and exchange competition spreading across Asia the FSC has seen fit to revisit the FSCMA last year with a set of revisions. These revisions are in fact the catalysts to competition and the drivers of a reborn Korea capital markets. In a nutshell, the FSCMA allows financial companies to operate under more than one business type and compete across different segments of the industry offering economies of scale and efficient use of capital. There are 6 different businesses Korean firms may engage in and they are advisory, brokerage, collective investment, dealing, financial investment,
investment management and trust. The goals of the revision are an attempt to boost Korea’s investment banks and push the industry closer to international standards. The policy revisions address: • Developing Korean investment banks • Improving asset management regulations • Reforming capital markets infrastructure • Diversifying direct financing channels • Strengthening the regulations of unfair trading practices
Developing Korean Investment Banks Investment banking in Korean is dominated by Goldman Sachs and Morgan Stanley who enjoy wide networks, industrial scale and deep pools of assets. Because of this, prime brokerage, among others, can be offered at much lower rates than the local market effectively creating a quasi-duopoly on these services. The multi-license environment is intended to develop the local players to compete with the global investment banks through securities lending, hedge fund financing and other prime brokerage services. There are some problems though. The FSCMA is proposing that minimum equity capital requirements for investment banks be set a KRW3 trillion (US2.7 billion) and not one securities firm in Korea can meet that requirement. The five largest domestic
firms, Daewoo Securities, Samsung Securities, Hyundai Securities, Woori Investment & Securities and Korea Investment & Securities have an aggregate equity capital of around KRW13.4 trillion (US12 billion). Japan’s Nomura Securities is more than twice that amount and CITIC in China by itself has capital equal to the group. All the same, these five firms are offering some elements of prime broking as the industry embraces its new found flexibility but they lack “experience” says Seunghyun Cho, Managing Director of Leonie Hill Capital a small Korean hedge fund. “We are trying out a few local brokers now but prefer to deal with the western investment banks”. The revisions also address broker internalization which opens the door for off exchange trading, currently unavailable. The capital requirements also entail that firms maintain net operating capital at 300% above the total risk amount known as the Net Capital Requirement (NCR). Basel capital adequacy requirements will also be applied. Korean firms need more capital and competition with investment banks could see some consolidation in the local market.
Improving Asset Management Regulations This element of the FSCMA is directed at supporting an ageing population and providing a wider range of diversified financial services for
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retirement. Among these changes will see asset management companies forced to exercise voting rights as shareholders of fund assets that are in line with investor interests. Fund merger procedures will be simplified without undermining investor rights. Other reforms include a clear distinction between collective investment businesses and discretionary investment services. The trust business will be reexamined to weed out inefficiencies that don’t protect investors and address the shortcomings
of its current definition and some of the more onerous regulations on fund operations will be cut or curtailed to foster innovation in the fund industry.
Reforming Capital Markets Infrastructure This revision of the FSCMA directly addresses exchange competition and alternative trading system (ATS) operations. Here, a licensing system will be introduced to permit new
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venue operators that will perform much like a Proprietary Trading System (PTS) in Japan or a Multilateral Trading Facility (MTF) in Europe. However, the government has said that once a certain market share or volume threshold is reached then the ATS must apply to become an exchange where it will then self-regulate and could offer IPOs. Order internalization is also addressed and could bring the onset of darkpools too. There are capital requirements to establish an ATS and they have been set at
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KRW50 billion (US 44 million). This is a rather large amount and will push out smaller players from establishing a competitive venue. There are also ownership rules where individuals will be allowed to hold up to 15 percent of an ATS and financial firms will be permitted to own up to 30 percent of the entity. By virtue of this rule only conglomerates will create ATSs which are likely to see the leading domestic brokers come together and some of the international players too. Also, a part of this revision is clearing where a new category called “clearing business for financial investment transactions” is put forth. These licenses will pave the way for clearing of OTC products and securities lending as well as provide for a Central Clearing Party (CCP). Will the KRX open its clearinghouse to competitors like they have done in Japan or will they make a profit on clearing as they have done in Australia? The last part of this section calls upon regulating credit rating agencies under the FSCMA rather than the existing Credit Information Act. As an important part of the bond market they will be held to higher standards to protect investors and public disclosure.
Diversifying Direct Financing Channels Under this segment it is intended to assist listed firms to raise further capital in the equity markets while preventing them from abusing these tools. Specifically, the issuance of warrants and contingent securities will be made readily available. However, the amounts to be raised will be limited to prevent exploitation. This section goes on to further eliminate the “shadow
voting” system by 2015 where the Korea Securities Depository (KSD) exercises proxy voting rights.
Strengthening The Regulations Of Unfair Trading Practices This principle is to address some of the past abuses from overseas investors in the capital markets, namely Deutsche Bank Securities 2010 arbitrage scandal that cost the firm KRW1 billion in fines and a 6 month suspension of their license. Price manipulation of unlisted securities such as OTC derivatives will be criminally punishable if the underlying asset of these products are listed securities. Administrative sanctions will be applied on other market abuses such as scalping. A broader range of market abuses than under the current regime will be subject to fines in order to preserve the integrity of the capital markets.
Korea Exchange What is the Korea Exchange (KRX) planning to do about this when there is an abundance of data on how primary exchanges fair when staring down the barrel of competition? In late July last year they did announce that a nextgeneration trading system dubbed EXTURE+ was in the works. It is really just an extension of the EXTURE installation that went live in March 2009. That upgrade consolidated the KOSPI market, KOSDAQ market and the derivatives market into one platform after all three markets had merged to form the KRX in 2005. The current platform can handle 58 million orders per day with round trip latency of 20 milliseconds. EXTURE+, due to go live in stages from later this year to 2013, is expected to process 200
“Volumes in 2011 did improve over 2010 growing by more than 3.8% inshare turnover and 8.9% by turnover value.” million orders per day, 100,000 transactions per second at 50-70μs. That is faster than SGX Reach in Singapore that bill themselves as having the world’s fastest matching engine. KOSCOM, a joint venture between the stock exchange and the government, is the technology vendor behind the matching engine. The exchange platform will run on Linux using x86 processors. Messaging technology is being built in-house rather than with TIBCO RV in the existing system. APIs for messaging protocols will include FIX and FAST and OUCH and ITCH when the upgrade is rolled out. There will be new order types such as Iceberg, pegged and stop loss to enhance member usage. They will also launch their own ATS sometime this year. What types of trading services they will offer remains to be seen but when the ASX in Australia remade itself they introduce 4 new venues along with the primary. In September 2009 Korea was bestowed ‘developed market’ status from FTSE in an endorsement of that economy’s strength. It’s
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no wonder given that the market capitalization of its equity market breached US1 trillion last April and its overall economy did the same in 2004. According to the CIA World Factbook Korea is the 13th largest economy with a GDP of US1.554 trillion or a per capita of US31,700 which ranks it 40th globally. The biggest sectors of its economy are Services (57.6%) and Industry (39.4%) and the country carries a relatively low debt of just 22.9% of GDP. Its largest trading partner is China who receives
27.9% of US558.8 billion in exports. China and Japan are the largest importers into Korea. Equity turnover on the KRX hasn’t returned to its 2002 levels nor has it achieved its 2009 high during the capitulation felt at the height of the Global Financial Crisis. Volumes in 2011 did improve over 2010 growing by more than 3.8% in share turnover and 8.9% by turnover value. The KOSPI 200 Index option, as most know, is the largest by volume on any exchange around the world. A recent development by the
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government who was concerned that too much retail was participating in the option decided to increase the multiplier from 100,000 to 500,000 in effect increasing the notional size of the option by 500%. This change was implemented only in March and the impact to the market is not known at this time. Last year 3.45 billion contracts traded hands and the index future managed 81.5 million in turnover. The Korea Capital Market Institute (KCMI) produced some interesting findings in a report on the KOSPI
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futures. They found that there are around 6300 people who trade the future daily with about 15 traders submitting more than 5,000 orders per day. These 15 traders comprise 32% of daily turnover. They also found that up to 63% of total orders each day come from traders who submit 1000+ orders.
The governments Real Name Act is a broad based rule in Korea and has its affects in the capital markets where international institutional clients are required to use this ID when making trades. This puts foreign firms at a disadvantage as domestic players can see what they are trading and act to their detriment. Anonymous trading is one of the major concerns for international buy-side clients trading Korea. One of the uses for the ID system is that certain securities have foreign ownership limits, say Telecom names, and through the IDs these limits can be tracked. The challenge comes in when there are multiple or even one other venue that is trading the foreign-restricted names, how are the position limits gathered over more than one venue in live time? In FIX4.2 tag 1 can be used to pass this ID but for those non FIX messages it could be a problem tracking ownership without hampering latency.
another year. Politics and the imminent general elections April 11 (after this magazine goes to print) are putting these changes in jeopardy as lawyers are too busy to pass the changes and are instead focusing on getting elected despite pressure from both the government and the industry. Despite being tabled last November, the revised rules were held up at the National Policy Committee and failed to even reach a floor vote. On March 13 a crowded hearing was held at the National Assembly in western Seoul to put pressure on pushing through this policy but fell on deaf ears as only 3 of 24 lawmakers attended to hear what the industry had to say. The effort to revise FSCMA rules would return to square one if the proposal does not pass a floor vote by the end of May, when the current parliamentary session ends. Not only would the entire process have to be repeated in the second half of the year, but the possibility of it being passed in the future would be slim given the looming presidential election in December. It sounds like Australia all over again. The competition mandate had to weather politics and a general election there as well but in the end, after 4 years, the monopoly was broken. While no doubt costly to the industry to delay these revisions competition will inevitably arrive in Korea.
All For Not
What’s Next?
The 190 revisions of some 440 articles within the FSCMA stand a chance of not passing at all and delaying these reforms for as long as
If the revisions do go forward and are voted into law there will be a whole slew of activity much like what we saw in Australia. At least one or two
Real Name Act
alternative venues will launch, likely from the local industry and one from the KRX. With the new venues will come the need for consolidated data, smart order routing and the foundation of best execution rules. Brokers internalizing orders may spawn reciprocal liquidity agreements in order to help customers find more trading size. The new KOSCOM data center in Busan will attract a host of brokers, vendors and high frequency trading players to take advantage of the latency and new order types. Local brokers, who have been offering colocation for some time should see an increase in participants. Next will come unbundling of execution and research more commonly found in the west. Trade performance measurements will be in demand as buy-sides will want to know how well broker algorithms are performing in fragmented markets. And with all low latency algo saturated markets order sizes should shrink, volumes increase and tighter spreads should be realized. We don’t expect to see a local clearer come into the market as it is just too small but it remains to be seen how the KRX will let competitors use their post trade infrastructure. At the end of the day, Korea, as do most of the regional centers in Asia, desires to become a leading, global financial hub. If the long history of the Koreans is any indication their resourcefulness and perseverance will achieve that end. Patience is a virtue but an expensive one if the FSCMA revisions aren’t addressed but, at some point, they will be.
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COVER STORy 2
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OTC Reform: The View From Asia Asia Etrading held two forums that gathered senior capital markets players in Asia for this discussion, moderated by Stephen Edge. Here is an edited transcript from both of these discussions.
HONG KONG FORUM Panelists Thomas McMahon, MD and CEO, Pan Asia Clearing Enterprise (P.A.C.E.) Jessica Morrison, Head of APAC Market Structure, Deutsche Bank AG Ketan Petal, OTC Head of Rick Management, HKEx Robert Rooks, Capital Market Consultant Lieven Van den Brande, COO, Operations & Technology, HKMEx
Asia Etrading: One of the key concepts that will define the scope OTC policies will be the term “OTC derivatives trading”. How would you define the term and what parts of the definition should be carefully worded? Ketan Patel: Often, OTC is incorrectly categorized as an asset class. It is not an asset class it just how the trade is done. I can trade a future OTC as a block and put the trade to the exchange’s Clearinghouse as a mechanism for trading and clearing. What drives OTC trading as OTC? It could be for confidentiality reasons or that there are complex products which are difficult to price on an order book. Beyond where these trades are going to be reported or where they are going to be traded, is the
concern how the clearing infrastructure is going to be managed this. Which is going to be tough and to add to your point Tom, where does a bank clear? Every bank is going to be asked to clear in many jurisdictions and within some of those jurisdictions you have multiple clearinghouses making it difficult for the banks. On top of that the regulatory ambiguity in how OTC trades are supposed to be cleared in multiple jurisdictions and when. Jessica Morrison: To be able to put a security on an exchange it needs a degree of liquidity and a lot of OTC products are very bespoke depending on what the client wants. Even if you can define OTC and trade it are there enough people that want to trade the same contract to make it liquid enough to make a market?
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Robert Rooks: When you look at how some of these transactions function some of these transactions go out for decades. How do you manage the longevity of the transaction through its entire life cycle? Defining an OTC trade is almost impossible. An OTC trade is what it is, a bilateral agreement between two counterparties based on a specific underlying and it’s priced according to the contract terms. If you have to start registering those contracts with a central depository does that depository assume some of that risk? It’s very difficult to define in a sentence. Tom McMahon: All of the above. The definition of OTC itself has always been a misnomer. The biggest problem is just the definition of a derivative. There is no clarification of who is a SWAPs dealer, who is a market participant and such. The definition is going to happen as the regulations are put into place. Asia’s probably going to have the most difficult part of it. If you look at the west and the current clearing structures of LCH and ICE Clear they have a clear definition of what sits on a SWAPs-side, OTC-side or margin-side alongside the ISDA versus out here in Asia where they have mostly be trailing. You might be executing a SWAP and clearing a SWAP in the west but you don’t define it as an Asian SWAP but in reality it is an Asian SWAP. You might have a counterparty with
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one European leg and one Asian leg how do you define that? The regulators expect it to be defined fairly quickly so there is going to be a lot of catch up here. Asia Etrading: Does mandatory reporting of OTC derivatives transactions make sense and what should be reported? Lieven Van den Brande: I do think mandatory reporting does make sense. It helps to provide transparency and it can help the industry by providing data for pricing and risk management. But, I think it is going to be very difficult. Tom McMahon: You have to drill down and see what it was that has caused all this scrutiny on OTC reform. It goes back to mark-tomarket, mark-to-model and margining are really the underlying key issues that the regulators are trying to address. There are enough standarisation models that have existed with some of the energy architectures like ICE Clear and ClearPort that started with single contracts and ultimately built out basis clearing models as the industry adapted that. I think we are on the front end of that for the rest of the industry and the rest of the world. Fundamentally, it’s probably the right thing to do. If you just look at BASEL III you have mark-to-market, mark-to-model and cleared, non-cleared with very diverse margining. The regulatory framework is saying the more you can clear on an exchange the more efficient your margin is going to be. Trying to create mark-tomodels is going to be more difficult on the OTC products that are very unique. Shifting from ISDA’s once per week to a 6 times per day margining on those models is going to be a monstrous task. It is not invalid though.
Jessica Morrison: You want to consider what the reporting hopes to achieve. If you look at the more traditional and listed equity space in the cash business there is a big difference between reporting to a regulator for supervisory and risk management purposes compared to post trade transparency which will influence price formation. Reporting data to a regulator you have to ask how are they going to manage that data? The US SEC struggled to cope with the information that came through on the flash crash and that was just 20 minutes of trading. As soon as you start putting OTC products on an electronic platform the volumes of data will explode. Data management for the regulators is going to be a real challenge. They are going to have to think carefully to make something meaningful out of the data that is being reported to them. Ketan Patel: There should be a goal with respect to reporting. If you look at the CFTC in the US they target 60-80% of the market. While it does not cover everyone, they do get a sense of what is out there. Furthermore, they provide aggregate statistics providing transparent reporting to the end users. If there is that type of goal, then it makes sense. Asia Etrading: The Legal Entity Identifier (LEI) does this make sense? What are the advantages and disadvantages? Jessica Morrison: It’s about controlling systemic risk. If every legal entity has a different identification code it’s very difficult to match up and figure out what your counterparty risk is. If we could get to a situation where there is one golden source globally with one identifier that you can link up through a parent company that
it is a very admirable goal and one of the first truly global pieces of regulation which is a huge milestone. This has to be the way forward in the derivatives space as it is a global marketplace. Within Asia the LEI has been mentioned in the recent Monetary Authority of Singapore paper, the HKMA has mentioned it and we are hoping that Japan will take it on. Each country in Asia has their own way of doing things and getting everyone on the same page will be really difficult. If the LEI’s do get indorsed at least at the G20 level then it should make everyone’s life a lot easier. Tom McMahon: I come from the traditional exchange space and anonymity was always the key at the client level. Using best practices, LEIs at the top of the food chain is a great idea but there will be a lot of resistance to it in the middle and bottom of the food chain because of anonymity. There is still a lot of debate but fundamentally if they were using LEIs they would probably know where the US1.6billion of missing MF Global money is. Robert Rooks: My concern is how it’s all going to be paid for? Is the cost going to be borne by the regulator, the government or by the institutions themselves? Fundamental changes are going to have to be made to your risk management systems to account for parent child relationships within your own company let alone your counterparty are going to be huge. And this is just the beginning. Once you establish that and start drilling down the work load is phenomenal and it’s going to take years to implement. You have to start somewhere and there has to be one cohesive agreement before you can take that first step. From an industry standpoint how am I going to
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fund this? What is the impact to my business? How do I manage it and who do I ultimately report to? Asia Etrading: Will trading infrastructure require more investment to cope with the electronification of OTC trading? What segments will need more than others? Ketan Patel: I think it’s going to be the middle office. Counterparties are using historic exchange based systems to clear OTC and vice versa. What systems will they ultimately use? Then add the complexity of a counterparty having to connect to twenty countries and each country has multiple CCPs. How do they manage that? Jessica Morrison: The internal cost has to be heavy on the middle and back office functions. The liability of misreporting is going to be considerable so we have to make sure we make the appropriate investment and get it right. Lieven Van den Brande: I think the investment in technology will be across the board but with a focus on middle office. There is going to be a need for standardized messages and data storage to a move away from the once a day batch run to possibly real time. These kinds of changes will need to be integrated across all segments of the trading process. Asia Etrading: Should standardised OTC derivatives trading be mandated to clear through central counterparties? Ketan Petal: If they are standarised enough then the market will push them to a CCPs for capital efficiencies. If you look back in the past
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5 years there have been multiple attempts for trading SWAPs on a screen. The CME attempted to offer standardized SWAPs on a platform names Swapstream back in 2007 and it failed. You can put the products out there but if the market doesn’t want to use it, they won’t use it. CDS clearing was mandated in 2009by the regulators for clients but less than 100 Billion in open interest was posted by clients.
two counterparties. Are you then going to say if I am trading the same product in 50 countries around the world I then have to meet my collateral requirements fifty times? If so, I am bankrupt. Name me a bank that actually has the capital or assets to do that now.
Lieven Van den Brande: I think standardized products should be made mandatory. The capital requirements for non-standardized OTC should incentivize participants to move to standardized products. It will take a lot of risk out of the market when you know what the risk is. There will be a cost and it will make transactions more expensive but if you look at the cost of the Global Financial Crisis you need to compare that to the cost of the new regulations.
Robert Rooks: I think it is to be determined. You can’t decide on what form a CCP will take until you decide what products have to be regulated. Every regulator in the world is trying to prevent systemic risk but how do you prevent risk in products most regulators don’t understand?
Robert Rooks: The concept of a CCP for standardized OTC contracts is a very viable one. The problem arises when you get to standardized contracts which are highly illiquid and very volatile so how are you going to manage the mechanisms of the CCP to handle that kind of risk? Where does that burden then sit? How do you regulate the CCP? I don’t know of any CCP that can take on any of the risk of some of the derivative products that are actually traded. How do you fund and indemnify a CCP to protect the participants? As a CCP they are taking the risk of the buyer from the seller and the seller from the buyer. Should those assets not be under management or control to be able to guarantee that risk? It’s almost impossible unless you standardize but how can you standardize products that are not standard. In an OTC market it’s a bilateral contract between
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Asia Etrading: What form should a CCP take in Hong Kong?
Ketan Patel: The CCP has to be carefully managed and is a complex set up. More and more CCPs are setting up infrastructures that are distinct from the exchange side which is what the HKEx is doing. Some of the other exchanges have the OTC clearing side as separate. Obviously, there are margin offsets where you might want to comingle positions like in the energy space with Clearport and ICE, for example, but with CDS there is no way you want to comingle those with very liquid exchange traded products. For OTC Clearing, the systems have to be more complex on the risk calculation side which is not impossible, it just requires more investment in human capital and technology. Lieven Van den Brande: CCPs have traditionally been commercial entities and the question be should they be commercial entities or not. The way the CCP manage instruments that they are taking on you probably don’t want
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COVER STORy 2
SINGAPORE OTC FORUM Panelists Jennifer Ilkiw, VP, APAC Sales, IntercontinentalExchange Tom James, MD, Navitas Resources Pte Ltd Lawrence Law, MD-Associate General Counsel, JP Morgan Thomas McMahon, MD and CEO, Pan Asia Clearing Enterprise (P.A.C.E.)
them to take on the risks of very illiquid assets. Reporting is something where the CCP can be an information provider to the rest of the community. When does a CCP take on a certain risk? Do you want the trade to be margined before you take on the counterparty risk? Does the CCP extend credit? They are all different models depending on the asset classes you are dealing with. SPAN margining is not sufficient. You need to have a set of risk management tools, historical data and forecasting techniques that you need to start using. Tom McMahon: If you look at the G20 model should the CCP look like the US Dodd/Frank model which are the most mature but they don’t exist in Asia. There is the possibility of fragmented CCPs. Hong Kong Exchange has a long history of building a robust clearing structure alongside the mature exchange that is one thing. Japan has no history of clearing OTC and suddenly they are going to have a rate swap model or Korea wants one because Japan has one or Singapore wants one. Potentially, you have fragmented the market on just one product. The industry, not the clearing industry, not the exchange industry or the regulatory industry but the industry that are the drivers of these trades are already trying to figure out how to create a unified force in Asia. The CCP that is going to finally show up is going to be integrated with the big banks and not necessarily with HKMA or other local authorities.
Asia Etrading: One of the key concepts that will define the scope OTC policies will be the term “OTC derivatives trading”. How would you define the term and what parts of the definition should be carefully worded? Tom McMahon: The word derivative is an ill-defined term in itself and that has caused more of a problem than anything else relative to the regulatory frameworks that are being adopted. Going back to the MAS paper [Regulatory Oversight of Over-the Counter Derivatives Market], MAS does not mandate trading they mandate reporting and clearing. In the US and Europe they are talking about reforming all three but Singapore is just talking about reporting and clearing. The MAS paper was very definitive identifying 5 categories where in the West it has been more ill-defined. This is where you have problems defining a derivative and what is a derivative versus what is a commodity. I am not sure anyone knows how to define a derivative. If we look at distinct products like a rates swap these can easily be defined. If you look at energy, however, such as Light Brent Crude or Natural Gas you have thousands of contracts that have derived from those underlyings which are on exchange. Now you have products which have never been on an exchange or cleared that have sat on bank books and there will ultimately be a discovery process on what is a derivative.
Tom James: Clearly, the focus has to be on the term derivative as the term OTC starts to get murky. If you talk to people in China there is no domestic OTC market. It’s likely that that market will just jump straight to electronic trading and central clearing; skipping voice broking entirely preferring risk management and control of these products. The focus is on derivatives and we certainly have to define swaps, options and other standardized contracts. The problem is if you don’t define enough you have problems and if you define too much you are going to have problems. It’s never going to be a perfect world. It’s possible to force some products that people actually do want to clear out of the market ending up with unbalanced books and with more risk than you started with. Lawrence Law: I have been focusing on the term trading because in any type of regulatory framework I like to break it down to who, what, when and why. Not everything that is traded will be regulated so you will have some exempt participants, exempt asset classes and certain transactions will not be subject to clearing or reporting. The piece that is really interesting is the where. In the Singapore context the MAS paper talks about booked in Singapore with some element of presence with an antiavoidance provision attached to it. The only piece that comes with any clarity is the when which is by the end of the year.
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Cover story 2
Asia Etrading: Should trading of standardized OTC derivatives on exchange or electronic trading platforms be made mandatory? Jennifer Ilkiw: There are two different ways to answer that. Obviously from an exchange and clearing house standpoint, while making clearing mandatory would be a good thing because we that is an endorsement of the business model, we’ve also been careful to say that it’s not a panacea or the answer to every problem. From a practical perspective, there are a number of considerations around customer impact that should be considered. For example, some of the physical energy houses simply do not have the cash to post margin collateral to clear all contracts. Making clearing mandatory does not necessarily make sense for all of our clients and for all contracts. Tom McMahon: The concept that all things have to be cleared is outside the universe of a lot of people. You are seeing a rolling back whether it’s the extremes of the Volker Rule or Dodd-Frank and EMIR [European Market Infrastructure Regulation] that all things can’t be cleared. The key to this is not clearing but marginability. Even non-cleared trades have to get margined and that is the bigger question going forward. What doesn’t get pulled into the cleared space by demand is all going to get pulled in under BASEL III in the margin space. You have a two-tier system that you have got to look at. All things are going to get margined but not all things are going to get cleared but a lot more things are going to get cleared than they did in the past. What’s ultimately going to get cleared is going to come from margin efficiencies. Whoever has a clearing
house has an opportunity to create efficiency of marginability. A non-cleared trade that has to be margined and be marked-to-market in some way is going to be margined somewhere between fourteen and seventeen percent. There will be a few products that will be lower but they will mostly be margined in the high end which are all higher than traditional clearing houses. This will create a second tier of people who want to clear with the lower margin clearing house rather than pay higher margin for non-cleared trades. There is a lot more to this than just being a derivative. Lawrence Law: When clearing was introduced as a cure-all for a lot of the ills of 2008 and 2009 what people failed to realize is that clearing is about the substitution of risk. You take counterparty risk and move it on to an exchange but behind this is the thinking that an exchange is only as strong as its weakest member. This is something that we all have to come to grips with recently. IOSCO published a paper [Requirements for Mandatory Clearing] about access to clearing houses and it looks like the industry is thinking that if a member is taking risk to a clearing house but they are willing to put sufficient margin to cover more than 90% of that risk then maybe that is not so bad after all. That is a good place to do business. We have moved away from membership concerns to focus on margin concerns. Tom James: The question about mandatory reporting of OTC should be addressed. Most firms in the commodity industry are ok with reporting because most corporates have to report derivatives trading in their accounting anyway. Some of the corporates came out and said if you make us clear everything then
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we are going to have raise several billion in capital to cover the margin calls. This is the biggest concern for corporates. You have to ask what is the goal of reporting? Is it to disclose what a firm has on its books? You can do that through the accounting and shareholder reports. Is the report because you want to have a safer market and remove counterparty risk by making entities clear? The problem for the commodity space is you can clear your futures and clear your swaps but you can’t clear your physical. Unless your bankers are willing to tie up financing with hedging and margin calls with the physical business you can find yourself making money on your physical business but losing money through margin and clearing your derivatives. As we saw in 2008 with the volatility in commodities, producers with oil fields were going bust even though they were making money in the oil fields they couldn’t get the margin to the exchange in time. You have to be careful when you are forcing people to clear to make certain other areas are considered. Asia Etrading: What form should a central clearing party take, the DTCC model or the competitive European model? Tom McMahon: Not all clearing houses are CCPs. There is even a misnomer in the clearing house architectures. Counterparty risk doesn’t get lifted at all clearinghouses and that’s actually more of a problem in Asia than anywhere else. Lawrence Law: Which is the model in India. CCIL [Clearing Corporation of India] doesn’t take the risk and acts as a pass-through facility. And Shanghai as well.
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cover story 2
Tom James: We should look at models that have been tested and survived brokers and big clients having gone bankrupt. In the 90s we had Drexel Burnham Lambert where the clearing houses got together and transferred positions to other brokers, then we had Enron and, of course, more recently MF Global. There is historical proof that certain models keep the market orderly. Jennifer Ilkiw: When we managed the MF Global collapse here in Asia we had several clients affected by the bankruptcy. Trading continued, markets were orderly and counterparties to the trade were unaware of the processes and operations occurring to manage the default. It was a seamless process for them. That is what a central clearing house does; it makes sure the counterparty risk is almost eliminated. During the bankruptcy we had a Gasoil contract that was approaching delivery and as such, we had to liquidate those contracts. The reason for liquidating those positions was for the protection of market participants, clearing members and the clearing house itself. Tom McMahon: The roadmap to CCP efficiencies in derivatives and commodities was written back in 2001 with the collapse of Enron. The reason that ICE exists is because of the collapse and the success of the clearing markets that were setup – ICE Clear and ultimately ClearPort. Enron collapsed against multiple exchanges as well as itself and didn’t take down any exchanges or clearing houses. The last time a clearing house failed in the world was in Hong Kong in 1987. As a result, the HKEx has built a robust clearing infrastructure. Clearing houses have survived Enron, Refco, MF Global,
Lehman, Bear Sterns and numerous other small failures and no major clearing house has failed. Suddenly, the derivatives world has become the bad boy for the regulators when in reality that is not the part of the system that failed. It was the banking system that failed. When we started first selling OTC Clearing in Singapore we had a lot of doors slammed in our face. But the business has done nothing but go straight up in terms of the viability out here. The integrity of the banks has improved in the cleared space and are now offering more leverage than three or four to one. There is a healthy roadmap for taking noncleared and non-margined products and putting them into the cleared space. It does work.
two, what was AIGs exposure. Out of that you had Dodd-Frank and its no surprise that the two main pillars from it were clearing and reporting. Asia Etrading: Is there an opportunity for Asia or Singapore to take advantage of some of the OTC policies that are being formed in the West?
Tom McMahon: No one should be afraid of this happening and the reality is it works. Is it costly in the beginning, yes. Once you go through the process and after the first year of cost your business will actually grow. It is proven that it grows. It is a painful exercise but a valid exercise. Ultimately, what products are subject to clearing is going to be trimmed down. There is a fundamental shift underway.
Tom McMahon: Any regulatory arbitrage has been completely taken off the table. There is no where to hide anymore. I think the difference is that Asia is the area of the world where these economies have been growing rapidly over the years and that is a luxury. If you are looking for a growing pool of liquidity we are in the middle of it. There is a natural liquidity pool in Asia there is just no central location for that liquidity pool. How do you amalgamate that? The regulatory affect will amalgamate it and that’s where I think the opportunity is. The unification of western regulations coming to Asia and the adaption of it where the G20 becomes the super regulator is going to cause an evening out process. The difference is do you create three liquidity pools? There are two liquidity pools now, North America and Europe where Asia is mostly tied into Europe. Does Asia stand alone? Can Asia finally work together? The regulations coming from the West and how they are adopted in Asia will determine that.
Lawrence Law: There is a good story I heard from my US colleagues about the week after Fannie Mae and Freddie Mac had gone under and Lehman, Merrill and AIG were about to go under. There were two questions that the US Federal Reserve were asking themselves. One was what would Lehman bring down with it and
Lawrence Law: The straight answer is no. If you look at the different countries in Asia where you may have an opportunity for a few years, those are the countries that lack regulation and are the countries where you don’t want to do business. I just don’t see that as an advantage.
Tom James: For the other financial markets, commodities have been pushing further than CDSs or interest rates because commodities have never had the luxury of lots of investment grade companies to deal with. Credit risk has always been a big issue.
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Cover story 2
Jennifer Ilkiw: We have a long way to go in Asia. When I came here I thought China would open up in five years and that was ten years ago. Between Indonesia and China and India I don’t think the opportunity is going to materialize in the very near term, but we have been seeing a more gradual impact. What has been established in the West is really where the regulatory standards are originating, though as you’ve seen with the proposal from MAS, we are going to be very thoughtful in our own approach to markets reform. Clearing may also be focused in the West, except for Asian based products and local exchanges such as HKEx and SGX, though certainly you can’t rule out participation by Western exchanges on some level due to their experience with clearing. Tom McMahon: The other side of that is that there is one entity that is completely across Asia and there is no regulator that is completely across Asia and that is the banks. If you look at BASEL III it says those banks have to margin and clear. It doesn’t matter what China says or the Philippines or Indonesia says. When an Indonesian coal exporter that is backed by a European bank and a Chinese power company who is going to use that coal with an American bank funding them that is a trade and it has to be reported, margined and cleared. It won’t be the regulators it will be the banks who will level the playing field. Tom James: From what I am seeing from funds moving from London to Singapore it hasn’t been due to regulatory arbitrage it’s the tax arbitrage. Asia Etrading: The MAS proposes an application process for new OTC derivatives does this make sense or will it slow down trading too much?
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Lawrence Law: It goes down to the debate of whether the regulatory process should be top down or bottom up. If the regulator says this is how you are going to trade and these are the product you are going to clear the argument is that the regulator doesn’t know what is best for the market. If you let CCPs who have a vested interest to say we can to clear this product and apply to the regulator for approval then that product becomes mandatory. The other side is what does the market want to clear and how does that feed into the whole process? There has to be some interaction between the CCP, the market participants and the regulator to come to some kind of consensus. It can’t be just a simple application process.
“When an Indonesian
Tom James: The risk is that the regulator could be in a rush to keep up with G20 and the other global policies and say everything has to be cleared tomorrow. As Jennifer said, the investment in infrastructure from Excel spreadsheets to a more robust risk and reporting process takes time. From the industry perspective it’s much better if the clearing houses and the exchanges work with industry to find out what can be cleared and what is best to be cleared and how to go about it in an orderly fashion.
bank funding them that
Jennifer Ilkiw: It would also depend on how the MAS is looking at approving certain contracts. When ICE launches a new futures contract for participants in Singapore to trade we have to apply to the MAS first. It takes around seven days so it’s not onerous. If it’s a set process for listing OTC products then I don’t think it will be a big issue.
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coal exporter that is backed by a European bank and a Chinese power company who is going to use that coal with an American
is a trade and it has to be reported, margined and cleared.”
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Opinion & Analysis
High Frequency Trading And Market Efficiency
S
tock exchanges are not static institutions; rather, they constitute a constantly adapting and evolving network of financial innovation. Over the years, revolutions in trading have been caused by a range of factors, including financial innovation, changes in markets and regulation, education and wider participation in markets, as well as advances in communication and technology. Several – if not all – of these factors are combined in the latest revolutionary force, high frequency trading (HFT), which by most estimates now comprises the majority of trading on the world’s major exchanges (e.g., Schapiro, 2010). Commentary and study of its causes and effects are now prevalent, and the phenomenon has led to proposed regulation and legislation. What should guide all such debate is an understanding of the benefits and costs of HFT, in particular its effect on market efficiency.
“Overnight” Change, 40 Years in the Making Technological change can appear to the general public as an overnight revolution but in actuality stem from years of intense, behind-thescenes development. For instance, widespread awareness and adoption of the Internet began in the 1990s, though its roots lay in the early 1960s and the creation of ARPANET, which itself built on years of earlier progress. In similar retrospect, calls for electronic exchanges can be traced back at least to the early 1970s: “[A] stock exchange can be embodied in a network of computers, and the costs of trading can be sharply reduced, without introducing any additional instability in stock prices, and without being unfair either to small investors or large investors” (Black, 1971). Financial theory has developed simultaneously with changes in markets. Theoretical work on nonsynchronous trading (e.g., Lo & MacKinlay, 1990; Miller, Muthuswamy, & Whaley, 1994; Scholes & Williams, 1977) serves as the intellectual foundation for HFT. More work is needed on formal theories, since traditional ideas such as Modern Portfolio Theory (Markowitz, 1952) are horizon specific. On the practical side, program trading was another step in the transition to computer-
based trading, along with the first ECNs in the late 1990s and later the decimalization of prices on the major exchanges. Hardware improvements, algorithmic breakthroughs, and creative competition all factored into the recent boom in HFT. Viewed in the proper context, HFT is an extension of decades of theoretical advances and market evolution.
Effects on Markets The term efficiency carries a significant semantic load in finance research, but its primary meaning here is the swift incorporation of information into prices. In this sense, there is strong evidence that HFT improves efficiency. Statistically, prices exhibit less mean reversion (Castura, et al., 2010) and more closely resemble a random walk (O’Hara & Ye, 2011), both implying greater market efficiency. Parallels exist in other disciplines: voice recognition, robotics, data storage, drug design, and GPS all have become incredibly more efficient at informational tasks, thanks to development in computing power. HFT is the financial analogue of these advances. Another metric of a market’s efficiency is the cost of transactions. The inverse relationship between trading frequency and price spreads is well established (beginning with Demsetz, 1968), in part because the higher liquidity lowers the inventory risk for a market maker. Empirically, this appears to be true, given that HFT has to a great extent supplanted the NYSE specialist. Quoted spreads have also narrowed in recent years. However, there is an important caveat that effective spreads have apparently widened in some cases, which may be due to high frequency traders managing to front-run orders through interpositioning algorithms (Hendershott, Jones, & Menkveld, 2011). Similarly, some long-term institutional investors have complained that HFT has increased transaction costs (Arnuk & Saluzzi, 2008, 2009). Proponents of HFT tout its improvements in liquidity, and there is unequivocal evidence that trading volume has grown tremendously in recent years. However, volume remains only one aspect of the multi-faceted construct of liquidity -- which is also a function of market breadth, depth, and resilience. Furthermore,
there is concern that HFT faces no affirmative obligation to trade and could withdraw liquidity in turbulent markets. HFT obviously improves some measures of liquidity in some periods, the ongoing question (still in the relatively early stages of understanding) is the overall impact on market liquidity. Similarly, the effect of HFT on market volatility remains controversial. Zhang (2010) argues that HFT increases volatility, while other studies suggest that it may dampen volatility (e.g., Chaboud, Chiquoine, Hjalmarsson, & Vega, 2009; Hendershott & Riordan, 2011). The diversity of HFT strategies suggests that some algorithms might dampen while others exacerbate volatility. This is an important area for further research. Order flow can be affected dramatically by algorithmic strategizing in computer systems. Predictably, the price competition rules of Reg NMS have allowed a proliferation of trading venues and competition, so that as much as 30% of all equity volume now takes place away from the traditional exchange (O’Hara & Ye, 2011). The question for the field of finance is whether market fragmentation due to HFT damages markets. In their analysis of trade reporting facility data, O’Hara and Ye (2011) conclude that fragmentation reduces transaction costs, increases execution speed, and generally improves market efficiency. The informational linkages through monitoring and arbitrage appear to be sufficient to overcome any feared problems due to the fragmentation of order flow. Computer algorithms are capable of monitoring, searching, and implementing trades across a range of venues that far exceeds the capability of a human trader. Thus, further development in computer science can only improve algorithms, power, speed, and market efficiency. HFT algorithms attempt to rebundle and route orders for optimal execution, which is an issue akin to the NP-complete problem of bin-packing, a cutting-edge question and momentous challenge for computer scientists. True market efficiency will thus become possible only if it can be demonstrated that P = NP (Maymin, 2011) so that such complex algorithms can be conducted in polynomial time. Financial theorists should monitor and participate in this
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Opinion & Analysis
vital question at the intersection of mathematics and computer science.
Regulatory Challenge and Public Perception A major challenge of HFT is regulatory concern for the maintenance of fair and orderly markets. Order entry errors and other potential glitches in automatic execution raise fears of potential market problems such as the “Flash Crash” of May 6, 2010. There are suspicions of an unfair advantage for some market players, such as flashing orders, a practice that allows some participants to trade on order book information before it is publicly disseminated. Other questionable activities include spoofing and co-locating, representing methods that traders can utilize to game the system or gain an unfair advantage. The trading that arises from these behaviors has earned the moniker toxic order flow. The goal of responsible regulation must be to minimize the use of manipulative games and unfair informational advantages, without squelching the benefits of HFT. But regulating and monitoring HFT will be difficult in light of the sheer volume and pace of trading as well as the proprietary nature of trading algorithms. As a final consideration, the financial community must take into account the public perception of HFT. It is human nature to fear that which one does not understand. Just as areas labeled terra incognita on Medieval maps were often illustrated with fantastical beasts, HFT lays beyond the ken of the average investor and is thus sometimes imagined to be confusing and dangerous, even a rigged game. This perception might lead investors to withhold or withdraw funds, thereby damaging markets. An important parallel exists in theories of insider trading, which have demonstrated both that legalized insider trading can aid informational efficiency (Leland, 1992) and that lack of public confidence can lead to market breakdown (Bhattacharya & Spiegel, 1991). Public perception should be of vital concern to financial academics and practitioners because a populist outcry can lead government and regulators to “do something” rather than take thoughtful and reasoned measures. Furthermore, education will be necessary, though likely not sufficient, to maintain fair and orderly markets. Thorough research, appropriate regulation, and clear communication can simultaneously calm fears and improve markets.
Conclusion This is a time of great change in global financial markets. Markets are simultaneously
more fragmented and closely tied together, as high-frequency algorithmic trading allows competition for order flow but also creates more linkages through global arbitrage. These changes are irreversible. Indeed, they represent an ongoing evolutionary process of market development. Properly handled, HFT should improve market efficiency and provide a range of other benefits for market participants by encouraging immense creativity and technology adoption, attenuating risk exposure (thanks to short holding periods), and providing significant profits. Computers are tools that simply enact perfectly logical principles, according to their programming. The future will show how market participants are able to use such technology to improve market functioning and efficiency.
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Econometrics, 45, 181 – 211. Markowitz, H. (1952). Portfolio selection. Journal of Finance, 7, 77 – 91. Maymin, P. (2011). Markets are efficient if and only if P = NP. Algorithmic Finance, 1, 1 – 11. Miller, M., Muthuswamy, J., & Whaley, R. (1994). Mean reversion of Standard & Poor’s 500 Index basis changes: Arbitrage-induced or statistical behavior. Journal of Finance, 49, 479 – 513. O’Hara, M., & Ye, M. (2011). Is market fragmentation harming market quality? Journal of Financial Economics, 100, 459 – 474. Schapiro, M. (2010). Testimony concerning the severe market disruption on May 6, 2010. Congressional testimony. Scholes, M., & Williams, J. (1977). Estimating betas from nonsynchronous data. Journal of Financial Economics, 5, 309 – 327.
*Correspondence concerning this article should be addressed to Jayaram Muthuswamy, Kent State University, College of Business Administration, Department of Finance, P.O. Box 5190, Kent, Ohio 44242. Phone: (330) 672 – 2426. Fax: (330) 672 – 9806.
References Arnuk, S., & Saluzzi, J. (2008). Toxic equity trading order flow on Wall Street: The real force behind the explosion in volume and volatility. White Paper, Themis Trading, LLC. Arnuk, S., & Saluzzi, J. (2009). Why institutional investors should be concerned about high frequency traders. White Paper, Themis Trading, LLC. Bhattacharya, U., & Spiegel, M. (1991). Insiders, outsiders, and market breakdowns. Review of Financial Studies, 4, 255 – 282. Black, F. (1971). Toward a fully automated exchange. Financial Analysts Journal, 27, 29 – 35 & 86 – 87.
Dr. Muthuswamy Dr. Muthuswamy holds a PhD in Finance from the University of Chicago, an MS in Statistics from Stanford University, an MBA in Finance from Wharton, and a bachelor’s degree from the London School of Economics. His research interests are in the pricing of derivatives, asset price equilibrium, financial econometrics, and high-frequency hedge fund trading strategies.
Castura, J., Litzenberger, R., Gorelick, R., & Dwivedi, Y. (2010). Market efficiency and microstructure evolution in U.S. equity markets: A high-frequency perspective. Working paper (RGM Advisors). Chaboud, A., Chiquoine, B., Hjalmarsson, E., & Vega, C. (2009). Rise of the machines: Algorithmic trading in the foreign exchange market. Technical report, FRB International Finance Discussion Paper No. 980. Demsetz, H. (1968). The cost of transacting. Quarterly Journal of Economics, 82, 33 – 53. Hendershott, T., Jones, C., & Menkveld, A. (2011). Does algorithmic trading improve liquidity? Journal of Finance, 66, 1 – 33. Hendershott, T., & Riordan, R. (2011). Algorithmic trading and information. Working paper. Leland, H. (1992). Insider trading: Should it be prohibited? Journal of Political Economy, 100, 859 – 887. Lo, A., & MacKinlay, A. (1990). An econometric analysis of nonsynchronous trading. Journal of
www.asiaetrading.com z Q2 2012 z Asia Etrader
Thomas A. Hanson Thomas A. Hanson is a Ph.D. candidate at Kent State University. His research interests include high frequency trading and market microstructure. He previously worked as a risk analyst for the corporate actions desk at Piper Jaffray in Minneapolis, MN, and holds an MBA from the University of St. Thomas (St. Paul, MN) and an MS in statistics from North Dakota State University.
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Buy-Side
QFII Name
Date
Quota
AUBS AG 23/05/2003 790 Nomura Securities Co. 23/05/2003 350 Morgan Stanley & Co. International Limited 05/06/2003 400 Citigroup Global Markets Limited 05/06/2003 550 Goldman 04/07/2003 300 Deutsche Bank Aktiengesellschaft 30/07/2003 400 The Hongkong and Shanghai Banking Corporation 04/08/2003 400 ING Bank N.V. 10/09/2003 400 JPMorgan Chase Bank 30/09/2003 150 Credit Suisse (HongKong) Limited 24/10/2003 500 Standard Chartered Bank (HongKong) Limited 11/12/2003 75 Nikko Asset Management Co. 11/12/2003 450 Merrill Lynch International 30/04/2004 300 Hang Seng Bank Limited 10/05/2004 100 Daiwa Securities Capital Markets Co. 10/05/2004 50 Lehman Brothers International (Europe) 06/07/2004 200 Bill & Melinda Gates Foundation 19/07/2004 300 INVESCO Asset Management Limited 04/08/2004 350 The Royal Bank of Scotland N.V. 02/09/2004 175 Société Générale 02/09/2004 50 Barclays Bank PLC 15/09/2004 400 Commerzbank AG 27/09/2004 75 Fortis Bank NV-SA 29/09/2004 500 BNP Paribas 29/09/2004 200 Power Corporation of Canada 15/10/2004 50 Credit Agrigole Corporate and Investment Bank 15/10/2004 75 Goldman Sachs Asset Management International 09/05/2005 500 Martin Currie Investment Management Ltd 25/10/2005 120 Government of Singapore Investment Corporation 25/10/2005 400 PineBridge Investment LLC 14/11/2005 150 Temasek Fullerton Alpha Investments Pte Ltd 15/11/2005 300 JF Asset Management Limited 28/12/2005 375 The Dai-ichi Life Insurance Company Limited 28/12/2005 200 DBS Bank Ltd 13/02/2006 100 AMP Capital Investors Limited 10/04/2006 300 The Bank of Nova Scotia 10/04/2006 150 KBC Financial Products UK Limited 10/04/2006 20 La Compagnie Financierr Edmond de Rothschild 10/04/2006 200 Yale University 14/04/2006 150 Morgan Stanley Investment Management Inc. 07/07/2006 450 Prudential Asset Management (Hongkong) Limited 07/07/2006 300 Stanford University 05/08/2006 100 GE Asset Management Incorporated 05/08/2006 350 United Overseas Bank Limited 05/08/2006 50 Schroder Investment Mangement Limited 29/08/2006 300 HSBC Global Asset Management (Hong Kong) Limited 05/09/2006 450 Mizuho Securities Co. 05/09/2006 50 UBS Global Asset Management (Singapore) Ltd 25/09/2006 250 Sumitomo Mitsui Asset Management Company 25/09/2006 350 Norges Bank 24/10/2006 700 Pictet Asset Management Limited 25/10/2006 100 The Trustees of Columbia University NYC 12/03/2008 100 Prudential Asset Management Co. 07/04/2008 75 Robeco Institutional Asset management B.V. 05/05/2008 150 State Street Global Advisors Asia Limited 16/05/2008 50 Platinum Investment Company Limited 02/06/2008 150 KBC Asset Management N.V. 02/06/2008 210 Mirae Asset Global Investments Co. 25/07/2008 250 ACE INA International Holdings 05/08/2008 150 Caisse de dép?t et placement du Québec 22/08/2008 200 President and Fellows of Harvard College 22/08/2008 200 Samsung Investment Trust Management Co. 25/08/2008 300 AllianceBernstein Limited 28/08/2008 150 Oversea-Chinese Banking Corporation Limited 28/08/2008 150 First State Investment Management (UK) Limited 11/09/2008 120 DAIWA Asset Management Co. 11/09/2008 200 Shell Asset Management Company B.V. 12/09/2008 0 T. Rowe Price International 12/09/2008 110 Credit Suisse AG 14/10/2008 300 UOB Asset Management Ltd 28/11/2008 50 ABU Dhabi Investment Authority 03/12/2008 200 Allianz Global Investors Luxembourg S.A. 16/12/2008 100 Capital International 18/12/2008 100 Mitsubishi UFJ Morgan Stanley Securities Co. 29/12/2008 100
QFII Name
Date
Quota
Hanwha Investment Trust Management Co. Emerging Markets Management DWS Investment S.A. The Korea Development Bank Woori Bank Co. Bank Negara Malaysia Lloyd George Management (Hong Kong) Limited Templeton Investment Counsel BEA Union Investment Management Limited The Sumitomo Trust & Banking Co. Korea Investment Trust Management Co. Baring Asset Management Limited Ashmore Investment Management Limited BNY Mellon Asset Management International Manulife Asset Management (Hong Kong) Limited Nomura Asset Management CO. Tongyang Asset Management Corp. Royal Bank of Canada Aviva Investors Global Services Limited Ivy Investment Management Company DIAM Co. OFI Asset Management Aberdeen Asset Management Asia Limited KB Asset Management Co. Fidelity Investments Management (Hong Kong) Legg Mason Investements (Europe) Limited Hong Kong Monetary Authority Fubon Securities Investment Trust Co. Ltd. Capital Securities Investment Trust Corporation BMO Investments Inc. Bank Julius Bear & Co. KTB Asset Management Co. Lyxor Asset Management Polaris International Securities Investment Co. Assicurazioni Generali S.p.A. Banco Bilbao Vizcaya Argentaria Cathay Securities Investment Trust Co. Fuh Hwa Securities Investment Trust Co. Ltd. Comgest S.A. Amundi Hong Kong Limited BlackRock Institutional Trust Company Grantham Monetary Authority of Singapore China Life Insurance Co. Shin Kong Life Insurance Co. Princeton University Shinko Asset Management Co. Canada Pension Plan Investment Board Van Eck Associates Corporation Hansberger Global Investors EARNEST Partners LLC Bank of Thailand Kuwait Investment Authority Northern Trust Global Investments Limited Taiwan Life Insurance Co. The Bank of Korea Ontario Teachers’ Pension Plan Board Korea Investment Corporation Russell Investments Ireland Limited Metzler Asset Management GmbH HI Asset Management Co. Shinhan BNP Paribas Asset Management Co. Stichting Pensioenfonds voor Huisartsen National Pension Service Mercuries Life Insurance Co Prudential Financial Securities Investment Trust Principal Global Investors LLC Hospital Authority Provident Fund Scheme TransGlobe Life Insurance Inc. Public Mutual Berhad Meiji Yasuda Asset Management Company Ltd. Cathay Life Insurance Co. Sumitomo Mitsui Banking Corporation
05/02/2009 70 10/02/2009 50 24/02/2009 200 23/04/2009 100 04/05/2009 50 19/05/2009 200 27/05/2009 50 05/06/2009 200 18/06/2009 100 26/06/2009 50 21/07/2009 100 06/08/2009 200 14/09/2009 200 06/11/2009 150 20/11/2009 200 23/11/2009 200 11/12/2009 100 23/12/2009 100 28/12/2009 100 08/02/2010 100 20/04/2010 100 21/05/2010 150 06/07/2010 200 09/08/2010 100 01/09/2010 150 08/10/2010 100 27/10/2010 300 29/10/2010 100 29/10/2010 100 06/12/2010 100 2/14/2010 100 28/12/2010 100 16/02/2011 100 04/03/2011 100 18/03/2011 100 06/05/2011 100 09/06/2011 100 6/9/2011 100 24/06/2011 100 14/07/2011 100 14/07/2011 N/A 09/08/2011 100 08/10/2011 100 26/10/2011 100 26/10/2011 100 25/11/2011 50 25/11/2011 100 09/12/2011 100 09/12/2011 N/A 13/12/2011 N/A 13/12/2011 N/A 16/12/2011 300 21/12/2011 300 21/12/2011 N/A 21/12/2011 100 21/12/2011 300 22/12/2011 100 28/12/2011 200 28/12/2011 N/A 31/12/2011 N/A 31/12/2011 N/A 05/01/2012 100 05/01/2012 60 05/01/2012 100 30/01/2012 N/A 31/01/2012 N/A 31/01/2012 N/A 31/01/2012 N/A 03/02/2012 N/A 03/02/2012 N/A 2/27/2012 N/A 28/02/2012 N/A 28/02/2012 N/A
Asia Etrader z Q2 2012 z www.asiaetrading.com
Buy-Side
19
QFII Update
T
he QFII (Qualified Foreign Institutional Investor) quota received a much needed and long overdue boost on April 3 when the China Securities Regulatory Commission (CSRC) announced it was increasing the quota from US30 billion to US80 billion. While the amount is still quite small, overall, it signals a continued shift in the willingness of the CSRC to continue to open up China’s capital markets. In another sign, in March, 15 firms were granted a record US2.1 billion in just one month when in the whole of 2011 just US1.9 billion was granted. According to our list below US24.6 billion of the quota has been granted so far accounting for around 1.1 percent of the total market capitalization of domestic A-share market according to a note issued by the regulator. Granting of quota is the function of State Administration of the Foreign Exchange (SAFE). While the measures do promote the internationalization of the renminibi (RMB) we believe the move by the CSRC is to prop
up the flagging stock market in China. The Shanghai Composite Index (SHCOMP) of domestic stocks has lost more than 60 percent from its peak in 2007. While the economy is expected to have grown at 8.4% in the first quarter the government is trying to drive growth in its export oriented economy. The central government has also committed to freeing up control of the Yuan and liberalize interest rates in its further attempts to deepen reform and to revive growth. Under the QFII scheme, which was launched in 2003, it allows foreign investors to buy Chinese stocks and bonds. The CSRC extended the acceptable assets to include the CSI 300 index future but that hasn’t appeared to materialize to date. Qualified institutions include foreign banks, securities firms, asset managers, insurance companies, pension funds, charity funds and sovereign funds. To take part in the QFII program, eligible firms must first convert foreign currency to RMB before placing the funds with a custodian. Profits from the investments must then be
converted back to another foreign currency before being repatriated out of the country. Taking foreign money out of China has proven difficult and is subject to restrictions.
RQFII Rules The Renminbi Qualified Foreign Institutional Investors rules were announced 16 December 2011 jointly by CSRC, SAFE and the People’s Bank of China. The RQFII Rules permit Hong Kong subsidiaries of qualified Chinese fund management and securities companies to use funds raised in RMB in Hong Kong to invest in mainland securities. The Hong Kong subsidiaries are required to satisfy certain conditions in order to qualify for a quota under the RQFII scheme. The initial quota was set at US 3 billion. Besides being allowed to invest in the same asset classes as the QFII access to China IPOs will be granted. There is a restriction that at least 80% of funds must be invested in fixed income products giving a boost to the debt market.
The Cost Of Central Clearing
A
lthough the details of OTC clearing regimes in the Asian markets are still developing, there will clearly be a cost for buy-side firms, as they migrate from typically bilateral arrangements to a centrally-cleared framework. Inherent to their risk management function, central counterparties (CCPs) are likely to be more conservative than the firms who have traditionally been bilateral counterparties, so potentially they may increase margin costs. There is also a risk that operational complexity will increase as multiple credit and operational agreements are required to help firms deal with numerous CCPs, brokers and bank counterparties. This may counter the benefits of consolidated margining and increase the impact of the regulation on liquidity. The assets that CCPs usually accept as collateral for margining are cash for the variation margin and assets perceived as low risk, but highly liquid, for the initial margin. Typically this would be government bonds, however the recently shifting credit ratings of western governments may have reduced the
pool of what is acceptable. The challenge for long-only investment funds in particular is two-fold. Firstly getting hold of the right assets to use for margining is costly and reduces the size of the investible assets pool. It hurts investment funds more than other types of market participants as they have a tendency to focus on single asset types with restrictive mandates. That gives them less access to either bonds or cash, which they do not hold in large amounts as they try to invest it for better returns. They are also unable to put either bonds or cash to any other use, something that a hedge fund with a broader mandate may not find. The second challenge for them is that they only invest in one direction. That removes their ability to net off the margins that need to be posted, something that sell-side firms will not be troubled by. In that sense the costs of posting margin will hit long-only buy-side firms hardest. In addition to long-only asset managers, commercial businesses that use derivatives markets for hedging, for example airlines that
www.asiaetrading.com z Q2 2012 z Asia Etrader
use derivatives to hedge against movements in fuel prices can also be punished. Effectively they face a shift in the risk they have to deal with; counterparty risk is removed by the central counterparty, but the requirement to post margin on a daily basis requires them to seek out collateral, a function that is far removed from their core business and increasing liquidity risk. Many regulators in the region are keen to push for central clearing for all asset classes, and standardisation of products to facilitate clearing. However there are still rules to be drawn up to determine factors such as acceptable collateral, where it will be held and the degree to which the collateral will have to match up with the CCPs imposed clearing requirements. There is ostensibly a benefit to the central clearing model of course; it will reduce counterparty risk. However buy-side firms will understandably look back at the financial crisis of 2008 and ask at what point their investment in derivatives were a problem. If they were not, they may ask, why are they now paying so heavily for them?
20
derivatives
In Case Of Default, Break Glass Investment firms must move beyond the pain that MF Global caused and make sure they are not left exposed again, says Dan Barnes
I
t is easy to stop reading at the headline that MF Global client money went missing. It is an unfortunate truth that even wellrespected financial firms have been fined for breaking the rules and segregation has been an issue for many. Buy-side firms have to mitigate against the risks involved in a default of its biggest counterparties. MF Global’s bankruptcy case demonstrated the precarious balance between risk and reward that some buy-side firms expose themselves to with their brokers, or in many cases, broker. It also highlighted the financial pressures that are bearing down on clearing brokers just as clearing becomes more important to the wider futures business. The bankruptcy, on 31 October 2011, followed an investment by the futures commission merchant (FCM) in European government bonds, a position which was revealed in regulatory filings on 20 May 2011 to be valued at over US$6 billion. On 25 October 2011, the
firm reported its bond trading had lost it $191.6 million in the previous quarter. Jon Corzine, the CEO, initiated the strategy of proprietary trading when he joined the firm in 2010, as he sought to take the firm from the role of broker-dealer into the business of investment banking. Previously the firm had made money from interest paid on margin that its clients deposited. “MF Global got into proprietary trading because they were having a hard time making a profit from commissions and interest on customer balances, as rates are nearly flat,” says Gary DeWaal, general counsel at futures commission merchant, Newedge. Other firms have also been hurt by low interest rates; Penson, a US broker, shut its Asian operations in October and sold its Australian business in November facing similar challenges. It made cuts rather than increasing its risk exposure. DeWaal says, “The profitability pressures on the brokers that serve as the backbone for
the clearing system are so dramatic, that I am not sure the system can be supported by that backbone going forward.”
The multi-broker model Everything in this environment says that buyside firms must play safe. That means not putting all of your eggs in one basket. Matt Simon, senior analyst at TABB Group conducted research with 51 head traders at US buy-side firms at the end of 2011, and found that 40% of those surveyed only had one clearing relationship. “Similar to the Bear Stearns and Lehman Brothers, where people started multi-priming and setting up more relationships, we’re starting to hear larger asset managers and bigger hedge funds are looking at putting back-ups in place with more clearing counterparties,” he says. “It has made buy-side firms look toward diversification of their clearing brokers to make
Asia Etrader z Q2 2012 z www.asiaetrading.com
Derivatives
brokers,” he says. “If you can use technology to reduce the complexity you end up with a much safer overall model.” Although DeWaal concurs with Simon, in that the effect of MF Global will be to make that extra effort worthwhile for fund managers, he is less certain of the sustainability of that drive. “Our experience has been that you see that hard work done for the first few months after an incident and then you see commissions taking over as the dominant factor,” he adds. “They often forget the firms have to make money, they go to firms that charge the least commission and the rest is history.”
At what cost?
sure they have got more than one access point both for execution and for clearing,” says Paul Orchard, global head of OTC clearing at UBS. “More and more clients are concerned about the credit quality of their clearing relationship and they are looking for a framework that allows them to transfer positions to another clearer, in case there were any problems with their current provider.” Given the experience with both Lehman Brothers and Bear Stearns, it would seem reasonable to ask why the such back-ups were not already in place. “People have short memories,” says DeWaal. “Clients want to have most of their positions at one shop to benefit from cross margining opportunities. The problem is that it takes effort to break up your positions and figure out how you minimise your margin obligations across multiple brokers.” Increasing the number of clearing brokers does increase operational complexities, since it involves dealing with post-trade settlement and margin management across a number of different brokers. But Ted Leveroni, executive director of derivatives strategy and external relations at post-trade technology supplier Omgeo notes that there are a number of tools that can help. “We and other firms supply systems to standardise the post-trade messaging, matching allocations and so on, across multiple
Smaller firms may not command a great enough volume of business to interest multiple clearing brokers. If they are forced to use only one, they should monitor its health and be able to move at will. Clients should keep a close watch of counterparty’s performance once selected; MF Global’s weakness was observable in its falling share price from August 2011 onwards and in its final week, the downgrading of its credit rating. Even if firms have to limit their broker options and base their relationship on costs, using this knowledge can tell a broker’s clients when it is time to get out, says James Gellert, CEO of the Rapid Ratings rating agency. “Before you get into the issues of whether it was trading on its own account and whether it was doing something wrong, it was firm that was deteriorating for many years,” he observes. “Market participants had all of the information available to them to understand that there were risks involved.” The degree of attachment is also reflected in the use of sell-side technology by fund managers, warns Chris Carter, head of equity derivatives, Japan, at broker Nomura. “Switching broker is more than just moving the collateral across; it depends how tied in a firm is to an executing broker,” he says. “There are some systems that are supplied by brokers that allow you to execute through multiple brokers and other systems that are proprietary and have you tied in. If you have built architecture on top of a system supplied by a broker then you can’t switch that off and can’t plug and play something else then obviously that’s a problem.”
At the last If a broker is going to go bust, its clients should know what that means for them, assuming no funds have gone missing. There are fundamental differences in the customer protection environments in each country, and depending on where a firm is
www.asiaetrading.com z Q2 2012 z Asia Etrader
21
“It has made buyside firms look toward diversification of their clearing brokers to make sure they have got more than one access point both for execution and for clearing,” says Paul Orchard, global head of OTC, UBS.
located and how it trades, it should assess where it will stand the best chance in a default situation. The model used by the local clearing house will determine the portability of positions. This is crucial, says Orchard; if the clearing house uses a net margin model, position and margin portability is difficult to achieve as only the net margin requirement is held at the clearing house, the difference between the gross margin call and the net requirement being left at the clearer and its agent banks. “The gross margin model is a more favourable for end clients, in the event that you want to port positions and margins between clearers,” he notes. Understanding a country’s insolvency regime, and in many cases multiple insolvency regimes, will also be imperative. The regimes that offer segregation, such as Singapore and Australia, are more favourable. “Clients are assessing where it makes more sense to host their accounts,” says DeWaal. “Even where their business only has one broker, there may be some sense in having accounts at different locations, in order to be covered by the different insolvency jurisdictions directly, as opposed to indirectly.”
22
derivatives
Top 50 Futures Contracts in Asia Product
Volume
2011 QA*
Net
National Stock Exchange of India
US Dollar/Indian Rupee
138,416,873
173,727,289
-35,310,416 Currency
Multi Commodity Exchange Stock Exchange * US Dollar/Indian Rupee
134,559,286
NA
NA
Shanghai Futures Exchange *
Rubber
52,044,435 47,838,293 4,206,142 Commodity
Zhengzhou Commodity Exchange
Pure Terephthalic Acid (PTA)
39,317,946
56,310,119
-16,992,173 Commodity
Dalian Commodity Exchange
Linear Low Density Polyethylene (LLDPE)
38,364,802
47,280,041
-8,915,239 Commodity
Dalian Commodity Exchange
Soy Meal
32,744,240
24,916,807
7,827,433
Shanghai Futures Exchange *
Copper
32,106,057 21,216,658 10,889,399 Metal
Shanghai Futures Exchange *
Steel Rebar
30,432,579
37,517,064
-7,084,485 Metal
Zhengzhou Commodity Exchange
White Sugar
28,063,278
59,696,252
-31,632,974 Commodity
National Commodity & Derivatives Exchange
Light Sweet Crude
24,770,600
763,659
24,006,941
Energy
National Commodity & Derivatives Exchange
Ref Soya Oil
22,678,480
1,190,856
21,487,625
Agriculture
National Commodity & Derivatives Exchange
Soybeans
20,881,170 NA
NA
Agriculture
National Commodity & Derivatives Exchange
Chana
20,529,990 1,816,710
18,713,281 Agriculture
Dalian Commodity Exchange
Soy Oil
19,866,312
-9,038,805 Agriculture
Dalian Commodity Exchange
Corn
17,891,848 13,356,661 4,535,188 Agriculture
Multi Commodity Exchange
Silver Micro
14,760,348
11,463,684
3,296,664
Shanghai Futures Exchange *
Zinc Futures
14,737,548
25,293,087
-10,555,539 Metal
Korea Exchange
US Dollar
13,889,216
14,416,128
-526,912 Currency
Multi Commodity Exchange
Gold Petal
13,127,207
7,560,396
5,566,812
Metal
Zhengzhou Commodity Exchange
Strong Gluten Wheat
11,943,450
478,985
11,464,465
Agriculture
Multi Commodity Exchange
Crude Oil
10,848,042
13,555,297
-2,707,255 Energy
Australian Securities Exchange
3 Year Treasury Bond
10,424,619
9,867,599
557,020
Multi Commodity Exchange
Silver Mini
10,237,962
11,542,767
-1,304,805 Metal
National Commodity & Derivatives Exchange
Cotton Seed
10,116,240
NA
NA
Multi Commodity Exchange
Copper
9,095,915 8,420,042 675,874
Zhengzhou Commodity Exchange
Cotton No. 1
8,159,886
68,809,510
-60,649,624 Commodity
Dalian Commodity Exchange
No. 1 Soybeans
7,803,936
12,550,808
-4,746,872 Agriculture
Dalian Commodity Exchange
Palm Oil
7,507,430
11,255,691
-3,748,261 Agriculture
Multi Commodity Exchange
Gold Mini
5,963,119
6,438,994
-475,875 Metal
Multi Commodity Exchange
Natural Gas
5,792,952
2,433,263
3,359,689
Tokyo Financial Exchange
Australian Dollar/Japanese Yen
5,633,692
9,819,416
-4,185,724 Currency
Tokyo Financial Exchange
Euro/ Japanese Yen
5,588,420
6,311,560
-723,140 Currency
Australian Securities Exchange
90 Day Bank Bills
5,131,834
5,319,997
-188,163
Interest Rate
Dalian Commodity Exchange
Polyvinyl Chloride (PVC)
4,953,456
4,706,881
246,576
Commodity
Multi Commodity Exchange
Silver
4,668,271 6,041,378 -1,373,107 Metal
Multi Commodity Exchange
Mini Copper
4,443,053
NA
NA
Metal
Australian Securities Exchange
10 Year Bond
4,267,614
3,567,800
699,814
Interest Rate
Multi Commodity Exchange
Nickel
3,938,502 3,738,004 200,498
Tokyo Financial Exchange
US Dollar/Japanese Yen
3,645,093
National Commodity & Derivatives Exchange
Guarseed
3,301,264 2,046,587 1,254,677 Agriculture
Tokyo Commodity Exchange
Gold
3,210,084 3,713,494 -503,410 Metal
Shanghai Futures Exchange *
Gold
3,206,328 3,199,637 6,691
Multi Commodity Exchange
Gold
2,692,842 3,119,418 -426,576 Metal
United Stock Exchange
US Dollar/Indian Rupee
1,717,183
Shanghai Futures Exchange
Aluminum
1,614,366 4,781,712 -3,167,346 Metal
Tokyo Financial Exchange
British Pound/Japanese Yen
1,315,002
2,833,761
-1,518,759 Currency
National Stock Exchange of India
Euro/ Indian Rupee
1,271,060
4,509,060
-3,238,000 Currency
National Commodity & Derivatives Exchange
Coriander
1,177,880 NA
NA
Agriculture
Tokyo Financial Exchange
3 Month Euroyen
1,040,131
-680,231
Interest Rate
National Commodity & Derivatives Exchange
Jeera
1,002,096 NA
NA
Agriculture
Tokyo Commodity Exchange
Gold Mini
919,922
172,783
Metal
Tokyo Commodity Exchange
Platinum
877,555 800,118 77,438 Metal
Tokyo Commodity Exchange
Gasoline
605,570 573,705 31,865 Energy
Tokyo Commodity Exchange
Rubber
561,330 775,518 -214,188 Commodity
National Commodity & Derivatives Exchange
Guar Gum
386,999
389,975
-2,976 Agriculture
Shanghai Futures Exchange *
Fuel Oil
6,426
985,039
-978,613 Energy
National Commodity & Derivatives Exchange
Pepper
NA 589,860 NA
28,905,117
7,593,822
NA
1,720,362 747,139
Type Currency
Agriculture
Metal
Interest Rate Agriculture Metal
Energy
Metal
-3,948,729 Currency
NA
Metal Currency
Agriculture
* Quarterly Average
Exchange
derivatives
23
Exchange
Product Net
Cotton No. 1 US Dollar/Indian Rupee White Sugar Pure Terephthalic Acid (PTA) Zinc Futures
Zhengzhou Commodity Exchange National Stock Exchange of India Zhengzhou Commodity Exchange Zhengzhou Commodity Exchange Shanghai Futures Exchange *
Top 5 Decliners -60,649,624 -35,310,416 -31,632,974 -16,992,173 -10,555,539
Exchange
Product Net
Light Sweet Crude 24,006,941 Ref Soya Oil 21,487,625 Chana 18,713,281 Strong Gluten Wheat 11,464,465 Copper 10,889,399
National Commodity & Derivatives Exchange National Commodity & Derivatives Exchange National Commodity & Derivatives Exchange Zhengzhou Commodity Exchange Shanghai Futures Exchange *
Top 5 Gainers
Exchange
Product Volume
Soy Meal 32,744,240 Ref Soya Oil 22,678,480 Soybeans 20,881,170 Chana 20,529,990 Soy Oil 19,866,312
Dalian Commodity Exchange National Commodity & Derivatives Exchange National Commodity & Derivatives Exchange National Commodity & Derivatives Exchange Dalian Commodity Exchange
Top 5 Agriculture Futures
Total
116,700,192
Exchange
Product Volume
Rubber 52,044,435 Pure Terephthalic Acid (PTA) 39,317,946 Linear Low Density Polyethylene (LLDPE) 38,364,802 White Sugar 28,063,278 Cotton No. 1 8,159,886
Shanghai Futures Exchange * Zhengzhou Commodity Exchange Dalian Commodity Exchange Zhengzhou Commodity Exchange Zhengzhou Commodity Exchange
Top 5 Commodity Futures
Total
165,950,347
Exchange
Product Volume
US Dollar/Indian Rupee US Dollar/Indian Rupee US Dollar Australian Dollar/ Japanese Yen Euro/ Japanese Yen
National Stock Exchange of India Multi Commodity Exchange Stock Exchange * Korea Exchange Tokyo Financial Exchange Tokyo Financial Exchange
Top 5 Currency Futures
Total
138,416,873 134,559,286 13,889,216 5,633,692 5,588,420 298,087,487
Exchange
Product Volume
Copper 32,106,057 Steel Rebar 30,432,579 Silver Micro 14,760,348 Zinc Futures 14,737,548 Gold Petal 13,127,207
Shanghai Futures Exchange * Shanghai Futures Exchange * Multi Commodity Exchange Shanghai Futures Exchange * Multi Commodity Exchange
Top 5 Metal Futures
Total
105,163,739
Exchange
Volume Index Percentage
National Stock Exchange India China Financial Futures Exchange* Korea Exchange BSE * Osaka Securities Exchange Australian Exchange Tokyo Stock Exchange * Bursa Malaysia TAIFEX Hong Kong Exchanges* Thailand Futures Exchange
24 978 605 20 477 024 15 629 281 4 752 366 4 113 063 2 508 632 2 212 224 506 263 311 798 241 854 42 957
S&P Nifty CSI300 KOSPI 200 SENSEX 30 Nikke 225 SPI 200 TOPIX KLCI TAIEX HSI SET 50
75 774 067
100%
Total region
Stock Index Futures 32.96% 27.02% 20.63% 6.27% 5.43% 3.31% 2.92% 0.67% 0.41% 0.32% 0.06%
24
Derivatives
Volatility In Asia Q1 2012
V
olatility in the first quarter of 2012 continued to trend lower in Asia as both macroeconomic and local factors have reduced fear and uncertainty in the capital markets. Globally, the US jobs recovery seems to be finally gaining some momentum. While there is still a long way to go the prospect of the worlds largest economy growing again has put a damper on volatility. Across the Atlantic in Europe the collapse of the Euro seems less likely as the 27 member EU have committed to saving Greece and are examining a closer economic union. While Greece and Europe still aren’t out of the woods the apparent stability has helped to minimize volatility as well.
Conclusion
Australia
There were two volatility index futures introduced this quarter in Hong Kong and Japan. The HSI Volatility Index (VHSI) began trading on the Hong Kong Stock Exchange 21 February 2011. The VHSI utilizes the CBOE VIX to measure the HSI Index implicit 30 day volatility. The derivative trades during the regular trading session with front month and two consecutive trading months available. The tick size is HK250 (US32) and has traded 289 contracts as of March 30. The Osaka Securities Exchange launched the Nikkei 225 VI Futures February 27 trading 166 contracts that month and 2,284 in March. The future underlies the Nikkei Stock Average Volatility Index and operates during the regular trading session. The contract is available in up to 8 serial months and has a tick size of ¥500 (US6).
Volatility peaked at 25.75 on the first day of the trading year and has drifted to its March 30 low of 14.57 ever since. There was some support around 20 with the Euro crisis’ latest bailout going down to the wire. Australia’s volatility was the lowest in Asia last quarter.
China Volatility in China remained in a tight band of 25 to 21 for the quarter reaching a low of 20.67 on March 16. It seems the ouster of Bo Xilai from the government has done little to stir uncertainty despite his popularity. The economic conditions, though putting a break on inflation, also do not appear to affect volatility.
Equity volumes returned to Asia in the first 90 days of the year to help a struggling industry. The lowered volatile will be helpful to the sell-side as their algos will undoubtedly perform better. The buy-side will be comfortable to use them too rather than relying on high touch or short term algo strategies. We expect volatility to remain low for the foreseeable future as the global economic crisis seems to be behind us for the most part. China’s economic slowdown doesn’t seem to overly concern markets in the region either. We would expect to see shocks from local market developments whatever those may be.
New Products
Hong Kong Hong Kong’s volatility was much the same as the rest of Asia with very little stirring activity. Volatility did seem to be affected by the 11th hour bailout of Greece but drifted to a low of 18.87 after the “election” of the Chief Executive CY Leung.
India India, on average, has traditionally had the lowest volatility of any country in Asia but this quarter was the most volatile of them all. India is the only country to have traded through its 200DMA (25.34) ranging from a high of 28.92 to a low of 21. Clearly, local factors are affecting volatility here.
Japan After last year’s tsunami Japan continues to move to the lower end of the volatility range in lock step with the rest of Asia. Japan recorded a record trade deficit this quarter as it imports energy to compensate for the lower output from nuclear power. It didn’t seem to affect the markets with Japan volatility reaching a low of 19.43 on March 30.
Korea Korea displayed the widest difference between the 200DMA and its low on March 27 of 17.1 of more than 12.8 points or 57%. Despite the saber rattling and recent talk of a long range missile launch from its northern neighbor volatility came in at the second lowest in Asia. The low volatility should make it difficult for the KOSPI Index option futures market, the largest in the world.
Taiwan Taiwan too had no reason to see increased volatility at the local level and traded in a tight range of 20 most of the month. Taiwan seems to be insulated from what is going on in Europe as was apparent on the other volatility graphs where this market didn’t bat an eye. Asia Etrader z Q2 2012 z www.asiaetrading.com
DERIVATIVES
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exchange spotlight
Punching Above Their Weight
L
ike most of Asia, the history of the Thai people goes back for centuries but it wasn’t until 30 April 1975 after recommendations from an American economist, Sidney Robbins, and an overhaul of capital markets regulations that lead to the Stock Exchange of Thailand (SET) to begin operations. In its 32 years, the exchange has grown from a small local market with just a handful of securities to have weathered the Asian financial crisis, political unrest and last year’s catastrophic flooding to become a rising star that will soon surpass its ASEAN big brother, Singapore, in equities and derivatives trading. As is typical across Asia, Thailand’s capital markets infrastructure is a vertical monopoly with the exchange group owning all parts of the business from execution of most asset classes, through to clearing and settlement at the depository.
The SET Group comprises the following entities: • The Stock Exchange of Thailand (SET) – Primary Exchange • Market for Alternative Investment (mai) – SME Exchange • Bond Electronic Exchange (BEX) • Thailand Futures Exchange (TFEX) • Thailand Securities Depository (TSD) • Thailand Clearing House (TCH) • Settrade.com Co., Ltd. – Online trading arm
The SET has been electronic as far back as 1991 when it launched the Automated System for the Stock Exchange of Thailand or “ASSET”. In August 2008, in anticipation of further growth in trading, the SET once again upgraded its matching engine called the Advance Resilience Matching System or “ARMS”. There are two types of trading methods i) Automatic Order Matching (AOM) which is a price, time method operating during the call auction and the continuous session and ii) Put Through (PT) trading which acts a negotiation facility where trades are then reported back to the ARMS. The seeds of further growth for the exchange and the industry were sewn on the 27 January 2009 when former Prime Minister Abhisit Vejjajiva appointed the Capital Market Development Committee (CMDC) which formulated 6 primary objectives in order to facilitate the growth of Thailand’s capital markets:
1. Capital market must be easily accessible by investors seeking investment opportunities and corporations seeking funds 2. Increase the quality and variety of products and services 3. Reduce the cost of funds to issuers and any intermediary and transaction costs to investors 4. Develop efficient infrastructure framework in legal, regulations, accounting, tax, information, technology and enforcement 5. Educate investors and ensure that adequate protection mechanisms are in place 6. Promote competition in the Thai capital market and build links with the global market The Committee, under these guidelines, formulated the following measures: 1. Abolish the monopoly and improve competitiveness of the Stock Exchange of Thailand 2. Liberalization of the securities industry to promote market efficiency 3. Reforming the legal framework around capital markets 4. Streamline the tax system 5. Develop new financial products 6. Establish a National Savings Fund creating a pension system 7. Developing a culture of savings and investments 8. Develop the domestic bond market
The SET Group was quick to embrace these changes and remain competitive in the face of bigger regional and global competitors. In June 2011, Cinnober Financial Technology signed an agreement with the exchange to replace the existing trading, market data and surveillance systems in both the equities and derivatives segments. It is worthwhile noting that they have been using NASDAQ OMX supporting the derivatives business line since 2006 when the TFEX was first launched and have since renewed their contract to 2016. The equities matching engine will be powered by TRADExpress Trading System and has been throttled to handle just 20,000 orders per second. According to published benchmarks this matching engine has a round-trip latency of 148 microseconds and a business logic
latency of 87 microseconds according to the vendor. Singapore Exchange is claiming a round trip latency of 90 microseconds under NASDAQ OMX. To allow its members to take advantage of this low latency and ramp up high frequency trading colocation is also coming in the third quarter of this year putting them ahead of heavyweight HKEx. The matching engine can also support combo order functionality allowing for multi-asset trading with one order. Dark order types are also supported paving the way for darkpools and alternative trading venues. Cinnober’s solution will also facilitate connectivity to FIX5.0 and amongst the members of the developing ASEAN link. Within the TRADExpress Trading System is the TradExpress Index Engine which calculates and disseminates the index levels in microseconds and in real time after each updating event something the Tokyo Stock Exchange only implemented just last year. The market data dissemination system will be based on TRADExpress Information Manager and its market surveillance system by Scila Surveillance. Information Manager besides pushing out tick data also supports Corporate Actions allowing for a wider and deeper interaction with the market. Though the market is still relatively small the introduction of Scila will scale with the growth of algorithmic trading and bring some measure of confidence to investors accessing Thailand. A new set of securities trading rules are expected in April to coincide with the launch of the new trading apparatus which are expected to go live July 2012 for equities, and 2013 for derivatives.
Equities There are 471 companies listed on the SET with a market capitalization at the end of 2011 of THB 8.41 trillion (USD 263 billion) yielding an average daily volume of both the SET and mai of THB 29.47 billion (921 million) the second highest in South East Asia (Singapore is the first). Reflecting the growing interest in automated trading, turnover velocity was the highest in the region. The cash segment at the exchange has seen volumes grow over the years influenced by macro events like the Global Financial crisis and local events like the recent flooding. There were 700,225 securities brokerage accounts with 153,147 of them active at the end of 2011. The regular trading session runs from 0930 – 1700 with a 90 minute lunch break from 1230
Asia Etrader z Q2 2012 z www.asiaetrading.com
exchange spotlight
– 1400. The exchange utilizes a call auction for both of the opening sessions and the closing session where a random time is generated to begin or end the session. Unlike the world’s largest exchange in Hong Kong, the SET offers a fair and orderly auction session to prevent price manipulation. Securities are traded in 100 share board lots unless they are trading under 500baht (~US16) then they trade in 50 share lots. The tick sizes vary, like most exchanges in Asia, depending on the price of the security. The SET has a trading band of ±30% for securities and also a circuit breaker policy if the SET50 index falls 10% then 20%. Block trading is conducted on the Big Lot Board where minimum trade sizes are 3million baht (~US98,000) or 1 million shares. The exchange allows several order types of which the most common is the Limit Price order. They do allow a market order referred to as a Market Price order and two other non-limit price types that are found during the auctions an At-The-Open order and an At-The-Close order. These two orders have a fill priority over the limit order. The conditional order types Fill or Kill and Immediate or Cancel are available as well. There is also a Publish Order which acts like an Iceberg where at least 10 board lots are shown to the market and when filled are immediately replaced. And last but not least is a Basket order where at least 10 securities within the SET 50 Index or the FTSE SET Large Cap Index must be included per trade. Baskets must be at least 15million baht (~US490,000) and within ±3% of the last traded price. This order type can be sent at any time including the auction session. DMA and Program Trading is only permitted for institutional clients and foreign firms having only been brought to the exchange in March and September 2007, respectively. Not all brokers can offer DMA and Program Trading. Covered short selling has been available at the exchange since January 2001 and was extended to include the SET100 index of names from 1 January 2011. As of March 5, there are eight ETFs listed on SET with a combined assets under management of THB 5.62 billion (USD 181 million) that saw total trading value of THB 19.3 billion (USD 623 million) in 2011. www.asiaetrading.com z Q2 2012 z Asia Etrader
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exchange spotlight
Trading Session Time
Trading Method
Notes
Pre-Open
09:30 - T1
Call Auction
T1 is a random open time between 09:55 - 10:00
Morning Session
T1 - 12:30
AOM, PT
Lunch Break
12:30 - 14:00
Pre-Open
14:00 - T2
Call Auction
T2 is a random open time between 14:25 - 14:30
Afternoon Session
T2 - 16:30
AOM, PT
Order matching stops. New orders may be sent for Call Auction
Closing Auction
16:30 - T3
Call Auction, PT
T3 is a random closing time between 16:35 - 16:40
After Hours Session
T3 - 17:00
PT
Dealer to dealer Put Through trading only
Broker DMA
ACL Securities
Asia Plus Securities
Bualuang Securities
Country Group Securities
Program Trading
expect to see more hedge funds entering the market with the flexibility and performance the new matching engine will offer. Foreign firms have been trading Thailand for quite some time. We can see that net buying and selling has fluctuated considerably over the last 6 years achieving an aggregate peak of US12 Billion in July 2007 and a low of US2.2 Billion in February 2009, the height of the Global Financial Crisis. These client types accounted for nearly 23% percent of the total equity trading volume in 2011. Along with a 7% VAT, foreign firms are subject to 15% capital gains, 10% dividend and 15% interest income tax.
Yes Yes Yes
Yes
Yes
CLSA Securities (Thailand)
Credit Suisse Securities (Thailand)
Yes Yes Yes
DBS Vickers Securities (Thailand)
Yes
Finansia Syrus Securities
Yes
Kim Eng Securities (Thailand)
Yes
KGI Securities (Thailand)
Yes Yes
Kasikorn Securities
KT ZMICO Securities
MACQUARIE Securities (Thailand)
Phatra Securities
SCB Securities
Yes
Yes Yes
Thailand Futures Exchange
Yes Yes Yes
Yes
Thanachart Securities
Tisco Securities
UBS Securities (Thailand)
Yes Yes
United Securities
Yes
Yes Yes
Top Five Derivatives Brokers
Phillip Securities (Thailand) pcl
8.44%
Maybank Kim Eng Securities (Thailand) pcl
7.40%
MTS Gold Futures Co., Ltd.
5.67%
KGI Securities (Thailand) pcl
5.42%
The eight ETFs listed on SET are: Bualuang CHAY Gold ETF (BCHAY) KTAM Gold ETF Tracker (GLD) K-Gold ETF (KG965) MTRACK Energy ETF (ENGY) ThaiDEX Gold ETF (GOLD99) ThaiDEX SET High Dividend ETF (1DIV) ThaiDEX SET50 ETF (TDEX) W.I.S.E. KTAM CSI300 China Tracker (CHINA)
38.21%
The fund industry has been growing as well with 346 funds managing around US13 Billion in 2002 to a record US86 Billion in 2010. 2011 was not a good performing year due to the macro environment and the flooding in the country but funds continued to launch achieving a record 1,300 mandates. Kasicron Asset Management and SCB Asset Management comprise nearly 50% of total AUM representing 25% of the total outstanding funds. Fixed income represents almost 60% of fund assets with only 22% representing equities. That is expected to change as the cash market is growing and we would
This market segment has seen substantial growth over the past few years since its launch in 2006. The SET50 Index future with its 10 Baht tick size was the first product to list. Fourteen Single Stock Futures were launched November 2008 and sixteen more were added March 2011. February 2009 saw the launch of gold futures with a contract size of 762 grams and 96.5% purity. Two interest rate and a 5-year government bond future were introduced July 2010. One year later saw the 100 gram silver future contract list. Then a cash settled Brent Crude future began trading October 2011 with the next product, a USD currency future, expected some time this year. The night session was added 20 July 2011 to the futures market. The T+1 session runs from 1930 - 2230 hours to match the opening of the New York market and allow domestic investors an opportunity to react to news in the US. The Thailand Futures Exchange currently has 41 members that saw 10 million contracts trade hands in 2011 or 41,145 contracts per day, up 120 percent from 2010. In 2011, SET50 Index futures represented the largest share of trading volume at 43 percent of the total followed by gold futures coming in at 40 percent and Single Stock Futures earning a 16 percent share. Open interest exploded in 2010 but subsided in 2011 as we saw an interesting shift into day trading from retail and the onset of algorithmic trading generating the huge volume growth.
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exchange spotlight
“...average daily volume of both the SET and mai of THB 29.47 billion (921 million) the second highest in South East Asia (Singapore is the first).
At the end of 2011, TFEX had 62,883 accounts up 50 percent from 41,880 accounts in 2010. Domestic retail investors were the largest group of derivatives players representing 60 percent of the total trading. Foreign investors accounted for 33.6 percent and 6.4 percent came from domestic institutional investors.
Post Trade In February 2010, the SET formally separated clearing and settlement from the Thailand Securities Depository in line with international standards. As of the end of 2011, the TSD has 37 broker and 33 bank participants. The volume of securities at the depository has grown by 81% since 2007 to 738.7 billion shares. The Thailand Clearing House has 89 members in the securities segment as of 2011 and does comply with the Bank for International Settlement and IOSCO. The value of securities cleared has grown almost 42% since 2007 to THB1,012 Billion (US32 Billion). Last year saw the volume of shares cleared hit 385.5 Billion up from 268.2 Billion or 43.75% from 2007. Futures clearing is done through this entity as well on T+1 basis and securities are T+3. In June 2011, the exchange announced its goal of becoming a regional post trade hub for Southeast Asia. In doing so, Corporate Action news will be sent via SWIFT, the first exchange in Asia to do so. They also announced third party clearing which will allow brokers that are clearing house members to clear and settle securities on behalf of non-member brokers. The Stock Exchange of Thailand, while still small by international standards, is putting in place a cutting-edge trading apparatus to rival any in the world and, by some measures, ahead of its regional peers. The forward looking policies put in place by its regulator and the technical sophistication at the exchange level is filtering down through the rest of the industry. This investment can only result in professional trading right across the buy-side spectrum from transition management to high frequency trading. These building blocks will see Thailand’s capital market quality, liquidity and efficiency surpass many of the more established exchanges in both the South East and the rest of Asia. www.asiaetrading.com z Q2 2012 z Asia Etrader
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30
RISK
ISDA Views On Hong Kong OTC Reform
Keith Noyes International Swaps and Derivatives Association Regional Director, Asia Pacific
T
he Hong Kong Monetary Authority and the Securities and Futures Commission closed a consultation on a proposed regulatory regime for OTC derivatives at the end of November 2011. While it is recognized that the OTC market in Hong Kong is relatively small the authorities are preemptively addressing the potential for future growth through observation of international standards. Briefly, the current proposals for an OTC derivatives regime in Hong Kong as stated in the consultation should not only introduce mandatory reporting, clearing and trading obligations in line with the G20 commitments where appropriate, but also provide for the establishment and regulation of the necessary infrastructure through which any mandatory obligations must be fulfilled. Secondly, it should provide for the regulation of key players in the OTC derivatives market – in particular authorized institutions, licensed corporations and large players whose positions may pose systemic risk. The results of the consultation are due at any time. Asia Etrading had an opportunity to sit down with Keith Noyes the Regional Director of Asia Pacific for the International Swaps and Derivatives Association to hear his views on the proposals put forth in the consultation. Asia Etrading: One of the key concepts that will define the scope of Hong Kong’s OTC policy will be the term “OTC derivatives trading”. How would you define term and what parts of the definition should be carefully worded?
Keith Noyes: OTC derivatives trading encompasses many different activities including swap dealing, market making and proprietary trading. Trading is the dynamic process of managing an intermediation business as a responsive presence in derivative markets. Trading optimizes an intermediation business’s ability to offer customers excellent pricing: it is comprised of intermediation itself, hedging, maintaining “inventory” and positioning to capture efficiencies (through arbitrage or otherwise) that the market presents in the course of executing these varied functions. All of these functions are interrelated and each must be allowed to operate flexibly in order to ensure that end clients continue to enjoy liquid markets with narrow bid/offer spreads. In setting out definitions, regulators should make a Hippocratic Oath not to undo what is working well already. AE: Does mandatory reporting of OTC derivatives transactions make sense? KN: Mandatory reporting of OTC derivatives transactions makes complete sense. The September, 2009 Pittsburg G20 Summit recognized the importance of reporting and this has been translated into enabling legislation under Dodd-Frank, EMIR and Hong Kong to name but a few jurisdictions. The banking industry also strongly supports reporting OTC transactions to regulatory overseers. OTC derivative transactions create interconnectivity between financial firms. Due to the lack of reporting prior to the financial crisis, regulators did not have a clear picture of what each firms’ exposures to other counterparts was and did not know where concentrations of risk had built up. Although counterparty credit losses on OTC derivatives ended up being a small fraction of total banking industry losses compared with those suffered on property-related security investments, opaqueness around OTC exposures exacerbated market jitters during the crisis. A central data base – available to the relevant regulators – of all OTC transactions and exposures would have ameliorated this anxiety. AE: What should be reported? KN: Current global reporting efforts center around building trade data repositories for each derivatives asset class, rates, FX, equity, commodity and credit. Another repository for counterparty credit exposure might add additional clarity. The most important result
“HKEx can be expected to face considerable competition from global CCPs and regional CCPs.” should be that systemically significant institutions report all trades. As a practical matter, regulators may set deminimus reporting exemptions for those market participants whose trading volume is not systemically significant. AE: What would be the cost to the industry of implementing mandatory reporting? KN: While there are significant costs associated with trade reporting, the important thing from the banking industry’s perspective is that this cost is only borne once. For many reasons, the world is moving toward multiple reporting venues in different jurisdictions rather than one global trade repository. As long as each trade repository collects the same data in the same format then the reporting cost can be minimized. Operational costs add up quickly with each different trade format that a bank must generate to meet differing reporting requirements. ISDA has worked closely with Asian and international regulators to try to settle on common reporting fields for all transactions. AE: Should standardised OTC derivatives trading be mandated to clear through central counterparties? KN: The global banks recognized the benefits of clearing through central counterparties before the beginning of the millennium and supported the development of Swapclear at LCH for clearing standardized OTC derivatives traded between major market participants. The experience of the Lehman bankruptcy vindicated this effort as all of Lehman’s cleared trades were successfully unwound and a portion of Lehman’s initial margin even returned to the estate following Lehman’s default. The case for mandatory clearing of standardized OTC derivatives between systemically important institutions is strong. The debate now is on whether non-systemically
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risk
important market participants should also have to clear mandatorily or not. US legislation provides a clearing exemption for corporate end users trading for hedging purposes only and most global regulators recognize that mandatory clearing for this group of derivatives users might dis-incentivize them to hedge business risks prudently.
“The business case and
AE: What form should a CCP take in Hong Kong and should it be separate to the SEHK or fall under its purview? KN: Hong Kong has made a strategic decision that as a global financial center it should have its own CCP. Within this context, the choice of HKEx to perform the CCP role makes eminent sense. Nonetheless, transaction volumes in Hong Kong are not substantial and HKEx can be expected to face considerable competition from both global CCPs such as LCH and CME and other regional CCPs such as SGX. The industry is most concerned that HKEx would gain market share through regulatory fiat rather than competing on the merits of its clearing service. As long as Hong Kong regulators mandate clearing, but not clearing location, this should not be an issue.
potential growth of the
AE: Should trading of standardised OTC derivatives on exchanges or electronic trading platforms be made mandatory and what products should and shouldn’t be electronic? KN: Trading through electronic trading platforms is an important component of the US Dodd-Frank legislation (where they are referred to as swap execution facilities “SEFs”). In Asia, however, the regulatory focus has not been on electronic trading platforms as the G20 commitment says “all standardized OTC derivative contracts should be traded on exchanges or electronic trading platforms, where appropriate,…” Instead the focus is on clearing and reporting. Many standardized OTC derivative contracts have been offered in exchange-traded form over the years and failed to become liquid. A strong argument can be made that OTC derivative markets are fundamentally different from, for example, futures markets in that each trade is basically a block trade with substantial time required post-trade to affect hedging actions. ISDA estimates that even a very liquid OTC contract such as the USD 10-year fixed/ floating swap trades on average once every 30 minutes during the trading day with an average size of USD75 million. This is very different from futures trading activity. Electronic trading platforms may offer efficiencies in terms of error reduction and straight through processing, but liquidity could arguably suffer if all trades were
justification for a CCP in Hong Kong rests on the
off-shore RMB market.” forced through electronic platforms which are by definition public. Ideally, the market would be left to decide which trades are transacted on exchange, via electronic platforms or over the telephone. All three mediums currently coexist harmoniously and there is no one-size fits all solution for such a diverse range of products. AE: Should higher capital requirements for OTC derivatives trades that are not centrally cleared be imposed and what will the impact be to the industry? KN: Basel III already provides that credit valuation adjustments (CVA) will be higher for bilateral OTC trades (20%) than for trades through CCPs that meet CPSS/IOSCO standards (2%). This will provide tremendous incentive for clearing. On the flip side, the amount of initial margin required to support clearing will be enormous. (The OCC, at the high end of the range, estimates a need for US$ 2.0 trillion in initial margin for cleared trades). Much of the same counterparty risk reduction offered by central clearing could be accomplished through bilateral margining at much lower cost since bilateral trades can be margined on net basis under the ISDA master agreement in netting friendly jurisdictions. Managing initial margin will be a challenge for CCPs. The legally separated, operationally comingled (“LSOC”) approach has gained momentum in the US, but there may be counterparties who are willing to bear the extra cost of fully segregated margin placed with bankruptcy remote third parties. Again, a one-size fits all approach will not meet the market’s needs. AE: Will the OTC reforms affect the off-shore RMB market that Hong Kong is building? KN: “While jurisdictions that have relatively large and complex OTC markets should assess the use of CCP clearing for CCP eligible products, the jurisdictions which have relatively
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small and non-complex markets should not need to centrally clear the transactions, as it may impose a considerable cost in doing so.” IOSCO Report, OTC Markets and Derivatives Trading in Emerging Markets, July 2010, Page 33, Recommendation 6. Based upon this statement, Hong Kong would not seem to have need for CCP clearing as the Hong Kong dollar swap market is less than 1% of global volume and its NDF and IRS markets are estimated to be of similar size. The business case and justification for a CCP in Hong Kong rests on the potential growth of the off-shore RMB market which could one day be large enough to justify Hong Kong’s investment in CCP. One potential hurdle for the development of the off-shore RMB market in Hong Kong is NAFMII’s intent to publish an offshore version of its master agreement for RMB transactions in Hong Kong. Transactions under the ISDA and under the NAFMII master agreements are not fungible and this would lead to market fragmentation and the greatly increase costs at the clearing house. At a time when there is a global effort to standardize OTC products, forcing new documentation upon the market would only cause fragmentation. AE: What requirement should counterparties based off shore trading with counterparties based in Hong Kong be subject to? KN: The important issue here is that trades that should be cleared get cleared, not where they are cleared. To this end, it is important for global regulators to develop a framework for mutual recognition of third country CCPs. The offshore counterparty and the Hong Kong counterparty can then decide between themselves as a matter of bilateral negotiation where they choose to clear the trade.
Keith Noyes Bio Keith Noyes is the Regional Director, Asia-Pacific at the International Swaps and Derivatives Association, Inc. Mr. Noyes is based in Hong Kong and heads the offices in Hong Kong and Singapore. His focus is on strengthening ISDA’s relationships with key constituencies in China, Hong Kong, Singapore, India, Australia and other countries in the region. Since July, 2010, Mr. Noyes also serves as an invited industry consultant in the Hong Kong Securities and Futures Commission’s Product Advisory Committee.
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Who’s Who
Tony Mackay Tony Mackay, the founder of Chi-X Europe and Chi-X Global, sat down with Asia Etrader and gave us his insights on the development of Chi-X Australia and Japan, lessons on setting up an alternative venue in Asia and why Japan’s Proprietary Trading Systems (PTS) have been slow to catch on. He provides his views on competitive clearing in Asia and whether high frequency trading is good or bad for markets. Finally, weighing in on exchange consolidation and mergers.
Asia Etrader: How did you get started in electronic trading? Tony Mackay: I started studying medicine at university and chose economics as a non-medical subject. When I was 19 I wrote a paper on valuing a company and coincidentally my parents had just given me some shares in an Australian airline which is now defunct called Ansett. I wrote the report and asked the tutor ‘what happens if you own shares in the company that are worth a lot more than they are trading for on the stock exchange?’ He looked at me as if I was complete idiot and said ‘If you are right, somebody with a lot more money than you and I will come along and take it over.’ About three weeks later, Rupert Murdock launched a takeover bid and my shares that had been worth a dollar a share went up to a dollar seventy-five. I thought ‘Wow, this is fantastic’! I went down to the stock exchange and I asked, ‘how can I go down to the floor and sell these shares?’ The fellow at the exchange said ‘no no you need a broker’. I then immediately found a broker to sell the shares and thought this was pretty good’. I think I got $800 for the sale. Then I bought 10,000 shares at 4 cents of another company and this was around the time of JR Ewing and Dallas and I remember thinking that 10,000 shares was huge. That stock went to 10 cents. $400 dollars turned to $1000 dollars and as a student at university I thought this was great.
I found a summer job with a broker and realized half their clients were doctors. Then I thought why don’t I become a broker and cut out the middle man. I changed courses at school and my part-time job became a full-time job and that’s where it all began for me. AE: How did you get involved with alternative trading venues? TM: My first day with Instinet (August 1995) was in the New York office and that was the day that Netscape went public. Instinet was the only order driven electronic market at the time and things went crazy with everybody trying to trade Netscape. This was the start of the Internet dot-com boom. In 1998 I set up an electronic trading desk trading Asian shares in London which was actually very successful because the Asian markets were closed. Instinet then became the de facto price for Hong Kong stocks and Japanese stocks, ADRs and GDRs in London. I realized that there was actually times when you could have an electronic market that complemented trading on the primary exchange. People used to refer to Instinet as the afterhours market in the US, but it actually traded all day long. After hours it was the only source of price quotes for traders and the TV channels such as CNBC. Then around 2000 I came back out to Japan to set up the PTS JapanCross. We also worked with the Korean brokers and regulators to get
“The whole idea behind Chi-X was taking bits of everything that I had learned and putting it into this vehicle.“ direct ID anonymous trade into Korea and setup electronic order routing in Hong Kong. Then in 2005, I was transferred to London and that’s when I set up Chi-X. The whole idea behind Chi-X was taking bits of everything that I had learned and putting it into this vehicle. We didn’t want to have a conflict with Instinet and that’s why I made it independent and invited other brokers to join. We also didn’t want investment banks writing large checks for ownership so we came up with a policy that they had to trade in order to get equity in the business and that worked really well. We also realized that if we were going to compete with exchanges we had to unbundle our costs in the same way that they unbundle their costs.
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who’s who
“Instinet has to get its ‘mojo’ back and start innovating again instead of trying to be a vendor promoting Newport.“
By unbundling and then offering clients an alternative on the other side we were able to get our costs down to just a fraction. We started off at 10% of the cost of the exchanges. What was interesting for Chi-X is that in the four or nearly five years since it launched in Europe they haven’t had to adjust its price. AE: Is Instinet going to Survive? TM: I certainly hope so – Instinet was arguably the global pioneer of electronic trading. Instinet flourished until Nomura bought Lehman and the ex-Lehman managers felt that the Instinet technology was not good enough for them. Important development funds were then diverted from Instinet to the ex-Lehman team to try to build what Instinet already had. It now looks as though common sense is prevailing and the Nomura Group will consolidate its electronic trading business under Instinet. Nonetheless, Instinet has to get its ‘mojo’ back and start innovating again instead of trying to be a vendor promoting Newport.
However, MIFID certainly did make Europe a lot more like the US. You can set up in the UK and are able to trade all of Europe from London. The real difficulty in Asia is that every market has different currencies, different rules, different regulations, different participant mixes between local and foreign. Therefore you must examine the region country by country. AE: How would you compare competition in Australia and Japan? TM: I would argue that Australia has had the most extensive change in their rules and regulations to bring in competition. Australia doesn’t have the equivalent of an ATS. Contrary to what people might think, Chi-X is not an alternative trading system in Australia. It is a market operator exactly the same as the ASX. It chooses not to do listings but it is effectively regulated exactly the same as the ASX as far as a stock exchange goes. That’s very unusual. The second thing that the authorities have done is go through a very detailed consultation with the market and have also looked at the rest of the world to create the Market Integrity Rules along with the rules for dark pools. To set up in Australia it took Chi-X four years hard work. Now it will probably take someone less than a year to get started. I think at the end of the day Australia will come up with the most American or most European-type rules. Whether that gives them competitive advantage or not, time will tell but it won’t hurt them.
AE: What lessons can you share about setting up an alternative trading venue in Asia? TM: The first thing to do with Asia is to contrast it to Europe and the US. The US is one homogeneous market with huge volume, extensive electronic connectivity, a standard of set of rules and one central clearing house, DTCC. Over the years the US regulators have said if you want to set up as a competitive trading venue or an exchange this is what you have to do. There is a clearly defined set of rules and regulations to do that. MIFID has almost done the same for Europe, not completely because places like Spain are still able to keep restrictions on clearing and settlement that make it difficult for people to compete. www.asiaetrading.com z Q2 2012 z Asia Etrader
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In Japan when we were trying to set up JapanCross in 2000 the regulators looked at us and agreed that there should be competition for the Tokyo Stock Exchange. The regulator then put in place some rules that said if any alternative venue started becoming more than five percent of the market, then 10 percent of the market it would have to be regulated as an exchange.
“Japan in contrast to the ASX in Australia is that the TSE agreed to open up the Japan Securities Clearing Corporation to all the PTSs.” Well the problem in Japan was that there wasn’t anything in their regulations that says how to apply to become an exchange. Japan is very much a country where unless the rules say you can do it, you can’t do it. All these rules that have been added for different reasons have actually made it very difficult for PTSs in Japan to operate. That’s the negative side. The positive side
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“The most likely solution is someone like the DTCC or LCH setting up in the region” of it is the Financial Service Authority in Japan actually understands that Japan has to become a lot more competitive. However, because of the way the legal structure is in Japan most regulatory changes have to be passed by parliament, making regulatory reform a lot more complex. When we went in to talk to the TSE about Chi-X setting up in Japan sitting across the table was [Atsushi] Saito-san who used to be a fund manager before he went to the TSE as President and CEO. He understood what we were trying to do that Chi-X has made the market bigger in Europe. The LSE and all the exchanges might have lost
market share but they are still trading the same volume of shares. We said yes, the frictionless cost of trading has come down and high frequency traders have brought more volume to the market. He said we are bringing in Arrowhead and the analogy we used is if Arrowhead is the only place that they can trade, this will be like clapping with one hand. You need to have two markets to arbitrage between. The thing that I think is quite extraordinary in Japan, in contrast to the ASX in Australia, is that they agreed to open up the Japan Securities Clearing Corporation (JSCC) to all the PTSs for no additional charges. That was, I think, the single development that has been the reason that SBI Japannext and Chi-X have been able to grow since getting unencumbered access to JSCC. Conversely, the ASX charges a huge amount for clearing and has made it very difficult for Chi-X to do what they did in Europe. My personal view is that Chi-X Australia can’t offer the same all in costs benefits as it did in Europe whilst it has to clear through ASX. ASX makes 50% more of every trade
that happens in Australia than Chi-X does and that’s just untenable. At the end of the day, the ASX has acted as a cynical monopolist by bringing down their cost of trading but they left their cost of clearing high as there is no competition for clearing. Clearing is 50% more expensive than trading which is really the wrong way of running the market. Going back to Japan, the FSA was very supportive of the market opening up and the TSE themselves realize that it’s better having a bigger market and a better market than a 100% monopoly that’s going nowhere. I think in time, Japan is a big enough market to have more than two alternative trading platforms operating. AE: What are some of the problems PTSs in Japan are facing to hinder growth? TM: One of the problems is that retail is still a very big part of the Japanese market. Even the Japanese domestic institutions have incredibly conservative policies. Also, many of their computer systems are archaic and many of the systems in Japan are built around the lowest common denominator rather than at the cutting edge. SBI has
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“The TSE will probably end up with 50 To 60 percent of the market then maybe 2 or 3 others will have the remaining 20 percent of the market.“ been able to bring in some retail flow to their venue. But I don’t think that Nomura has been able to bring their retail into Chi-X. If someone like Nomura can’t bring their retail into Chi-X that shows you the extent of the problem getting the retail into these venues. I don’t think most of the Japanese institutions themselves are actually geared up to trade DMA and certainly not DMA into alternative markets. The fact that combined, between Japannext and Chi-X, they’re pushing 8% of equity trading market share that’s actually pretty good given the restrictions they’ve got. That’s why I think there’s room for more than just two alternatives in Japan. AE: What will a mature, competitive Japan look like? TM: The industry will eventually follow what’s happening overseas. You’ll end up with two major platforms with the TSE being one and the other whether it be Chi-X or SBI or one that hasn’t started yet will probably get a quarter of the market assuming the other rules and regulations are changed. The TSE will probably end up with 50 to 60 percent of the market then maybe 2 or 3 others will have the remaining 20 percent of the market. AE: Is Australia big enough for competition? TM: I think Australia is big enough for competition but there are a couple of problems, aside from dealing with the clearing monopoly. The government has passed the cost of the regulatory changes on to the end users causing people to say it was actually better before competition. It’s pushing things back a bit. AE: Will Chi-X Australia survive? TM: Chi-X hasn’t entered the market with what I call a proper Chi-X offering as they
haven’t offered the clearing and settlement. The second thing is when we set up Chi-X in Europe, for the first three or four months we had less than 10 participants on the platform, but they were fully committed to making two way prices and or bringing institutional liquidity to the platform. There was a mixture between hedge funds and high frequency traders that only post liquidity and some that only took liquidity. There were participants that were doing arbitrage between dual listed stocks. There was one of the big French banks and they have a very different way of looking at the market plus Instinet and Credit Suisse with their institutional flows. There was actually a really interesting mix of people in the platform – the clapping analogy. Chi-X Australia launched with an impressive level of support from Australian brokers, but not enough support from market makers or liquidity providers. The typical broker will program his algos to seek liquidity rather than post liquidity, so Chi-X has everyone looking to take liquidity and not enough people actually posting liquidity. I know from speaking to a few of the high frequency firms that backed Chi-X in Europe that they are not going to back Chi-X in Australia until the clearing costs come down significantly. I wish Chi-X Australia well, but I think they’ve got a real struggle until they sort the clearing out. AE: What is your view on Chi-east? Why has it been slow to grow and will it survive? TM: I think the concept of Chi-East was incredibly ambitious to try and launch a regional dark pool venue as an exchange joint venture regulated in Singapore. I think that they have had problems in other markets such as Hong Kong because they are not a member of the Hong Kong Stock Exchange. The second thing is that they’ve got a few brokers on board but not enough. Most of the brokers have set up their own dark pools or internalizers rather than support Chi-East. I think markets are going to have to move beyond where Chi-X took things which is a dumb matching engine that’s cheap and fast. AE: Does that mean exchange led Dark Pools will struggle in Asia? TM: Dark Pools have a role in Asia, but they need to be smarter and offer real benefits to the buy-side. Something I’m just looking at
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now is applying social networking principles of choice to market infrastructure. It’s almost going back to the old phone based trading days where traders made choices at all points about who they preferred to deal with and who they don’t. In the current electronic world there has to be a way where institutions can come to an exchange environment and prefer to trade amongst themselves instead of, say HFT and aggressive hedge funds. You know big institutions like Templeton, Blackrock, Fidelity and others all have different views on the market – one side of the market is going long and the other is going short so let’s match up as much as we can amongst the long term investors. Exchanges have to allow equal access to all participants.
“ASX makes 50% more of every trade that happens in Australia than Chi-X does and that’s just untenable.”
That doesn’t mean that all participants should have to trade with all parts of the market. The exchange can have payers – say a transitions or portfolio trading section where participants trade against others doing the same portfolio, but in the opposite direction. One of the biggest barriers to banks putting their proprietary liquidity on exchanges rather than into their internal dark pools is that they want to ensure that their competitors can’t ‘pick off’ their liquidity and use it against them. An exchange that allowed banks to define a group of competitors that they didn’t want to deal with would promote them all providing more liquidity to the long term investors. The exchange can provide access high frequency, but investors can opt out of accessing that liquidity. Far easier to let professional investors have the choice of how and where they trade than have regulators/politicians try to regulate for every possible eventuality. That’s what used to happen by the telephone. The sales trader would call Fidelity, call Black Rock and call Templeton individually. If you can replicate that into an
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electronic exchange business, you’re going to have a far more successful operation. AE: Why have alternatives struggled in Hong Kong? TM: Hong Kong, is probably most frustrating place because there is a regulated monopoly, the government owns a stake in the Hong Kong exchange and the exchange is aggressively lobbying that it should be excluded from the proposed competition laws.
“The concept of Chi-East was incredibly ambitious to try and launch a regional dark pool venue as an exchange joint venture regulated in Singapore.“ Everything is just stacked against competition in Hong Kong. To set up an alternative, the SFC regulations say that, one, you have to be a member of the Hong Kong exchange and two, you’ve got to pay all the Hong Kong stock exchange fees. The Government stamp duty has almost no exemptions. So, it’s really difficult to add value in a market like Hong Kong. I heard at a conference someone describe the Hong Kong exchange as being a fat cow in a lush paddock. There’s not any pressure for innovation or giving the market a better deal. But under Charles Li, the exchange is actually recognizing that eventually competition will come, maybe not from outside China, but inside China. Shanghai has got a fantastic marketplace now and Shenzhen is also upping the ante. The eventual competition at the exchange level will probably come from within China. AE: Is High Frequency Trading good or bad for markets? TM: I think HFT is generally good but as with all things nothing is one hundred percent. A normal broker algorithm is high frequency these days. How I would define HFT is that
they have a proprietary book that is not trading client money. If they are being paid to post liquidity then they should have an obligation to post that liquidity continuously and in a proper manner. I think an HFT will eventually have to take on market maker obligations to get the benefits that they currently do in the markets. What is high frequency? Take away the emotion of high frequency, take away the emotion of computer versus people, the computer will win. If HFT is regulated and they are not quote stuffing or manipulating the market then HFT is incredibly good – they should become market makers providing two way liquidity to the market. AE: Would you like to see competitive clearing in Asia or is the DTCC model better? TM: When we looked at competitive clearing with Chi-X in Australia, it was clear that Australia alone is too small to set up the equivalent of an EMCF (European Multilateral Clearing Facility). But if you set up an EMCF or competitive clearer in Australia that can move into other markets that would make a lot of sense. It would make a lot of sense for the global investment banks that trade all the different markets.
“It’s really difficult to add value in a market like Hong Kong.“
However, the problem in Europe is that the domestic participants don’t get the benefit out of the competitive clearing side. The most likely solution is someone like the DTCC or LCH (if it remains an independent consortium) setting up in the region so that the banks are effectively getting the benefit of their European volumes, US volumes, and their Asian volumes combined. Because you don’t have a common currency or a common regulatory framework like Europe it’s going to be very difficult. However, I think each of the domestic markets have got to protect the domestic participants. That being said there is no reason why a domestic clearing house could not become a member and offer
“I think an HFT will eventually have to take on market maker obligations to get the benefits that they currently do“
interoperability with an international clearing house as we’ve seen in Europe. The second thing is that a pan-Asian clearing house has got to be more than just equity and become a multi asset vehicle that way you can get the volume on the economy of scale. AE: What is your view on the global and regional exchange consolidation? TM: What I don’t understand about the exchanges is why they are trying to merge to create these global behemoths. You don’t really need to do it that way. If you open your market up and let anybody trade there the market as a whole becomes more liquid. Eventually, the market will become global and those exchanges that adopt that global linking and ability for regional clearing and settlement will actually do much better than the ones who close their doors. Trading is two ways. If you open your doors to overseas participants to invest in your market will grow. The exchanges that are trying to merge and claiming better efficiency but you haven’t actually seen that out of any of the exchanges that have merged so far. If anything, I think the mergers are more about creating bigger monopolies rather than generally trying to expand the business. Why does an exchange have to merge with another exchange? I know SGX and ASX tried cross listing each other’s shares and it didn’t really work. Well, part of the reason it probably didn’t work is that they were probably 5 or 10 years ahead of the curve in doing that. But in time, it will start working. The appetite for Chinese people to buy shares such as Apple will be huge. Exchanges don’t need to merge to make that happen.
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Cut To The Commission Kym Graham, Head of Asia (ex-Japan) Sales for Instinet
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ith volatile markets and tight budgets, buy-side firms are examining their research and execution spends like never before. However, without the ability to unbundle the brokerage services they’re consuming, many cannot allocate commissions as effectively as they’d like. The pressure on budgets is leading increasing numbers of asset managers to consider commission-sharing arrangements (CSAs) to improve trading performance, although adoption in Asia still lags behind that of the US and Europe. “There has been a tremendous increase in scrutiny of research,” says Richard Kramer, managing director at independent research firm Arete. “For example, in the US, investors are increasingly concerned about research providers deliberately or inadvertently passing on material non-public information, or insider information.” The effect has been for research providers to invest more time and effort in compliance, says Kramer, noting that this evolutionary process has helped firms such as his own that have long had professional compliance staff and robust procedures. Execution services have been under pressure, too. With the significant drop-off in trading volumes in the last couple of months of 2011, triggered by the macro-economic uncertainty, many pools of liquidity have dried up. With 2012 thus far bringing much of the same, asset managers are looking at their commission budgets and asking themselves who they are going to pay.
Making your money work “The drop-off in volume is pushing the bigger firms to increase their usage of CSAs, as most have a reduced commission wallet and consequently need to spend it more efficiently,” says Kym Graham, head of Asia (ex-Japan) sales for agency-only broker Instinet. “Some have decided to increase their commission sharing usage because they are reluctant to completely cut off their regional brokers that provide many services that the bulge brackets simply can’t.” CSAs give them a chance to spread money around with greater flexibility explains Kramer. “Unbundling has opened up the door
for the buy side to leverage innovative new service providers,” he says. “For example, the Meteorological Office, which is the official weather forecasting service in the UK, can provide detailed global weather forecasts to commodity traders. There was no way for a group like that to be compensated for its services – which were very much desired – prior to the introduction of CSAs.”
Conflicts and compliance In 2003, the UK Financial Services Authority estimated that as much as 40% of execution commissions were used to pay for research and other services, resulting in it setting out, in Consultation Paper 176, the model for payment using CSAs, which later became policy. The motivation was to remove the barriers and conflicts that bundled payments can create for fund managers. In the UK, the commission is charged to customer funds directly on a per-transaction basis, making the cost of each individual service acquired with the payment unclear. As a result, fund managers were passing on fund management costs without being able to effectively scrutinize them. A similar model to the UK’s exists in the US, where client commission agreements (CCAs) are used. In both cases, the buy side builds “credits” with their CSA broker, and then directs the broker to allocate payment to its various service providers as appropriate.
No momentum At this point, much of Asia lacks the same regulatory framework for CSA usage. Graham points out that in some jurisdictions – such as Japan, Korea and Taiwan – CSAs are not accepted by regulators. In addition, he notes that even in countries that have been pushing regulatory reform recently, such as Australia, unbundling has not been adequately addressed. “There was some talk about unbundling in Japan but that has gone cold recently,” he says. “And in Australia, ASIC has really been focusing primarily on competition between the markets rather than brokers. There really isn’t a regulatory push for unbundling anywhere in the region.” The greatest use of CSAs in the Asian jurisdictions where they are permissible – Hong Kong, Singapore and Australia – has been by the big global fund managers, which have
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followed the lead of their affiliates in Europe and the US by using CSAs with their larger brokers.
Clever for clients Where unbundling is taking place, it is leveling the playing field for agency brokers and independent research providers, giving their clients the opportunity for improved execution quality and access to a broader range of research sources. “Prior to unbundling, it was not always easy for certain buy-side firms to understand why they should trade with a broker if it didn’t provide ideas and research,” says Graham. “But with CSAs, firms that provide high quality trade execution like Instinet have been able to attract more institutional order flow in Asia since the buy side is more focused on execution costs.” In addition, for those firms in Asia that are unbundling, Instinet has recently begun providing its T*Share commission aggregation system, which alleviates the headache of administrating multiple CSAs for buy-side firms. Nevertheless, Kramer warns that buy-side firms operating in Asia are still a long way from fully realising potential savings and finding efficiencies in their payment models. “There are still substantial cross-subsidies of execution and research on the part of the traditional banks,” he says, “and this can hurt buy-side performance, as has been seen in the many cases of stocks with a dozen Buy ratings and little to no Sells.”
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A Bargain At Half The Price The practice of bundling brokers’ research and execution services together cheats the end investor, finds Dan Barnes.
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sset managers can only demand improved execution performance from brokers if they can threaten to move execution to another broker, should the incumbent underperform. Where execution and research payments are bundled together, and the research is deemed worth paying for, the buy-side is stuck with the execution the broker chooses to provide. Best execution has become a competitive tool in many developed markets, driving unbundling of research and execution and allowing competition to drive service provision for asset managers. Commission sharing agreements (CSAs), which allow payments to be split between research and execution brokers, have become more popular as a result. “One of the main benefits of having CSAs is that they would be an efficient part of best execution; as it is standard practice in many Western markets, most of the leading global brokerages want to have it in Asia too,” says Anshuman Jaswal, senior analyst at research firm Celent. In most Asian Pacific markets, uptake has been slow. Best execution matures in a three-step process. Initially it starts off as fiduciary duty, in a broker doing a good job for his client. Then it becomes a regulatory burden, with something akin to the Markets in Financial Instruments Directive (MiFID) in Europe, or the Regulatory Guide 223 (RG223) produced by the Australian Securities and Investments Commission (ASIC) providing guidelines. Then, once the rules are established, the market has the chance to turn best execution into a competitive edge rather than a function of compliance. “We are seeing the rise of real-time execution consulting,” says Steve Grob, head of strategy at trading systems supplier Fidessa. “Rather than showing how well a trader is doing his job after 100 trades, he has tools on his desktop that can tell you in real time how an order is being executed. In a more complicated landscape with multiple venues, these tools can advise him to drop a trade in and out of different algos. It’s a more dynamic process than it has been.”
A guiding light In Asia, such ‘complicated landscapes’ are just starting to emerge, creating the imperative for best execution rules. Japan has seen the proprietary trading systems (PTSs) SBI
Japanext and Chi-X Japan increase their share of Japanese equity trading volume from 0.84% and 0.7% in January 2011 to 3.22% and 2.65% in January 2012, according to Thomson Reuters’ Equity Market Share Reporter. The progress may appear slow, but that is not too remarkable; there is no regulatory best execution obligation to route orders in Japanese markets, so although both markets can compete with the dominant Tokyo Stock Exchange (TSE) and smaller Osaka Securities Exchange (OSE) on cost, brokers are under no obligation to use them. These alternative venues are faced with a number of disadvantages. For example, when on 2 February 2012 the TSE halted trading for four hours, due to a technical problem with a market data feed, the PTS’s were also shut down by the Japan Securities Dealers Association, their regulator, while trading on the OSE remained open. “Ironically Japan is leading the region in the use of alternative trading destinations, but lagging in best-execution legislation,” says Glenn Lesko, CEO of execution-only broker, Instinet Asia. “Many Japanese firms don’t use the alternative venues. They often have the use of the primary market written into their best execution agreements, and if they buy more than 5% of a company’s stock offexchange they have to make a regulatory filing.” Australia, which saw competition to the incumbent Australian Securities Exchange introduced last October when Chi-X Australia launched, has specific best-execution guidelines, under RG223, but these are not effective at making the separation between execution and research, Lesko notes. “Many funds trade with brokers on the fully bundled model and select them on the basis of their access to research for deals; there is often little to demonstrate how trades are being allocated on a best execution basis,” he says. “There are standards for brokers now, but there is room for formal responsibility on the fund side as well.” Regulatory pressure to deliver unbundling itself is also muted in Asia. Celent says that 76% of US fund managers used CSAs in 2011, as did 83% of British fund managers; both countries incentivised their use following concern over conflicts of interest with brokers. “There is no one strong party who would argue for CSAs in Asia,” says Jaswal. “The greatest pressure is coming from the global brokerages.”
These big players are taking standardised practices from their home markets in the US and Europe and exporting them, he says. “They have not been completely successful; they have the ears of the regulators, and they have got them interested in Singapore and Hong Kong, and also some Asian brokerages are interested,” he observes. “However they have other priorities right now due to the tough market conditions, but there have been agreements to look at this again in the next year or so.”
Rights of the buy-side Those same market conditions that are dissuading the sell-side may be having the opposite effect on their buy-side clients, asserts Clare Rowsell, head of commission management services and marketing, Asia Pacific for broker and execution analysis provider, ITG. “There are a lot of business imperatives which are encouraging firms to move towards CSAs,” she says. “At an operational and business level we are seeing increased adoption and interest in how to set up these programmes. In the current environment commissions are much tighter and there is less to go around. Most fund managers are adopting a rigorous evaluation process of the brokers and research providers they use.” Rowsell says that this is leading to the processes for broker rating and research voting becoming better established, on a quarterly basis with fixed voting procedures and statistical weighting used to deliver improved accountability for what the buy-side is buying. “Buy-side firms are also trying to reduce the number of brokers on their broker panel, so there is more commission available to reward highly valued brokers,” she notes. “That requires them to work out who they want to carry on trading with, and then add CSA credits onto those trades. If they want to reduce the number of brokers on their panel, the CSA mechanism gives them the ability to still make payments to other brokers who are providing research and value often from one of the smaller or emerging markets.” The crisis has also meant that larger sell-side firms are often not servicing smaller boutique firms, leading them to look to independent research, while the number of independent research analysts is increasing as banks cut back head count.
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“The big sell-side firms don’t have analysts in place so that smaller buy-side firms can just pick up a phone to get a view on what’s happening with a particular Chinese stock today,” says Edward Stockreisser, director for Asia Pacific at Lombard Street Research and co-chair of AsiaIRP, the independent research analyst association. “The more people who get laid off by the banks, the more experienced analysts there are with an independent view.” Of course where there is opacity there is profit and brokers may well exert pressure the other way if feel they may be losing out. ITG estimates that for a buy-side firm trading
US$1 billion in equities, the additional costs for trading in Asia, rather than the US, would be close to US$4.6 million. There are also challenges to the model, argues Grob. “Unbundling sounds like a great idea but there are two fundamental problems with it,” he says. “One is, how do you pay instead for research. By the page? By the investment decisions you make? The second is that the buy-side prefer to pay in commission dollars because that comes out of their funds, not their own pockets. And I think the CSA model has an equal problem in that it lowers the incentive for
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the execution broker, at a time when he’s got to support the kit to keep navigating this landscape.” Nevertheless, the economics of successful research will win out asserts Stockreisser. “Asia is not one market; an analyst must have so much local knowledge to be effective,” he says. “You can’t have a French Bank, with a recently expatriated English analyst, based in Hong Kong, covering Korea and tell me that his is the best research available for tech stocks. As an investment manager you have to ask how you can get access to the Korean analyst who has been covering his technology sector for 20 years, and work out how to pay him.”
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Asia’s Fragmentation Footprint Q1 2012 Venue competition and fragmentation continued to evolve in Asia last quarter. Japan’s Proprietary Trading Systems (PTS) continue to garner market share and meaningful data out of Chi-X Australia is starting to emerge after only 5 months in operation. Also, competing brokers continue to access each other’s liquidity as you can read in our report that will try to measure the width and depth of Asia’s Fragmentation Footprint. Japan As the biggest and more dynamic competitive marketplace we start here. Total equity turnover in Japan rebounded from its December 2011 (US237 Billion) low to a February 2012 high (US365 Billion) and during that four months, according to Thomson Reuters Equity Market Share Reporter, the Tokyo Stock Exchange (TSE) breached less than 90% (89.55%) market share in January with the PTSs capturing a record 5.88% or US16.5 Billion. SBI Japannext (SBIJ) continues to hold its lead as the largest PTS in Japan. The primary seems to have regained more than 2% of market share as volumes returned to the equity market but the PTSs had only given up less than 1.5%. The Osaka Securities Exchange (OSE) now seems to be seeing its equity market share wane in the face of competition. The OSE is more focused on building its derivatives business than competition in the equity space. We think this is an error as Japan is large enough to support more competitors. If the exchange merger does go through the OSEs dwindling volume will be added to the TSE’s anyway. It remains to be seen if SBIJ can continue to grow its market share but the PTS did achieve a record on February 15 with daily turnover of US 715 Million or 3.5% of the TSE. SBIJ has retail flow in its venue through SBI Securities and operates a night session as well. Chi-X Japan appears to have stalled in terms of growth in market share since Aug 2011 averaging around 2.25%. The exact nature of the lack of growth isn’t known but we do know that that PTS has no retail flow at this time. SBIJ continues to have the lowest trade size of any of the venues at around US5,300 (Q1 average) supporting the notion that the amount of High Frequency Trading going on is higher than both Chi-X (US7,040) and OSE (US6,964). The Primary TSE has a Q1 tick size average of US17,445. This is slightly higher than last quarter (US16,894) but the longer term trend is decreasing with the onset of smart order routing and growing HFT community should
see tick sizes continue lower and PTS volume continue to grow. Instinet Japan’s dark pool trading data is readily available and volume continues to grow rapidly. Quarterly volume was almost equal to the entire volume in 2011 achieving almost US 1 Billion. Tick sizes remain lower than the PTSs averaging just US3,235 this quarter. Instinet is connected to Chi-X and would expect that volume growth and tick size might be reflected in the latter’s statistics but that doesn’t seem to be the case. It looks as though their darkpool has attracted their own HFT players trading against the primary or Nighthawk is effectively finding better prices throughout its network. Daiwa Routing Execution and Crossing Technology (DRECT) is apparently reporting matching rates of 13% in Japan where it launched in the middle of last year. As for data from the other broker internalizers in Japan we don’t have any further information.
Australia Data Down Under is starting to come in from Chi-X Australia. There is some discrepancy between Thomson Reuters Equity Share Market Report and the daily market update from Chi-X but we are confident enough to say that between 1-2% of market share is being executed on Chi-X already. The alternative’s March 30 daily report showed 1.5% market share valued at over US75 Million on 36,000 trades. While the data still needs time to grow we can see that more than 40% of the daily volume into Chi-X is anonymous and we believe this to be the likes of GETCO among other HFT players. Investment banks are also using this venue too and it also looks like they are trading against the anonymous flow. Average trade size from Chi-X’s March 30 report shows just US2,100. No price improvement information was made available and none of this data was double counted.
ASX Like most markets in Asia volumes in Australia grew this quarter after the December doldrums
growing from US56 Billion to a peak of US82 Billion at the end of February. While Chi-X appears to be chipping away at the market share stone the primary had some interesting developments this quarter too. ASX Average trade sizes grew slightly from last quarter from US5,563 to US5,923 in the face of the growing volume but the long term trend shows a decline in average trade size. The more interesting market structure segments spawn from the ASX’s Advance Order Type Report. Though we only had February’s data for this article there is information to share all the same. Centre Point the ASX’s dark pool continues to prove a valuable venue for execution. In February, double counted reported value breached US 2 Billion over 591,000 trades (average trade size US3,400). Our records indicate that the 3 biggest brokers accessing this venue, in order (avg trade size), are UBS (US2,900), Deutsche Securities (US3,000) and Citigroup (US3,950). Centre Point Crossing, the lit crossing venue using the mid-point from the CLOB for matching at 30 second intervals rebounded from the lows of last year but hasn’t recovered to a new high like Centre Point has. All the same, US1.3 Billion of double counted value was overturned on 195,903 trades in February. Because of the 30 second price interval the average tick sizes vary widely from broker to broker. In aggregate, the venue tick size for February was US6,400 but sell-sides such as Citi, Goldman and Morgan Stanley are averaging more than US1 million in average trade sizes some months at the very least matching Liquidnet’s reported average trade size for Asia of US1.2 Million. UBS and Credit Suisse are by far the largest users of this order type.
Hong Kong There really isn’t much to say about Hong Kong except we did have confirmation from the regulator that just over 2% is being internalized with the brokers. March turnover at
Asia Etrader z Q2 2012 z www.asiaetrading.com
EQUITIES
the HKEx was US119 Billion and 2% of that would be US2.38 Billion. If we assume 4 bps for commission we can see that the 19 brokers who are internalizing made about US952,000 or about US50,000 each this month. Average trade size on the HKEx was up to US14,300 this quarter compared to US12,600 Q42011. Instinet and JP Morgan did announce a reciprocal liquidity agreement this quarter to access Hong Kong, Japan and Australia. It’s no wonder in the face of the paltry commission they are earning under a large fixed cost.
Singapore Chi-ea st hasn’t published any new numbers since last quarter but expect an update sometime in April. We do know that volume is going the right way. Hopefully, we can have more for you in Q2. www.asiaetrading.com z Q2 2012 z Asia Etrader
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Equities
Is Fragmentation Finally Taking Hold In Japan? By Fidessa
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Source: Fidessa
hen Chi-X Australia formally opened up for trading in November 2011 it was always going to invite comparisons with Japan where it has been operational since July the previous year. But the approach of the regulators to multi-market trading is completely different between the two. In Australia, ASIC has gone down a deliberate path with a clear aim since it took over market supervision from the ASX in August 2010. In Japan, alternative venues (PTSs) have been around for nearly 15 years but it is only recently that the dial has started to move in terms of meaningful levels of trading moving away from the TSE. Japan’s PTSs haven’t had the benefit of a formal concept of best execution as exists in other countries. As a result, there is nothing to compel market participants to use them even if they do provide better prices. The PTS community is also hamstrung by the 5% Takeover Bid (TOB) rule that makes institutional buy-sides wary of purchasing stock anywhere other than on the TSE and another rule that obliges any alternative venue to become a fully-fledged investment exchange once it reaches 10% market share. Despite these impediments it looks like things may be about to change. The arrival of Chi-X, a global brand associated with successfully disrupting the status quo in Europe and Canada, prompted international brokerage firms (familiar with the Chi-X story elsewhere) to invest in the necessary smart technology to navigate between multiple markets. And, as we have seen elsewhere, liquidity begets liquidity. More important, though, has been the attitude of Japan’s FSA which seems slowly but surely to be levelling the playing field between the incumbent TSE and the alternatives led by SBI Japannext and Chi-X. In July 2010 it allowed the PTS community to participate in central clearing and a few months later it further softened its stance by removing a ban on short selling that only applied to these alternative venues. The introduction of arrowhead by the TSE has also, ironically, provided a boost for PTSs. The faster performance of arrowhead created a more HFT-friendly market and, as we know, high-frequency trading operates best across a multi-market environment. All these factors combined give the PTS venues a new-found legitimacy, confirmed by the fact that the Japan Security Dealers Association has revoked its previous ban on using PTSs if the primary market is unavailable for any reason, effective from April 2012. As the accompanying chart shows, the combined share of Chi-X and SBI Japannext in the Nikkei 225 is already approaching 5%. So will Japan see the levels of multi-market trading that is now commonplace in the US, Canada and Europe where no single venue dominates liquidity? It’s possible, but without a formalised best execution obligation on market participants it looks likely they will still have an uphill battle. Reclassification of PTS trading as ‘on-exchange’ would also help them get around the 5% TOB rule. So the answer lies with the regulators. Recent evidence suggests that they are trying to create a more multi-market friendly environment but, as with all things Japanese, it will take time. Asia Etrader z Q2 2012 z www.asiaetrading.com
258,265,031,806
609,116,514
Indonesia Stock Exchange
Korea Exchange
www.asiaetrading.com z Q2 2012 z Asia Etrader
Osaka Securities Exchange
Philippine Stock Exchange
Sinagpore Exchange
Shanghai Stock Exchange
Shenzen Stock Exchange
Taiwan Stock Exchage
Stock Exchange of Thailand
Tokyo Stock Exchange
Average Trade Size Q1 2012 (USD)
6,650
1,043
Hanoi Stock Exchange
Hochiminh Stock Exchange
Hong Kong Exchanges
Indonesia Stock Exchange
Korea Exchange
5,801
Bursa Malysia
New Zealand Exchange
National Stock Exchange of India
Osaka Securities Exchange
Philippine Stock Exchange
Sinagpore Exchange
Shanghai Stock Exchange
Shenzen Stock Exchange
Taiwan Stock Exchage
Stock Exchange of Thailand
Tokyo Stock Exchange
18,322
5,983
17,637
7,443
2,891
11,547
6,743
7,169
1,489
10,220
1,208
KOSDAQ
3,621
3,415
14,532
2,834
616
BSE
Australian Securities Exchange
998,845,324,034
55,685,300,287
224,192,502,378
701,695,705,056
913,300,696,930
69,035,066,217
8,061,481,638
51,552,718,664
147,784,752,777
19,426
7,646
18,824
9,165
2,887
18,920
7,852
8,462
1,444
7,197
6,277
1,363
4,604
3,910
15,712
2,883
1,106
688
7,271
Share Volume Q1 2012
Share Volume 2011 QA Net
Number Trades Q1 2012
QA Trades 2011 Net
1,477,430,500
856,744,825
620,685,675
584,078
128,116
497,033 205,982
455,963
6,964,048 299,895
33,512,717,789
9,845,428,825
91,548,088
28,442,353
51,514,039,074
704,015,156 36,826,190,231
749,497,409 14,687,848,843
390,997,491,976
250,486,677,557
140,510,814,420
102,354,561
8,052,585
1,692,153
1,026,740
665,413
6,198,345 6,092,266 106,080
110,407,145
-45,482,253 173,456 151,874 21,582
234,438,389,970
225,880,398,145
8,557,991,825
9,728,500
7,283,273
2,445,227
Share Trade Size 2011 QA
Change
467
4,059
973
360
4,935
18
107
-876
2,214
1,828
385
-1,104 2,567 2,387 180
-1,663 24,098 31,014 -6,915
-1,187 13,964 13,920 44
-1,722 4,847 4,866 -19
4
-7,373 18,006 19,774 -1,768
-1,109 231,065 243,963 -12,898
-1,293 992
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3,023
-476 14,850 11,574 3,276
-154 361 366 -5
-983 365 276 89
-495 27,518 33,380 -5,862
-1,180 25,934 29,034 -3,100
-49 4,283 3,301 982
-63 2,530 1,879 651
-72 311 299 13
-620 2,886 3,579 -693
Average Trade Size Size Q1 2012
-363,365,361,916 3,185,160,205,548 3,042,854,926,913 142,305,278,635 893,209,673
887,340,343 5,869,330
-25,549,217,799 136,344,047,265 122,738,179,353 13,605,867,912 53,121,345 51,417,256 1,704,090
2,519,674,547
-15,340,546,601 165,354,464,900 165,785,370,075 -430,905,175 11,841,769 11,909,878 -68,109
-49,579,470,653 424,659,393,589 372,572,920,569 52,086,473,020 87,613,471 76,563,314 11,050,157
-166,953,787,181 571,532,751,701 578,390,425,541 -6,857,673,840 258,202,957 316,392,197 -58,189,240
-830,310,851 106,357,937,710 72,152,784,163 34,205,153,547 5,906,658 3,648,852 2,257,806
3,347,999,331
119,990,441
84,347,702,600 59,433,435,000 24,914,267,600 5,679,985 5,134,896 545,089
43,358,146,614
-7,115,826,699 6,147,231,313 5,929,988,854 217,242,459
16,598,784,253
679,759,082
719,959,561
20,249,730,649
-63,236,881,814 34,336,021,562 24,195,408,945 10,140,612,617 94,042,608 87,704,417 6,338,191
-2,424,493,773 199,892,157,858 232,460,045,819 -32,567,887,961 7,263,943
-41,948,513,616 600,520,371,836 699,333,298,923 -98,812,927,087 23,155,330 24,086,292 -930,962
559,388,292 3,011,068,530 1,640,895,080 1,370,173,450 703,014
104,845,634
-1,336,064,678 18,078,873,716 16,108,942,811 1,969,930,905 58,070,540 53,934,343 4,136,197
-33,830,389,599 112,088,669,678 143,801,005,825 -31,712,336,147 38,833,935 40,175,056 -1,341,121
Average Trade Size QA (USD) Change
4,105,439,637,745 4,468,804,999,661
973,296,106,235
58,204,974,834
208,851,955,777
652,116,234,403
746,346,909,749
68,204,755,366
11,409,480,969
44,436,891,965
Exchange
Total
National Stock Exchange of India
1,093,042,185
1,772,801,267
New Zealand Exchange
164,383,537,030
32,951,715,002 32,231,755,442
124,743,342,271
144,993,072,920
Bursa Malysia
403,785,924,173
KOSDAQ
340,549,042,359
27,231,234,717
378,452,278,541
336,503,764,925
Hong Kong Exchanges
24,806,740,944
1,992,223,489 1,432,835,197
504,270,881
37,081,346,869
292,095,421,405
Value Share Trading 2011 QA (USD) Net
Hochiminh
Hanoi Stock Exchange
35,745,282,191
BSE
Australian Securities Exchange
Value Share Trading Q1 2012 (USD)
Exchange
Equities
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Equity Trading Recap
Source: Thomson Reuters Equity Market Share Reporter
* Quarterly Average
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equities
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OPInIOn POLL
Opinion Poll 1
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Visit: http://www.AsiaEtrading.com/opinion-polls/ Vote on the latest Opinion Poll
Should Standardised OTC Derivatives Trading Be Mandated to Clear Through CCPs?
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he impetus for the Global Financial Crisis (GFC) was the poor oversight and risk management of OTC derivatives by the banks. Previous financial shocks such as the Enron collapse precipitated the energy business to move away from bilateral trading to central clearing to see the likes of ICE Clear and ClearPort succeed. The destruction of wealth that had affected those far removed from these markets post-GFC has heralded an across-the-board reform of all OTC products in all corners of the globe. One of the central questions with respect to this reform is whether or not all standardized OTC derivatives trading should be cleared through a central counter party or a clearing house. We asked this question in our second opinion poll of the year that ran from mid February to the end of March and this was the outcome. Nearly 74% of those votes felt that yes, some or all standardized OTC derivatives should go through a clearing house. Bad news for dealers
but good news for clearing houses. However, a scenario such as this raises a lot of questions. What products are considered standard? Who will be exempt? What jurisdiction will clearing fall under? Will these CCPs become to big to fail? Will firms have enough money to post margin or how do you characterize a derivative in the first place? Clearly, there is no simple answer and the global nature of this kind of business exponentially complicates the issue. We would have to concur that there is room for some products to move to a CCP but we think it should be a measured approach with vanilla contracts moving across first. Much of the regulatory proposals are seeking to centrally clear by the end of the year but that isn’t realistic. The third most popular response, though with only 14.04%, was the ‘No costs will go up’ camp. With the investment in risk management platforms, reporting systems and processing and storage of the sheer volume of transactions there is some merit to these voters response. We could look at it this way, however. The cost of the GFC would
have more than paid the bill for the move of OTC trading to clearing houses. After the initial investment the visibility into positions and the ability to manage the risk will, in our opinion, over the long run reduce average costs to the industry and likely bring about some financial innovations not possible otherwise. 7.02% of respondents believed the moving to a CCP model wasn’t necessary. Perhaps, the added costs and the nature of some of these OTC products won’t make any changes to the market necessary. These will have to be identified as the reforms evolve. Lastly, with only 5.26% of voters not sure clearly most people have a view and those that don’t probably are waiting to get all the facts. What is clear in the results of this opinion poll is that the industry feels that OTC derivatives trading needs to be managed differently than it has been in the past. The Singapore Exchange and Australian Securities Exchange along with data vendors and risk systems stand to benefit in the changes bearing down upon us.
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OPInIOn POLL
Opinion Poll 2 Who Should Pay ASICs Inflated Regulatory Costs?
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ustralia has arguably had one of the most sweeping regulatory reforms to accommodate exchange competition in any market in the world. Because of consultation with the industry and a national election that extended reforms across four years to come up with the Market Integrity Rules (MIR) Chi-X Australia was allowed to compete against the incumbent having sent its first trade 31 October 2011. As part of this reform the Australian Securities Exchange (ASX) handed over self regulation of its business to the Australian Securities and Investment Commission (ASIC) 1 August 2010. Despite the lengthy process of creating a competitive regulatory framework, on 1 January 2012 the regulator quietly told market operators and participants without warning that a transaction tax to claw back regulatory costs would be imposed. We ran this poll over the first six weeks of the year to find out from the industry who should pay these extra regulatory costs.
It is clear that the industry feels that either the government with 37.5% of the votes or the regulator with 29.2% of the votes should bear the cost and we agree. The purpose of a financial regulator is to create and enforce policies that maintain the integrity of the capital markets. The ASIC website even says “We contribute to Australia’s economic reputation and wellbeing by ensuring that Australia’s financial markets are fair and transparent” We don’t know that penalizing one market operator more than the other is fair and we don’t know that quietly imposing a tax without consulting the market is transparent either. There were those that believed the exchange or market operators should foot the bill but they only represented 12.5% of the voters. ASX could certainly afford it but can Chi-X whose target market are high frequency traders? We were surprised to see that the buy-side came in as the third most voted selection in the opinion poll though with only 14.6% of respondents. Perhaps their thinking was that the high frequency trading firms should be paying the fee as the nature of
the tax is transaction based. The fee structure is only limited to display equity transactions leaving dark pool and derivatives trades alone (See Article: Australia’s Invisible Transaction Tax?). The brokers will be encouraged to see that only 6.5% of respondents believed they should cover ASICs extra regulatory burden. It’s just as well as it’s been the brokers that have had to pay for the added infrastructure of connectivity, market data feeds and smart order routing already in the face of lower trading volumes and fierce competition. In the end these costs are going to filter down to the little guy in either higher costs of commission or wider spreads in the market impacting liquidity and increasing volatility. The unexpected and unilateral decision by ASIC has actuality pushed Australia’s market structure back in some respects rather than pushing it forward damaging its “economic reputation and well being” to some degree. We think the question begs have these regulatory costs actually negated the cost savings and efficiency in a competitive Australian market? Time will tell.
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opinion poll
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Expert Opinion Who Should Pay ASICs Inflated Regulatory Costs?
Head of APAC Market Structure, Deutsche Bank AG jessica.morrison@db.com
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hen the Australian government agreed to introduce exchange competition, it was persuaded the market would benefit from a resulting increase in innovation, choice and improved market quality with a positive impact on market depth, liquidity and price formation. Additional market participants would be attracted to opportunities presented via new trading strategies and any additional costs resulting from the increased supervision would be more than offset by the expected cost savings. The Australian equities markets has indeed taken strides in relation to choice with the Australian Securities Exchange (ASX) launching a range of new initiatives including the highly successful CentrePoint (a mid-point match that saves half the spread), VolumeMatch (a block execution facility) and most recently the low latency PureMatch platform. Chi-x Australia has been up and running since October 2011 and has captured around 2% market share. On the cost front, the ASX lowered their fees for trades executed on the central order book from 0.28bps to 0.15bps from June 2010, a saving of 0.13 bps for each side. Chi-x is operating a maker/ taker model where those providing liquidity can benefit from lower transaction costs than those removing liquidity. ASX reported the average cash market trading clearing and settlement fee has come down steadily from AU$3.25 in 2006
to just AU$0.93 in 2011. On the surface it looks like the purported cost saving benefits have in fact come to fruition. What is now sinking in is the reality of an estimated AU29.8 million bill for the period 1st January 2012 to 30th June 2013 to go on top of the AU12.2 million already spent from August 2010 to December 2011, as disclosed in the ‘Proposed financial market supervision cost recovery model’ consultation paper released by the Treasury in August 2011. The paper proposes that 84% of these costs should be allocated to market participants on the basis that the majority relates to surveillance of their activities. Market operators will make up the remaining 16% and although there has been a contribution of AU4.2 million from the National Guarantee Fund and the Australian Securities Exchange Fidelity Fund, the paper does not include a proposal for any further help being given to the industry supporting 100% of the costs going forward. Historically, exchanges have covered their costs, including supervision, by charging on a per trade basis. In ASX Limited’s 2011 Annual Report, it was stated that the 11.2%, or AU16.9 million, decrease in the Cash Market revenue was primarily due to the above mentioned reduction of fees given there was not a significant difference in traded value from 2010 to 2011 with just under AU1,400 billion being traded each year. ASIC took on their additional responsibilities on 1st August 2010 and although real-time monitoring is unarguably new to ASIC, supervision of compliance with the regulatory framework including investigating market abuse and bringing enforcement actions have always been rightfully in the domain of the regulator albeit with the help of the venues. The cost recovery proposal includes recovery for these activities as well as the new supervisory costs. Under the Government’s Cost Recovery Guidelines, entities should set charges to recover costs where it is ‘efficient and effective to do so [and] where the beneficiaries are a narrow and identifiable group’. The cost proposal breaks out the guiding principles and points to specific areas where the paper reflects this guidance. Interestingly, the ‘narrow and identifiable group’ is not included in the table of key principals which begs the question of whether the benefit can be attributed to such a group. Given Senator Bill Shorten’s introductory comments describing competition as necessary for an efficient
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Australian financial market, it could be said that the beneficiaries are far from a narrow group but are in fact a wide community. Later in the paper, the net impact of competition on investors and issuers is described as ‘very likely to be positive and large in net terms’ yet they do not seem to have to pay a share of the costs. The proposal that has caused the most industry debate is the potential charge for all messages submitted to the trading venues. The Treasury state basing a charge on message count should ‘encourage market participants to more carefully consider how they are consuming ASIC’s [IT] capacity, and in turn the capacityrelated costs that message traffic may impose on the entire industry’. This idea has been taken from IOSCO’s paper released in July 2011 titled ‘Regulatory issues raised by the Impact of Technological Changes on Market Integrity and Efficiency’ which said the ‘increased messaging that has come with the extensive use of algorithms raises costs for many participants, including marketplaces, vendors and competent authorities [...] is especially true with respect to HFT.’ The ASX have not suggested that they are going to look to recover any of the decreased revenues through the introduction of a charge for entering, amending or deleting an order but this possibility should not be ruled out as other global venues are putting forward such proposals. Direct Edge, the fourth largest U.S. venue, may start to target order to execution ratios giving a less favourable rebate to those with rates in excess of 100 to 1. Brokers would earn one cent less for every 100 shares, with the exception of market makers who will not be subject to the new proposal. These sentiments are also present in Asia with the Shanghai Stock Exchange imposing trading limits on HFT firms which cancel a high proportion of orders. So who really is bearing the cost of competition? Without getting into the debate around the value of HFT, it would seem that these are the strategies that will bear the brunt of the costs. It does not seem clear that the range of beneficiaries are paying, and the costs being recovered are wider than those relating to the new ASIC responsibilities. These costs will inevitably seep through to investors as they are passed from regulator to broker, to investment manger, to investor. In time it will be interesting to see whether the costs are truly offset by the savings as promised.
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post trade
Cutting The Post Trade Drag On Broking Low volumes, high fixed costs and intense competition have taken their toll on the broking industry. Implementing some strategic steps to optimise post trade could save the day, writes Paul Egan
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he sustainability of equities broking industry in APAC is under threat. We have already witnessed several bloodied noses from equity broking, where the original aim of world or regional domination just hasn’t reconciled with the reality of fluctuating volumes and intense competition not to mention the high fixed cost burdening each firm. Although blame in a brokerage firm tends to run downstream, in the case of equities, the truth is pretty startling for the sell-side: Post Trade comprises 65% of the all-in cost of an equity transaction. However for equities, responsibility for such a high cost of post trade processing lies, as its name implies, with everyone. The problems are magnified when we focus on Asia Pacific as this region delivers complexity, volume, investment return and heterogeneous market infrastructures. At the crux of the matter has been the hitherto approach taken by individual broking firms in addressing post trade processing costs. For starters, this issue affects ALL brokers, yet besides the occasional post trade panel discussion yielding a cry to arms, there is scant evidence of any industry-led approach. Several straw polls I have conducted over the past few years have evidenced a growing indifference within the broking community to manage post trade operations in-house. No longer viewed as a competitive advantage then, one would have thought that a more cohesive approach by the industry would be the logical start. This is especially relevant when we consider the traditional approach being to target cost reduction through ad hoc lobbying for lower fees at the infrastructures, such as exchanges and their (often siloed) Central Counterparties (CCP) and Central Securities Depositories (CSDs), swiftly followed by pressuring service providers such as custodian banks, technology vendors etc. Now while having your service providers cut fees is a quick kill, this can also be bolstered by some more strategic steps to optimise post trade. For the simplicity’s sake, we can simplify
the benefits of achieving these efficiencies by focussing on 3 APAC markets, which account for the greatest settlement instructions volume in the region: Japan (84M), Hong Kong (22.5M), Australia (15M) and the highest percentage of institutional participation. We also will make a conservative assumption that only 50% of domestic settlements in each of these 3 markets are institutional and ‘fair game’.
Squeezing the Infrastructures Let’s start back to front…CSDs tend to be responsible for effecting settlement transfers instructed by their participants. It is neither their responsibility nor should it be to net down transactions – the exchange end, this falls to the CCP – instead they simply charge per settlement and sometimes bulk this up through pre-matching fees which they generate. The reality in APAC is that clearing (at the CCP) and settlement (at the CSD) charges are far higher than Europe or North America, often excessively so, which is why this has been the obvious place to aim at when trying to reduce post trade costs. With the exception of Japan (JSCC and JASDEC being viewed as non-siloed) all other post trade infrastructures are owned by the exchange. If we looked again into investment distribution (R&D), we would find that the exchanges tend to mirror their member firms, ploughing most investment dollars into the front end, with minimal investment in post trade infrastructure. Similarly on a cost per trade basis, exchanges tend to reflect their trading participant’s ratio of execution v post trade of 35% v 65% (At the ASX for example, the published execution cost per trade in 2011 was 29%, remainder being clearance and settlement). For their part, in anticipation of competition from alternative execution venues (AEVs), exchanges have tried to enhance market velocity (liquidity and turnover) and attract High Frequency Trading (HFT) business by investment in their trading platform, increasing capacity etc. However unless post trade costs are lowered, the frictional cost of trading will remain high. It is therefore also in the interests of the
infrastructures to replicate what they have done in the front and invest in efficiency in post trade processing AND lower fees. Taking our 3 markets as an example, were CSDs to heed this efficiency call investing for the future, with say, a 20% reduction in fees, the yield from this would be approximately $50-million for institutional business. However we shouldn’t rest on our laurels hoping to be rescued by such foresight, so let’s move closer to home and address the issue of settlement congestion.
Offshore vs Onshore We now move onto the CSD participants, whether Domestic or “Glocal” institutions, who are responsible for in-country settlement of all trades. Typically these service providers are paid through settlement and custody fees which are typically unbundled with the CSD charges. This clearly isn’t the only source of revenue as Transaction Banking is all about sitting on and converting (FX) client money, no more so than in emerging markets. Unlike infrastructures though, such service providers (sub custodians) live in a very competitive world, for not only can the broker/Global Custodian client migrate to a competitor, they can join the CSD themselves and self-operate. Indeed we have seen in recent years that the resolve of subcustodians to maintain the status quo albeit with reduced settlement fees and not deliver enough efficiency has seen a drive to consolidate business in-house, be it Global Custodians building out their local sub-custody footprint, or Brokers consolidating business with their Glocal Broker (HK, Japan and Australia provide clear examples). Translated: Sub-custodians by not delivering proactive processing efficiencies to their clients are losing out to self-operating and their universe is shrinking. Traditionally trades on behalf of the international broker have been settled by a sub-custodian, primarily to leverage the subcustodian’s STP messaging (i.e. SWIFT), corporate action and treasury capabilities. But as technology enhancements (migrating the local broker platform to the international
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post trade
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up, not just in APAC, but globally. Equipped with timely ETC information, the offshore netting engine would provide easy access to smaller fund managers (especially if there was a web portal for easy interfacing/access) and brokers, and at say, 10 cents an allocation could derive ETC fee reductions for the industry in the region of a further $50m, let alone the benefits (commercial and psychological) gleaned through consolidation Reference Data functions into an industry wide Repository.
Industrial Scale Processing
broker’s global system) and trade volumes increase, the drive to e self-operate has proved too irresistible. Nevertheless, there is still a need to analyse often high settlement volume between international and executing brokers and look to net down/bulk trades per stock to economise on costs. But it is not only trades between a local exchange member and the international broker where we should focus, but also between the investor’s global custodian and the international broker (either settled through its local affiliate or a sub-custodian). The millions of institutional settlements comprising allocations per fund between buy and sell side typically settle gross at the CSD. I characterise such settlements as ‘offshore’ given both counterparties are non-local and suggest that these could be condensed offshore into a bulk/net settlement between CSD participants onshore. Fee savings at a minimum would be in processing volume, CSD charges (both pre-matching and settlement). Providing bulking/netting efficiency between international brokers and global custodians could deliver a combined $150 million in cost savings from CSD charges (i.e. reduced settlements at the CSD) and sub-custodian settlement fees. The message for subcustodians being quite clear: help us economise offshore versus onshore settlements, otherwise the threat of self-operating increases. As to the ‘how’ in achieving this utopian state, we next move closer up the value chain to post execution – allocations & confirmations.
Trade Repository The past decade has witnessed a technology inspired migration from ‘Straight To Printer’, to ‘Straight Through Processing’. Whilst this has delivered perceived benefits in terms of automation more so reduced human error, it has also delivered higher costs to the industry.
OMGEO have enabled significant automation of the middle office function of Electronic Trade Confirmations (ETCs) cutting down on staff and settlement fails, however this has also come at a hefty $1.00 per allocation to buy/sell side (OMGEO/IRESS etc). As with other post trade practices, the immobility in changing the way things are done is prompting the industry to consider alternatives, however that is no easy task. Given that only 50% of trade allocations are automated through ETC providers, there is still some way to go to deliver automation – possible reason for this reticence to implement ETC is the cost to smaller firms to implement such systems. Is there anything else then which can be provided to reduce this high post trade cost element. The obvious place to look for help would be with the Global custodians as they are the ones who safekeep at the individual fund level. The brokers frankly don’t get paid to split an order into 10 settlements per fund, they are more interested in delivering best execution, which is embodied in the latest R&D induced craze termed in Transaction Cost Analysis. In fact one of the many bugbears of brokers is the transaction charges they must incur, despite the fact that they earn fees based on an ad valorum tariff. When it comes to sorting out post trade for institutional fund managers, it’s the Global Custodians who are at the centre of things. Fund Allocation, daily NAV calculation, contractual settlement…it all happens offshore, so why shouldn’t the responsibility to help manage the allocations process and indeed manage the centralisation of reference data for the industry? Any firm bold enough to invest say $10 million in a matching/netting engine (for offshore v onshore as above) and repository of fund reference data details should in theory clean
www.asiaetrading.com z Q2 2012 z Asia Etrader
Such is the pressure on the sell-side that, were there to be a suitable solution to providing Middle & Back office services, not only for offshore, but supporting local broking operations in-country, they would jump at the opportunity. While there are viable solutions for the smaller brokers both in APAC and Europe, there doesn’t seem to be any large scale player able to absorb mid-tier broking operations and large sized players. With Penson closing down in Europe (where the need for outsourced solutions is far less due to centralised operations for the region), and other providers not able to crack the tier 1 brokers, it is difficult to see the solution coming from anywhere else but within the APAC broking industry, which can provide expertise, independent scale processing and commitment to invest in the necessary infrastructure to succeed. There are several third party technology platforms already available to support the equities business, which coupled with expertise and efficient management could just work. If the belief holds that post trade is not a competitive advantage, but more a matter of delivering efficient operational support, then the time must be right to build an independent Post Trade platform which delivers settlement finality at a fraction of the current cost.
The Opportunity Starting with the assumption that the all-in APAC industry spend on post trade services for equities by the sell side approximates US$650 million, we can build a financial straw man case for creating a Post Trade White Knight for institutional broking in APAC. Potential savings would be provided through solutions from Infrastructures at US$50m; Offshore Netting at US$150m; Trade Repository at US$50m. If we take 50% of these numbers to represent the savings for the sell side and then add in a 20% saving gleaned through Industrial Scale Processing then we have reduced the Post Trade Cost for the industry in 3 of the markets in APAC by 35% or US$230 million.
50
regulatory
Australia’s Invisible Transaction Tax? Australia has effectively imposed a transaction tax, say market participants, that will punish high frequency trading (HFT) firms and venues competing with country’s incumbent exchange. Dan Barnes writes.
“They are using a very imperfect proxy; what they are doing is taxing messages for cash equities, while the equity options markets and futures markets go unscathed,” says Peter Fowler, chief operations officer at Chi-X Australia, a rival venue to the ASX that opened on 31 October 2011. “There are no taxes on messages or trades done in dark pools. ASIC have taken one narrow segment, and they are taxing trades and messages in that narrow segment only.”
Breaking down the figures
Hon. Wayne Swan MP Treasurer Australia
O
n 30 January 2011, Wayne Swan, Australia’s treasurer said, “The Government has no plans to introduce a financial transaction tax.” Market sources claim this is borderline semantics. A fee has applied to both capital market transactions and the messages used to arrange those transactions since 1 January 2011, something traders believe could stifle new market participants and trading venues. The levy, agreed by the government’s Treasury, is intended to pay for the costs of Australian Securities and Investment Commission (ASIC), the national regulator, to supervise the financial markets, a responsibility it took over on 1 August 2010 from the Australian Securities Exchange (ASX). The difference between a tax and this cost recovery model, the principles of which were established by the Australian government in 2002, is that a tax does not need to directly reflect outgoing costs. The degree to which costs are just being recovered is disputed.
“In practice, financial services fees and charges already cover far in excess of what is required to fund their regulation,” says Duncan Fairweather, executive director at sell-side trade body, the Australian Financial Markets Association. “ASIC is a profit centre for the Government that delivered non-taxation revenue of almost A$532 million in the form of fees to consolidated revenue in FY2010/11 which is well over A$100 million in excess of what it costs to run ASIC. Talk of ‘cost recovery’ in this context is misleading.” ASIC and the Treasury offered no comment in response to this claim, beyond Swan’s original statement. Under the cost recovery model, when insufficient information is available to formulate prices that reflect the cost drivers precisely, a proxy is allowed to be used. In this case the proxy for non-IT related costs is a charge for the proportion of transactions; for IT related costs a charge is levied per proportion of messages, which includes trades, order entry, order amends and order deletion or cancellations.
Transaction and message fees only make up part of the fees. The total costs incurred by the regulator have been added up and payment of them is being allocated in a proportional manner. Cost recovery for the futures market operator, ASX 24, and the small financial markets is achieved purely though fixed charges. The rest of the ASIC fees affect the Chi-X Australia and ASX market operators and the equity market participants. Each of these two groups faces charges based on the degree of involvement they have for each regulatory function. For example, the Markets Disciplinary Panel is purely focussed on market participants and so no costs are recovered from market operators to support it. ASIC has calculated that the total costs it intends to recover for the period of 1 January 2012 to 30 June 2013, which relate to the transfer of supervision and the implementation of market supervision, come to A$26.53 million. A further A$6.08 million from implementing market competition will be recovered over the2013-14 and 2014-15 financial years. The regulator says it expects to recover 14% (A$3.72 million) of the total costs from the market operators and 86% (A$22.81 million) of costs from market participants, calculated according to the proportion of regulatory functions that each group uses. For the non-IT costs, the two main markets are both faced with fixed and activitybased charges. The fixed charges are A$44,310 per quarter for ASX and A$72,730 per quarter for Chi-X Australia. The regulator says that the lower costs for the incumbent exchange are a result of existing connectivity being used, that was originally put in place
Asia Etrader z Q2 2012 z www.asiaetrading.com
regulatory
to facilitate the transfer of market supervision to ASIC. The activity-based fee is calculated by taking each market’s share of the non-IT costs, multiplied by the number of transactions made on their platform, divided by the number of transactions made across all markets. Market participants also face activity-based transaction costs, calculated in a similar manner, but with the number of trades they have executed replacing the number of trades made on their platform, in the equation. For IT costs, the proportion of messages that market operators and participants produce, as measured by ASIC’s integrated market surveillance system (IMSS), is used to determine each firm’s contribution. The total will be A$1.29 million for operators and A$7.89 million for participants. Fowler says, “I don’t have a detailed analysis of the ASIC costs. They seem to be extremely high and set against the cost that ASX said it was incurring when it supervised the market, this suggests a fair degree of over-recovery.” Fairweather concurs, observing, “Since ASIC has taken over market supervision in 2011 from the ASX the cost of exchange supervision charged to participating brokers has risen from around $A5 million to over $A18 million per year.”
price and volume that a firm is trading at so they can take advantage of that information; intention is hard to prove. “There is a lot of concern about HFT, how it interacts with flow both in the central limit order book and in some of the broker dark-pools, although it is not very well understood,” said Sam Macqueen head of Liquidnet Australia, the buy-side block trading venue. “The buyside aren’t particularly unhappy about [these fees] and the impact they have had on high frequency firms.” Liquidnet, which allows buy-side firms to trade large blocks of equities anonymously preventing them from being ‘gamed’, says it has seen an uptick in the average daily principal traded by 57% for the three months since Chi-X launched, compared to the four months prior. Liquidnet operates as a market participant, and although large values of stocks are traded through it, the small number of high value transactions, typically over A$1 million, limits the pain of the transaction fees. Nevertheless, buy-side firms that trade long may also find their execution options limited.
51
With costs attached to the use of messages, placing and potentially cancelling unfilled orders on a venue like Chi-X Australia with low liquidity levels becomes expensive and possibly counter to a broker’s best execution obligations. “You have a fiduciary responsibility to get best execution, and part of that best execution takes into account best price,” Laible says. “There may come a point in time when the incremental gain of getting best price is not outweighed by the fees associated with incremental transactions.” The harm that this may cause to Chi-X’s Australian operations would run counter to the Government’s stated policy that it is encouraging competition in the country’s markets. Resolving that political dissonance could require a government rethink, however observers are sceptical. “Historically, Australia has made the process for Chi-X to get up and running an onerous one,” Laible observes. “It took four years to launch. Is it completely out of the blue that they could propose something that could be perceived as being detrimental to Chi-X? You can decide that for yourself!”
ASIC’s Competition Cost Recovery
Market impact
* 84% of costs allocated to market participants
Not only are these costs said to be high, it is also argued that they are overly punitive on particular types of trading strategy and trading venues. “For someone who doesn’t have a long-term time horizon for stock value to increase, whose alpha is not based on the stock doubling the stock value but rather is based on capturing the spread, these transaction and messaging costs can severely impact the profitability of trades,” says Rob Laible, global co-head for electronic trading at Japanese broker, Nomura. This kind of trading, typical of HFT firms, is effectively short-term market making, he notes, which can narrow spreads, helping investors that buy small amounts of shares at time such as retail investors. These individuals could be disadvantaged if market-making type players were to be prevented from entering the market. For Chi-X Australia this also could pose a serious threat; Getco, an electronic HFT market-making firm has been reported as providing around 30% of liquidity on the venue. However not all investors welcome HFT firms. Long-only buy-side firms have voiced concern about the way that HFT firms operate, placing a massive number of small orders on a venue, the majority of which are then cancelled. In doing this, HFT firms might be trading as close to the price as possible or they might be finding out the
* 16% of costs allocated to market operators * AU29.8 million expected costs between January 2012 and June 2013 * AU12.2 million spent between August 2010 to December 2011 * AU4.2 million given from the National Guarantee Fund and the Australian Securities Exchange Fidelity Fund * Transaction type fee based on volume * Chi-X fixed fee component AU72,730 * Charged quarterly in arrears * Fee Equation Participant A’s quarterly fee = Participant A’s share of ASIC’s total participant related non-IT costs + Participant A’s share of ASIC’s total participant related IT costs. Which means – [$2,486,069 * (multiplied by) No. of transactions for equity securities executed on or reported to the ASX and Chi-X cash equities markets by Participant A during the quarter / (divided by) Total no. of transactions for equity securities executed on or reported to the ASX and Chi-X cash equities markets by all participants during the quarter (as recognised by ASIC’s real-time integrated market surveillance system)] + (plus) [$1,314,876 * (multiplied by) No. of messages by Participant A for equity securities) in the ASX and Chi-X cash equities markets during the quarter / (divided by) Total no. of messages by all participants for equity securities in the markets during the quarter (as recognised by ASIC’s real-time integrated market surveillance system)] Source: ASIC website
www.asiaetrading.com z Q2 2012 z Asia Etrader
52
Technology
Compliance System: How Can The IT Department Help? The old proverb “garbage in, garbage out” still holds as the quality of your monitoring will depend on the data you feed the system with.
I
n the current market environment, compliance is in the front line. All entities executing transactions on a regulated exchange are bound to follow the market monitoring regulation on trading. Sometimes this regulatory duty is subject to legal interpretation, so the rule of “better safe than sorry” prevails. IT service providers are providing monitoring tools that raised alerts in case of market manipulation, insider trading, crossing breach… Solutions are mature for most of the products such as equities and derivatives. You have the choice to monitor manually or build your own basic tool and this is recommended for low volume. For high volume, some vendors offer cloud solution over the Internet providing the IT as a service. The advantage of cloud technology is multiple: capacity, monitoring, redundancy, availability, disaster recovery, support, security, procedures, incident and change management are all externalized. Cloud computing provides an efficient, flexible, and cost-effective way for IT to meet escalating business needs.
The path to success This is however not the end of the story. The old proverb “garbage in, garbage out” still holds as the quality of your monitoring will depend on the data you feed the system with. Compliance systems are expecting several types of feed: pre and post exec orders, static data and market data. Compliance systems providers usually have signed contracts with external market data providers and these costs are passed on customers. Pre-exec orders may be sufficient if the quality of the data is consistent with the requirements of the system. At this level, static data mapping may be required for fields containing data such as product, exchange, price, strike or clients information. Financial company may build their own referential of static data internally with some data gathered externally such as the Reuters Instrument Code for the product. This referential is not to be taken lightly: the right information should exist
at the right time, any change of the data must be review appropriately, a dedicated team with proper processes and procedures must be held responsible. If the data is not available easily upfront, the financial company will have to dig deeper into its workflow. Workflow here encompasses multiple execution platform, opaque back-office systems, layers of database and datawarehouse… Developments are essentially database and programming scripts, sometimes object programing in Java or C++. The difficulty is to link the data together and by experience finding the unique key between a pre and post trade executed is a challenge. This difficulty is due first to the fact that each exchange and each trading platform has its own rules and data normalization, second to the trading configuration of the financial institution (omnibus account for example), lastly to the cost of having all data into the financial institution internal systems. And even if the cost of storage may be irrelevant today, legacy systems where performance were reach by cutting all extra are still predominant in most middle and back office workflow.
How much can I rely on my system? Compliance systems are as good as the parameters you define in them. Parameters such as thresholds of volume or percentage of price movement for market manipulation need some serious thoughts to avoid false positive (alerts raised that should not be raised) and false negative (alerts not raised that should be raised). A compliance operation team is responsible to resolve alerts by either closing or escalating them. In any cases, internal IT systems should be able to provide all data necessary for the analysis, including the possibility to drill up and down into the data and to provide all adequate references. If the compliance officer is unable to find the final client in relation to an execution or the relationship between two accounts for a cross trade, it means the compliance system does
not deliver all its promises. The percentage of unresolved alerts should be kept to a minimal. The current trend in market globalization translates into a more integrated compliance monitoring. The difficulty for a compliance operation team is to get access to local data, know the local regulations in parallel to investigate multi-countries transactions, setup the right organization. This is more than system requirements even if a good process may facilitate that. The hard truth however is that most company will struggle and even failed to provide the necessary information to the compliance systems so that none or only part of the monitoring will be delivered. This is not the case for predominant exchanges like CME or NYSE which propose a service whereby participants give authorization to their compliance systems providers to pull trading data directly from these exchanges. On the other side of the spectrum, low volume exchanges and new marketplace such as ICE may simply not have any implementation of compliance feeds. You may find yourself in a position where you go into unknown areas together with your compliance system vendor, with an uncertain outcome.
How much will it cost? The cost of the systems can be a show stopper. The price is usually a fixed monthly cost per exchange with sometimes some volume threshold. Trading companies may simply have a conflict between their internal compliance policies stating all trading activities must be monitored versus the price of the monitoring considering the revenue of the aforementioned exchange. In conclusion and amidst the cost and difficulties you may encounter during your project, the quality of compliance monitoring will certainly give an advantage to a trading company. It will demonstrate fairness and impartiality. The cost will certainly be outweighed by the reputation gained by being in line with best practices and regulations.
Asia Etrader z Q2 2012 z www.asiaetrading.com
TECHnOLOGy
53
Latency In Asia PoP distances in Asia are measured in fractions of seconds unlike those found in the West.
L
et’s face it Asia is a big place. It’s more than 12,000 km from Mumbai to Wellington, 5,300 km from Tokyo to Singapore and 7,500 km from Sydney to Bangkok. These are straight line distance but in Asia you have to consider plate tectonics, underwater volcanoes and earthquakes when laying a submarine cable. Indonesia, the Philippines, New Zealand and Japan all sit along active subduction zones. Then you must consider redundancy. You don’t want your network to go down but if it does you will want to reroute and failover within minutes to the next fastest path. In December 2006 an earthquake off the coast of Taiwan saw
6 regional cable systems damaged causing widespread outages in Asia. Connectivity had to be rerouted to London or the US then back out to Asia to service clients. The Japan earthquake last year, however, affected only 100 out of the 6,000 network prefixes out of Japan according to Internet intelligence firm Renesys. The trading business in Asia has a high fixed cost and relatively low volumes when compared to smaller, concentrated geographies like the US and Europe and because of this most firms can’t afford to have a data center in every city in Asia. The question is where do you put your smart order
router or host applications for your customers that can reach most of Asia under the lowest latency and the lowest costs by utilizing 1 or 2 key centers in Asia? It’s no small task for IT heads. There are many carriers in the zone such as Singtel, IPC and TNS a leading provider of connectivity to the global financial markets with broad Asian coverage. They all offer their own Service Level Agreements (SLAs) with regards to up time and guaranteed latency. We have put this matrix together of roundtrip time (RTT) PoP to PoP primary path latencies in milliseconds for Asia.
Round-Trip Time (RTT) Milliseconds PoP to PoP Via Primary Path Dubai
Hong Kong
Kuala Lumpur
Mumbai
Seoul
Singapore
Sydney
Taipei
Tokyo
Frankfurt
Dubai
Paris
Chicago
New York
185
240
270
129
Hong Kong
60
102
42
33 (44)
24
46 58 (80)
65
32 (40)
58
67 (95)
220
230
285
70 116 (130)
82 100 135 (152)
345
265
290
76 280
128 (170)
200
105
64.9 (85)
Kuala Lumpur
60
57
Mumbai
102
79
Seoul
42
Singapore
33 (44)
Sydney
119 (170)
Taipei
24
65
58
Tokyo
46 58 (80)
32 (40)
67 (95)
Frankfurt
174
London
London
129
57
79
119 (170)
70 116 (130)
176 (240)
82 100 135 (152)
174
76
176 (240)
8.7 220
345
280
8.7
Paris
185
Chicago
240
230
265
128 (170)
105
New York
270
285
290
200
64.9 (85)
www.asiaetrading.com z Q2 2012 z Asia Etrader
14.6 (30) 14.6 (30)
54
BACK PAGE
Asia’s eTrading Industry Career Board
www.asiaeheads.com
T
he first quarter of 2012 was a tough one if you were employed within the brokerage industry as the investment banks and agency firms were reducing head count in the face of weaker volume, lower markets and pains in Europe. Firms such as Daiwa, HSBC, RBS, Standard Chartered, Merrill Lynch, Nomura and ANZ in Australia have all begun or have completed a reduction in head count across Asia. These redundancies will have a ripple effect with the vendors who service these firms such as trading applications, data feeds and other technology necessary to run an electronic trading business. However, we do see a continued investment in the region with first time entrants keen to get a piece of the Asia growth story. Careers in sales remain the most available opportunity within the vendor space where hiring managers are paying a premium for qualified sales. That being said the cuts at the brokerage firms have added some highly skilled industry people to the market but whether or not they will move across to the vendor space remains to be seen.
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We believe that by the end of the year those same investment banks will be adding back some of these heads as the US continues to gain steam and the Europeans have a better handle on the crisis which has been going on for more than two years now. China’s influence in the region is not to be underestimated. It is not clear how much further their economy will slow down or if they have hit a bottom but an improvement in the mainland will further support a turnaround in Asia’s financial industry.
Unemployment Feb 2012 Australia – 5.2% Hong Kong – 3.4% Japan – 4.6% Korea – 3.7% Singapore – 2.0% Taiwan – 4.25%
(Oct 2011) (5.2%) (3.2%) (4.5%) (3.2%) (2.0%) (4.3%)
Role
Company
City
Contact
Tradebook Sales Representative
Bloomberg
Hong Kong
Jill Fleming
jfleming39@bloomberg.net
Business Manager, Electronic Trading, Asia
CityExec
Hong Kong
Miles Nicholls
miles@cityexec.co.uk
Sales Manager – Brokerage Accounts
Futurestep
Hong Kong
Marc Baloch
marc.baloch@futurestep.com
Mid to Senior Level Distribution Sales
Matthew Hoyle Financial Markets
Hong Kong
Tammy Chung
Tammy.Chung@Matthewhoyle.com.hk
Reserach Analyst
Matthew Hoyle Financial Markets
Tokyo
Tammy Chung
Tammy.Chung@Matthewhoyle.com.hk
Investor Relations
Matthew Hoyle Financial Markets
Hong Kong
Tammy Chung
Tammy.Chung@Matthewhoyle.com.hk
TMT Analyst
Matthew Hoyle Financial Markets
Hong Kong
Tammy Chung
Tammy.Chung@Matthewhoyle.com.hk
Junior Trader
Matthew Hoyle Financial Markets
Singapore
Tammy Chung
Tammy.Chung@Matthewhoyle.com.hk
ETF Traders
Matthew Hoyle Financial Markets
Hong Kong
Tammy Chung
Tammy.Chung@Matthewhoyle.com.hk
Junior Researchers/ Quantitative Trader
Matthew Hoyle Financial Markets
Hong Kong
Tammy Chung
Tammy.Chung@Matthewhoyle.com.hk
Senior Risk Manager
Matthew Hoyle Financial Markets
Sydney
Tammy Chung
Tammy.Chung@Matthewhoyle.com.hk
Quantative Algorithmic Trader
Matthew Hoyle Financial Markets
Chicago
Tammy Chung
Tammy.Chung@Matthewhoyle.com.hk
Senior Kospi Trader
Matthew Hoyle Financial Markets
Seoul
Tammy Chung
Tammy.Chung@Matthewhoyle.com.hk
Asia Etrader z Q2 2012 z www.asiaetrading.com
BACK PAGE
55
Dates Date
Event
Where
Type
April 18-19
TradeTech China
Shanghai
Conference
April 24
Sungard Industry Seminar
Kuala Lumpur
Conference
April 24
TradeTech Emerging Markets
London
Conference
May 7
Impact of The New Capital Requirements in Hong Kong
Internet
Webinar
May 17-18
ETF Index Investing and Trading Summit Asia 2012
Shanghai
Conference
May 22-23
Shorex Wealth Management Forum
Singapore
Conference
May 29-31
Financial Data 2012
Hong Kong
Conference
June 6 - 7
TradeTech Japan
Tokyo
Conference
July 20
Sungard Industry Seminar
Hong Kong
Conference
Date
Country
Holiday
Date
Country
Holiday
April 11
Korea
National Assembly Election
May 1
Philippines
Labor Day
April 11-16
Thailand
Songkran Holiday
May 1
Singapore
Labour Day
April 25
Australia
ANZAC Day
May 1
Thailand
Labor Day
April 30
Japan
Showa Day
May 1
Vietnam
Labour Day
April 30
Vietnam
Reunification Day
May 7
Singapore
Vesak Day
May 1
China
Labor Day
June 1
China
Children’s Day
May 1
Hong Kong
Labor Day
June 4
New Zealand
Queen’s Birthday
May 1
India
May Day
June 4
Thailand
Vesak Day
May 1
Korea
Labor Day
June 6
Korea
Memorial Day
May 3
Japan
Constitution Memorial Day
June 11
Australia
The Queen’s Diamond Jubilee
May 4
Japan
Greenery day
June 11
Philippines
Independence Day
May 5
Japan
Children’s Day
June 22
China
Dragon Boat Festival
May 17
Indonesia
Ascension Day of Jesus Christ
June 23
Taiwan
Dragon Boat Festival
May 18
Indonesia
Joint Holiday
July 2
Hong Kong
The day following HKSAR
May 28
Korea
Buddha’s Birthday
May 1
Malaysia
Labour Day
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Establishment Day July 16
Japan
Children’s Day
56
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DIRECTORY Asia eHeads
57
Deutsche Bank Asia’s eTrading Industry Career Board
Asia eHeads is the leading career portal for Asia’s electronic trading industry. The websites specialist focus makes it an ideal venue for relevant high quality positions across Asia. There are no agents or headhunters to worry about and you can submit your placement enquiries directly to the hiring manager anonymously. The company is based in Hong Kong in one of the leading global financial centers on the planet. Please visit http://asiaeheads.com or contact support@asiaeheads.com or follow on @asiaeheads or scan the QR code
Deutsche Bank is a leading global investment bank with a substantial private clients franchise. Its businesses are mutually reinforcing. A leader in Germany and Europe, the bank is continuously growing in North America, Asia and key emerging markets. With more than 100,000 employees in 72 countries, Deutsche Bank offers unparalleled financial services throughout the world. The bank competes to be the leading global provider of financial solutions, creating lasting value for its clients, shareholders, people and the communities in which it operates. For more information, visit www.db.com
Fidessa
Asia Etrading
AsiaEtrading.com is the leading institutional electronic trading industry portal in Asia. Providing in-depth coverage and insights including articles, news, videos, opinion polls, exchange reference, regulatory information, a free newsletter and much much more. Dedicated to keeping electronic trading practitioners with an eye on Asia informed and enlightened on the latest trends, developments and innovations in this exciting and complex region of the world. AsiaEtrading is also available as an iPhone app too. Please visit http://www.asiaetrading.com or contact support@asiaetrading.com or follow on @asiaetrading or scan the QR code
BNP Paribas
BNP Paribas Securities Services, a wholly-owned subsidiary of the BNP Paribas Group, is a leading global custodian and securities provider backed by a strong universal bank (rated AA- by Standard and Poor’s). It provides integrated solutions to all participants in the investment cycle including the- buy-side, sell-side, corporates and issuers. Barnaby Nelson. Head of Client Development, Asia – Banks, Broker Dealers and Corporate Issuers BNP Paribas Securities Services PCCW Tower, Taikoo Place, 979 King’s Road, Hong Kong Tel : +(852) 3197 3318
Fidessa is a global business with scale, resilience, ambition and expertise. We’ve delivered around 30% compound growth since our stock market listing in 1997 and we’re recognised as the thought leader in our space. We set the benchmark with our unrivalled set of mission-critical products and services and, uniquely, serve both the buy-side and sell-side communities. Ongoing investment in our leading-edge, integrated solutions ensures Fidessa remains the industry’s number one choice. Tel: +852 2500 9500 Email: ap.info@fidessa.com www.Fidessa.com @fidessa
IPC IPC’s market-leading offerings include the first unified communications/application platform, award-winning hard and soft turrets, electronic connectivity services including enhanced voice services, business continuity solutions, and followthe-sun service and support. IPC’s global reach extends to more than 58 countries ñ including a Financial Extranet of 4,000 on-net locations in over 700 cities and more than 115,000 turrets deployed worldwide. Headquartered in Jersey City, New Jersey, IPC has approximately 1,000 employees located throughout the Americas and the EMEA and Asia-Pacific regions. For more information, visit www.ipc.com. Tel: +852.2899.8000 Email: info@ipc.com @IPC_Systems_Inc
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