Asia Etrader Magazine Issue 4 by Asia Etrading

AsiaEtrader Issue 4 | Volume 1

HEAdInG

I 2012 Q4

The Electronic Trading Resource for Asia

Is algo advisory crossing the line? Asiaâ&#x20AC;&#x2122;s first international exchange merger The new Japan Exchange Group Mandarin link to rival ASEAN

Japanâ&#x20AC;&#x2122;s Electronic Trading Restoration Dodd-Frank: What you need to know

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LEAdER

AsiaEtrader Issue 4 | Volume 1

HEADING

I 2012 Q4

the shift to the East

The Electronic Trading Resource for Asia

Is algo advisory crossing the line? Asia’s first international exchange merger The new Japan Exchange Group Mandarin link to rival ASEAN

What a summer we had! Normally, these are relaxing times spent with families on vacation enjoying a reprieve from hectic and stressful lives sitting on beaches, hiking in mountains and eating from barbeques. It was anything but as Asia Inc. keeps buying, building and becoming the centre where global

Japan’s Electronic Trading Restoration Dodd-Frank: What you need to know

trade converges.

CrEDITS

The HKEx swallowed a big fish in

Editor-in-Chief Stephen Edge steve@asiaetrading.com Managing Editor Dan Barnes dan@icorp.co.uk Contributing Writers Roger Aitken roleoa@aol.com Stephen Price steveprice@ymail.com

the LME along with its important role in physical commodity trading where Asia ravenously consumes to develop its economies. We shall see in the months and years ahead how this plays out. Japan seems to be finally waking up to the fact that it must compete or become obsolete as its bourses move toward the “Comprehensive Exchange”, a concept long held by its global

Shri Navaratnam shri12.navaratnam@gmail.com

counterparts. Interestingly, Japan is experiencing both consolidation and

Hongsong Chou hongsong.chou@cradvisors.com.hk

fragmentation at the same time.

Rekha G. Menon rekha.gmenon@prayag.com 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

The ASEAN Trading Link went live in what can only be described as a precursor to a regional clearing and regulatory framework sorely needed here (if it succeeds). Knight Capital’s ‘Algo Gone Wild’ in the US had reverberations in this part of the world too as Hong Kong and Australia regulators put further scrutiny on the value and safety of algorithmic trading. Dodd-Frank, MIFID II, EMIR and FATCA all look set to impact electronic trading in Asia at some point as well. I think we all need a vacation just from all the regulatory change going on in our industry that is if we can afford it after increasingly burdensome rules are put in place. I hope you will enjoy our fourth publication. Our next issue in January will ring in the New Year and our first anniversary. Already, another year has almost gone by.

Subscription Enquiries support@asiaetrading.com Scan the Quick Response Code with your iPhone or Android Phone to take you to the Subscription page

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contents

Contents IN THE ZONE Our quarterly round-up of industry news and developments across Asia last quarter. Page 4

Cover Stories Japan’s Electronic Trading Restoration – Historically, Japan has gone through periods of rapid development through reform and investment. It seems they are doing it again. Page 6 Dodd-Frank: What you need to know – The global deluge of regulatory change brought on by Lehman, the Global Financial Crises and algorithmic trading has far reaching implications in Asia. Page 14

Opinion & Analysis A Brand New Game in Electronic Trading? Hongsong Chou, weighs in on the upcoming Hong Kong SFC Electronic Trading Regulations. Page 12

DERIVATIVES Intensifying competition in derivatives trading in India has been growing as incumbent exchanges vie for market share and new players push in. Page 20

Asia Futures Trading Q3 2012 Recap. See our quarterly update on which exchanges are trading the most futures around Asia. Page 22 Volatility in Asia Q3 2012. Volatility was much lower this summer as Europe went on vacation and macro activity was mediocre. Page 19

BUY SIDE The high-touch, low-touch desk. Algorithm advisory desks offer traders support but some see the desks as crossing the line with sales trading. Page 24 Shut ‘em down. Media spin and large losses have put algorithmic trading in the spotlight. Will Australia and Hong Kong ban some electronic trading too? Page 26

EXCHANGE SPOTLIGHT China’s first step in exchange acquisition waltz. Exchange consolidation reaches ever corner of the globe including China. What will Asia’s first international merger bring? Page 28

RISK Roads to strengthening barriers against trading technology risk. Roger Aitken looks at how firms can take measures and deploy cutting-edge technology to protect themselves and their brands from potentially disastrous scenarios. Page 32

WHO’S WHO Kotaro Yamazawa, managing director at Osaka Securities Exchange, talks to Asia Etrader about the merger with the Tokyo Stock Exchange, exchange competition, and Japan’s future as a trading hub. Page 34

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contents

EQUITIES China and Hong Kong compete with Korea as ETFs blossom. ETFs are a great access product and are growing rapidly in Asia. Hong Kong’s new China A-Share ETF is set to grow the market further. Page 38 Asia’s Fragmentation Footprint Q3 2012. Fragmentation and the regulations supporting it are gaining momentum. See just where liquidity in Asia equities markets is going. Page 40 Asia Equity Trading Q3 2012 Recap. Our quarterly review of turnover, average trade sizes, spread and market impact costs on Asia’s exchanges. Page 44 Short Report Q3 2012 Recap. Overview of short selling trading in Hong Kong, Korea, Singapore and the Tokyo Stock Exchange. Page 48 GreTai pushes for Mandarin link to rival ASEAN. Steve Price writes that Taiwan’s GreTai Securities Market has set its sights on China and Hong Kong for growth. Page 50

post trade Backstage passes. Smaller markets need to strengthen post-trade processing to build up investor confidence and drive liquidity. Page 52

OPINION POLLS How do you select algos before trading? Sell side algorithms are expanding in variety but Asia tends to go with only one or two. See what the industry said. Page 54 Which exchange technology will the merged OSE/TSE select? The OSE and TSE have made large investment in technology and the merger will force them to choose just one. See how the industry voted. Page 55

WORD ON THE STEET What do you think of the HKEX takeover of the LME? We asked the industry their views on Asia’s first international merger. Page 56

TECHNOLOGY Algo development challenged in tough market. Cost cutting and downsizing are affecting everyone including developers. How will that impact your algos? Page 58

BACK PAGE 60 Dates – Exchange holidays and important industry events Directory – A listing of Asia’s electronic trading industry participants Social Media – News and information on the trends in Social Media of Asia’s financial industry

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In tHE zonE

In the Zone... Though the third quarter of 2012 included the summer holiday lull, it was dominated by exchange mergers, enrichment and outages. Throw in regulatory engagement in algorithmic trading and the past three months probably saw the biggest-ever market structure transformation in Asia. Read on for In the Zone’s roundup of developments...

ho doesn’t know about the Tokyo Stock Exchange (TSE) and Osaka Securities Exchange (OSE) merger? While still subject to shareholder approval, the marriage will consolidate cash and derivatives (ex-commodities) trading in Asia’s biggest market. The merger will bring about cost savings for members, the elimination of duplicate infrastructure and a regional exchange group ready to move into the big leagues with CME, NYSE and Deutsche Börse. Hong Kong Exchanges and Clearing Limited’s (HKEx) expensive takeover of the London Metal Exchange (LME), an icon of global commodity trading, promises to shake the foundations of the international markets and further shift the balance of power to the East. It remains to be seen if HKEx shareholders will get a reasonable ROI. On September 18, the ASEAN Trading Link went live, connecting Bursa Malaysia and Singapore Exchange (SGX) in its first stage (see “The ASEAN Trading Link Explained” on page 6 of Issue 3, Volume 1). Five years in the making, the endeavor aims to link seven exchanges in six countries, covering more than 3,600 companies. The Stock Exchange of Thailand is next in line, to be followed by the Hanoi Stock Exchange (HSE), Hochiminh Stock Exchange (HOSE), Indonesia Stock Exchange (IDX), and the Philippine Stock Exchange (PSE).

Australia

In other news, it was a busy quarter for the Australian Securities Exchange (ASX), which welcomed provider of trading and information solutions CQG to the Australian Liquidity Centre, worked with Singapore Exchange (SGX) to enhance market connectivity, and unveiled a new fee structure that includes the “unbundling” of fees to settle trades. Meanwhile, the Australian Securities and Investments Commission (ASIC) reviewed risk management in the funds management sector, published a consultation paper on electronic trading, and released its fourth Market Supervision Report.

China Trading fees also popped up on the radar in China, where the Shanghai Stock Exchange (SSE) reduced its trading supervision charge. The country welcomed a new addition to the fold in the form of Citi Orient Securities, which officially launched its operations there. The quarter also saw Omgeo and YSS Tech Infotech Co partnering up to increase post-trade automation in investment management firms, and Nomura acquiring additional QFII quota. On September 20, Deutsche Börse announced that the DAX had been licensed to Hua An Asset Management Co to underlie an exchangetraded fund. It will be the first ETF in China to be based on the Deutscher Aktien IndeX.

Hong Kong Moving south, Hong Kong hit the headlines over the past three months, and not only for the takeover of LME by HKEx. Several firms were reprimanded by Hong Kong’s Securities and Futures Commission, including IMC Asia Pacific Limited, which was slapped with a HK$1.5 million fine, SocGen, and RBC Investment Management (Asia), which was punished with a HK$4 million penalty. Besides dishing out reprimands, the regulator proposed enhancement of the regulatory for electronic trading, and released consultation conclusions on proposals to regulate the OTC derivatives market. The Hong Kong Mercantile Exchange (HKMEx) made two new appointments: Jane Wang and William Barkshire were made copresidents. Phillip Commodities joined the

exchange as a clearing member, and CIFCO was made a Broking Member as well. In other developments: the HKEx introduced renminbi currency futures on September 17, and reduced the ATS reporting window from 15 minutes to 1 minute; and Equinix said it would boost data center investment in APAC.

India The Securities and Exchange Board of India (SEBI) moved to simplify and rationalize the trading account opening process for direct market access by clarifying and modifying previously issued rules. They also allowed MCX Stock Exchange Ltd (MCX-SX) to become a fullfledged bourse.

Indonesia ITG announced the expansion of its POSIT crossing network to Indonesia. POSIT’s coverage of Asia comprises Australia, Hong Kong and Japan.

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in the zone

Japan Though the TSE and OSE merger caught the attention of observers, there were plenty of other noteworthy developments. TSE was also in the news for extending the trading time of TOPIX features listed on the NYSE Liffe market to cover Asian hours, and for receiving a business improvement order from the Financial Services Agency after a hardware failure occurred on its derivatives trading system network device on August 7, causing trading to temporarily halt on the Tdex+ NYSE Technologies Platform. Staying with TSE, MarketPrizm began offering a fully managed direct market access solution at the exchange’s colocation facility. In a letter to the CFTC on proposed crossborder releases on swap regulations, the FSA laid out its concerns about the plan, particularly regarding the application of registration and transaction requirements to operations of foreign financial institutions established outside the US. TOCOM was approved by the Dubai Financial Services Authority as a recognized body, and it launched a low-latency connection service provided by Dot Commodity, a futures broker. On July 30, it was announced that SBI Securities had implemented OneTick, a single solution for complex event processing, analytics and tick data that spans both historical and real-time. Also in July, NYSE Euronext (NYX) announced the appointment of Hiroshi Nomoto as its Chief Representative of the Tokyo office. The following month, Japannext PTS announced record monthly market share and turnover performance.

Korea The Korea Exchange (KRX) and the Stock Exchange of Thailand (SET) signed a contract for the development of an integrated clearing and settlement system. In other news of cooperation, Eurex and KRX marked the second anniversary on August 30 of the launch of their Eurex KOSPI Product, which has seen a steady increase in the notional value of its daily average volume.

Malaysia On July 16, trading began of Bursa Malaysia Derivatives Berhad’s (BMD) new Options on Crude Palm Oil futures contract (OCPO), the first Asian exchange-traded agricultural options contract. But perhaps the most significant development was the ASEAN Trading Link going live on Sept. 18, linking Bursa Malaysia with SGX in the first stage. Securities Commission Malaysia Chairman YBhg Datuk Ranjit Ajit Singh delivered a keynote address on the theme of “Making the Asian Bond Market a Reality” at the RAM Annual Bond Market Conference, which took place on 12

saw direct market access to securities trading go live on September 18. Over at the Singapore Mercantile Exchange, turnover of more than US$100 billion was posted for its second year of operations, which ended August 30. The exchange has proposed the introduction of a Negotiated Trade Facility. In regulatory news, the Monetary Authority of Singapore (MAS) reprimanded Evia Capital Partners for breach of Securities and Futures Regulations.

Taiwan

July at the Mandarin Oriental, Kuala Lumpur. Also under discussion in the quarter was the need to enhance and harmonize disclosure requirements in the Islamic Capital Market. The topic was addressed at a roundtable meeting in Kuala Lumpur convened by the International Organization of Securities Commissions (IOSCO) and Islamic Financial Services Board (IFSB). In related news, on September 19, BNP Paribas Malaysia and INCEIF, The Global University of Islamic Finance, launched the BNP Paribas-INCEIF Centre for Islamic Wealth Management, which will be located in Kuala Lumpur.

Philippines Global institutional trading network Liquidnet rolled out a new service on September 4 enabling institutional investors to trade securities that are listed in the Philippines through its platform.

Singapore SGX signed a cross quotation agreement with London Stock Exchange. It also inked an MOU with Istanbul Menkul Kıymetler Borsası (IMKB) to foster mutual cooperation towards the development of both exchanges and their respective markets. On July 6, SGX announced that it was ready to list, quote, trade, clear and settle securities denominated in renminbi (RMB). Ten days later it began offering SGX S&P CNX Nifty Options in partnership with the National Stock Exchange of India (NSE), enhancing offshore investors’ access to the Indian economy. The following month, SGX entered the electricity market with a 49% stake in Singapore’s Energy Market Company. On September 10, SGX successfully launched its new OTC Options suite for SGX Iron Ore and SGX Forward Freight Agreements (FFA). The move followed new records for SGX Iron Ore and FFA Swaps in July, when they outperformed. Another launch by the exchange

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Cross-Strait relations deepened with the announcement that Taiwanese investors will be able to invest in Chinese stocks via reconsignment through securities companies. Previously, such investments could be made only through mutual funds. Numerix strengthened its presence in Asia in July when it opened its new office in Taiwan.

Thailand The Stock Exchange of Thailand made several advances on the technology front. In August it linked up with KRX to develop a clearing system for equities, derivatives and fixedincome products. The system is scheduled to be rolled out in the first quarter or 2013. On September 3, the Thai bourse launched its new trading engine SET CONNECT, which is based on Cinnober’s TRADExpress technology. Meanwhile, to ensure effective post-trade facilities for investors, depository members, and clearing members, SET stepped up its posttrade service expansions, including third-party clearing (TPC) and global custodian services. And in order to cope with trading innovations, new products, and regional connections, the exchange announced that it has revised its trading rules to comply with practices of leading international stock exchanges. The Thai Bourse appointed Kirati Kosicharoen as senior vice president and group head of technology products. Over at the Thailand Futures Exchange, improvements to its SET50 Index Futures and Options were announced in August, along with the introduction of Sector Index Futures this month (October). On August 20, YLG Bullion & Futures Co became a full member of the exchange, allowing the broker to trade all types of derivatives products.

coVER stoRy

Japan’s Electronic trading Restoration

n recent history, Japan has experienced two periods of marked transformation resulting in sustained financial affluence in the wake of stagnation and entrenched inefficiency. The ‘economic miracle’ of the 1960s which propelled Japan to become the second and now third largest global economy and the Meiji Restoration in 1868 that had ushered in prosperity such that Japan became the first non-European Power. Each of these ages brought with it regulatory reform and investment in infrastructure that would make Japan more competitive, lower costs and reverse a deep-rooted decline. With Japan having moved through its ‘lost decade’ and having missed out on the global commodity boom of the past 10 years amidst the rise of China, there is now a consensus on every level of government and industry to refocus, reform and restore electronic trading in Japan. The Meiji Restoration was the catalyst for change from a feudal society to a market economy and accelerated industrialization in Japan. In 1868 the Charter Oath (五箇条の御誓文), considered the first constitution of Japan, spelt out the goals of the emperor and formed the legal apparatus which drove modernisation, making Japan more competitive and prosperous. Meiji, meaning ‘enlightened rule’, was brought about by a number of factors one of which was the technological impotence of Japan. After the signing of The Convention of Kanagawa (日米和親条約) in 1854 it was clear with the arrival of US warships and advanced technology that Japan was behind the curve and needed to do something about it. Part of the Oath was an “international search for knowledge” where Japan sent many countrymen to go abroad and learn about the world and bring that information back home. The Economic Miracle in the 1960s saw the government agency the Ministry of International Trade and Industry (now modern day METI) at the centre of the post-war economic recovery. Under prime minister Hayato Ikeda, who Lyndon Johnson called “the single most important individual architect of the Japanese economic miracle”, the ‘Income Doubling Plan’

mandated a policy of investment in industry and coordinating international cross-border trading much like his predecessor Meiji and now under the ’Comprehensive Exchange’ being brought to Japan. The years after the war were difficult; there were no jobs, infrastructure or resources to draw upon. Policy and investment were the way forward.

Economy Japan’s Lost Decade of the 1990s saw real wealth shrink, government debt grow and deflation reign supreme. GDP having peaked at US$5.3 trillion in 1995 has been gyrating lower and sideways for more than 10 years. Meanwhile, across the Sea of Japan, China has seen its GDP grow from around US 800 billion in 1995 to over US$7.1 trillion displacing Japan to be the number three global economy from number two it had earned during the ‘Economic Miracle’. Japan has been going through a protracted deflation cycle since the ‘Dot Com’ heydays of 1999 achieving a record low of -2.5% October 2009. Here, lower demand causes prices to fall further fuelling less demand as consumers expect prices to go lower still and will hold on to their money. The government has had little room to reverse demand and investment as the Bank of Japan has kept interest rates around zero going back to 1999. Instead, government spending with borrowed money is the only recourse to prime the pump and kick start the economy. Because of this Japan now has the highest debt to GDP ratio of any of the G8 countries and GDP growth has been anaemic at best. The turn of this century saw the rapid growth of the BRIC nations who were competing for resources and pushing commodity prices higher. Japan lost out in that regard as well with TOCOM, the largest commodity exchange, seeing volume drop from 87.25 million contracts in 2003 to just 27.64 million contracts in 2010. These two decades taken together, have been a long road of stagnation for the country but it appears they have finally put together a plan which has seen the start of regulatory reform, investment in technology and a restructuring of the electronic trading industry.

Regulatory Reform In the past 6 years there have been a series of ongoing amendments to the Financial Instruments and Exchange Law (FIEL) in Japan, the main statute codifying securities law and regulating securities companies. Like the Charter Oath for the Meiji Restoration, it is the policy at the centre of the electronic trading restoration. The latest and perhaps most significant change to FIEL was submitted 9 March, 2012 to the Diet, Japan’s legislature. This bill allows the creation of multi-product exchanges referred to as “Comprehensive Exchanges” and multi-product brokers, and would see regulation consolidated in order to create a framework for these firms. The amendment, approved on 6 September, will see commodities reclassified as a financial instrument as currently specified in the Commodity Derivative Act (CDA) as long as the trading of the commodity benefits the national economy and trading would not impede accurate price formation. Trading participants who operate as a Type 1 Financial Instruments Business now have commodity derivatives transactions falling under their licensing agreement so securities companies will be able to engage in the commodity business too. Those firms that wish to only trade commodities will see financial requirements eased, lowering costs. Clearing members of a Comprehensive Exchange, under the amendment, will allow for clearing of commodity derivatives at a licensed financial clearing house. The Financial Services Agency (FSA) will direct the Comprehensive Exchanges rather than the ministries that oversee each commodity and derivative. This, the yoke of many jurisdictions governing the business, has been widely cited as one of the key barriers permitting Japan commodity trading to flourish. However, MAFF and METI will continue to supervise exchanges trading only in commodities and will be deferred to when changes to the commodities business under the Comprehensive Exchange are needed. Also, on 26 June, Japan’s FSA gave a boost to the proprietary trading system (PTS) operators and exchange competition with an amendment of the Takeover Bid (TOB) Rule in

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coVER stoRy

the Financial Instruments and Exchange Law which will allow for exemptions to the rule. As it stands, any entity that buys 5% of a company’s issued stock over a 60-day period off-exchange must mount a takeover of that firm. This regulation has been a deterrent to most of the big Japan buy-side firms who shunned PTSs as a result. With this restriction expected to be lifted in October they are likely to take another look. To qualify under the exemption a PTS must disseminate realtime market data, provide a continuous limitorder book and execute trades within a timely manner. But there is still more to be done. For example, Japan’s domestic proprietary trading community accounts for roughly 18% of volumes but could be increased if the regulations did not require a compliance officer to be present during trading. In effect, this limits firms’ participation in the night session and affects trading during vacations. Also, trading by these firms must be affected at the registered office than at home. In light of the pension fund scandal brought on by AIJ Investment Advisors that saw around ¥109 billion (US$2.4 billion) disappear, the Japan FSA announced in late September a review of the regulations and supervision of asset management. The changes will require much more due diligence on the part of trust banks to verify details of a fund including better audit trails, stricter requirements to qualify as a professional investor, more frequent reporting and harsher prison sentences and fines. Japan’s policy makers, like their predecessors, have been busy rewriting the rules of engagement to support industry as a whole.

Technology When Commodore Matthew C. Perry arrived on the shores of Japan in 1854 with the latest in navigation and superior military machinery Japan’s electronic trading market structure today has succumbed to advanced international trading technology. At the height of the trading boom Japan had 17,000 sales people servicing 300 domestic brokerages. Now, there are around 8,000 employed by 80 firms. Where there was once a thriving domestic community of prop houses they have been closing down unable to compete with the technology of foreign firms who use computers, software, algorithms and post trade STP. Foreign firms, as of 2011, now comprise nearly 60% of trading on the TSE up from 34% in 2003. Investment in infrastructure has been one of the drivers of www.asiaetrading.com z Q4 2012 z Asia Etrader

cover story

Japanâ&#x20AC;&#x2122;s modernisation over the past 150 years and the capital markets space is finally a beneficiary. The highest profile investment, and perhaps the triggering event of Japanâ&#x20AC;&#x2122;s electronic trading miracle, is the arrowhead matching engine upgrade made by the Tokyo Stock Exchange on 4 January, 2010. This enhancement to the cash trading segment was sorely needed as the TSE was struggling with a slow and unreliable matching engine that was known in the market for confirming fills long after the price had been reached and for

disruptions that halted trading entirely. Before arrowhead was introduced, the latency for firms trading on the TSE was as high as one or two seconds, where international peers were achieving millisecond intervals. Today, arrowhead now claims to see order response times of less than 1 millisecond which, while still not the fastest, is a marked improvement and supports algorithm trading for both the buyand sell-side. The derivatives segment, not the TSEâ&#x20AC;&#x2122;s strongest, was refurbished in November 2011 to the LIFFE CONNECT system under

the name Tdex+. Order-response times fell to 5 milliseconds on the new engine, which was capable of processing 36 thousand orders per second. The upgrade not only improved performance but also enabled strategy trading allowing a member to trade more than one product at the same time, using one order type. Co-location had been introduced in May of 2009 for the TSE, but its low-latency advantages were not really employable prior to the upgrades of arrowhead and Tdex+. In June 2010 the National Tax Agency (NTA) of Japan

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cover story

confirmed that foreign investors using colocation or proximity services of the exchanges or third party vendors who are not physical present (Permanent Establishment) in Japan for conducting business will not be subject to corporation or income tax. The Osaka Securities Exchange (OSE), the only publicly-listed bourse in Japan, has also entered the arms race. On 14 February, 2011 its new derivatives matching engine, J-Gate, was delivered to the market. Based on NASDAQ OMX technology it delivered latency reduction

from 100 milliseconds to 2 milliseconds and increased throughput from 800 orders per second to 12,000 orders per second, both necessary to foster the OSEâ&#x20AC;&#x2122;s position as the leading derivatives exchange in Japan. The Tokyo Commodity Exchange, which has experienced a marked decline of volume over the last decade, has been reacting to restore its place with a number of developments. As with its peers TOCOM has invested in technology to improve the performance of its trading engine somewhat; since 2009 it has been able

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to achieve 10 millisecond order responses, offer 24 hour trading and introduced strategy order types. The futures market the Tokyo Financial Exchange (TFX) is making changes to help support an evolving market. Most notably are the reduction of tick size, increasing its highly successful currency futures contract to 3 decimal places, reducing trading costs and allowing for high frequency trading. Also, a new matching engine is expected in 2013 to increase processing by four fold.

cover story

Restructuring The TSE/OSE merger, which are expected to be reborn as the unified ‘Japan Exchange Group’ on 1 January 2013 is the most significant development in Japan’s electronic trading restoration. The merger paves the way for the Comprehensive Exchange that will consolidate operations, technology and asset classes creating a new exchange group to rival those of NYSE LIFFE, Deutsche Börse and NASDAQ OMX. Though still a domestic titan with more than 90% of equity trading and 100% of index futures trading; the merger will give them the clout to compete globally. Thus far, the merger has had to clear several hurdles to reach this point. First, was the anti-monopoly watchdog, the Japan Fair Trade Commission (FTC), giving its blessing for the business combination. Next, and perhaps more difficult, was the TSE’s successful tender offer for the OSE that was launched in July. The former required a minimum of two-thirds of the latter in order for the tender to succeed. They were, in fact, able to acquire 80% of the OSE at the tender price of ¥480,000 yen per share (US$6,100) valuing the OSE at ¥125 billion (US$1.66 billion) but some shareholders believed the TSE should be paying more for the company. The last hurdle is an extraordinary meeting of OSE stakeholders on 20 November where the merger itself must be approved by two-thirds of the vote. The combined market value of stocks traded on the exchange created by the merger would be more than ¥268 trillion (US$3.43 trillion). The OSE has been quietly maneuvering itself within Japan’s electronic landscape. For example, in February 2008 it signed a memorandum of understanding (MOU) with TOCOM which included the development of common products and information sharing about technology, as both use technology based on NASDAQ OMX. Because of the common platform, members will be able to lower their cost of connectivity, development, streamline support and eliminate duplication of infrastructure. Furthermore, each exchange’s board decided in December 2010 to share a disaster recovery site together. Again, eliminating further overhead and focusing operations to be more effective and efficient for the industry. But there is another leg of product consolidation in the commodity space that will ultimately further reinforce OSE’s position as the Comprehensive Exchange. TOCOM is taking over the Tokyo Grain Exchange’s (TGE) agricultural futures products by February 2013. Under the arrangement all open positions and operations will migrate to TOCOM except for rice futures which will go to the Kansai Commodity

“The cost of clearing

initially listed on it. Given the pace of change it is only a matter of time before this statute is addressed in the spirit of competition.

dropped substantially

Trial and Tribulations

and was no longer manual and prone to human error.”

Exchange (KCE). TOCOM will become an industrial and agriculture commodity exchange with the arrival of azuki, corn, raw sugar and soybeans futures to complement its precious metal, energy and rubber products In 2010, TGE agreed to divest its holdings of the Japan Commodity Clearing House (JCCH) to TOCOM resulting in it owning 63.3 percent of that entity. The JCCH is responsible for clearing all commodity futures in Japan and will allow for greater margin efficiency once TOCOM has the TGE products under its umbrella. The fate of the KCE is not clear but given its low volumes and secondary position to TOCOM it too might find itself swallowed up as part of the Comprehensive Exchange.

Competition Proprietary trading systems (PTS), Japan’s term for alternative venues, have been around for 12 years but were not taken seriously until July 2010. That year an important market structure change occurred when the Japan Securities Clearing Corporation (JSCC), wholly owned by the TSE, began clearing trades for PTS operators. The impact of this was substantial. First, clearing was no longer bilateral between the counterparties of trades conducted on PTSs eliminating counterparty risk. The cost of clearing dropped substantially and was no longer manual and prone to human error. Also, Chi-X Japan entered the market giving further legitimacy to the notion of an alternative trading destination other than the primary exchange. This triggering event really set the stage for growth of PTS volume. More is being done to support Japan alternatives. The removal of the TOB will be a significant advantage, although also to be addressed is the rule that says when a venue trades 10% of a security it must be licensed as an exchange, at which point it can only trade securities that have

As a backdrop to these improvements, Japan has been rocked by a chain of events impacting everything from physical infrastructure to investor confidence. Several large insider trading scandals have come to light, the most notable of which led to the chief executive of Nomura resigning, hot on the heels of Sumitomo Mitsui Trust Holdings receiving a ¥130,000 fine (US$1,600). Other blows to the country’s reputation for corporate governance include the Olympus accounting scandal and pension manager AIJ Investment Advisors. The Financial Service Ministry has been aggressively investigating these issues as they undermine confidence in the capital markets and wider corporate culture. Despite the investments in new technology, the number and length of outages have been painful for traders. In August, a problem with a router in the Tdex+ derivative trading system brought trading to a halt on TSE. That followed an outage in February related to market data distribution. While technology is not infallible, the TSE’s backup system failed to kick in as it should have in both instances and for this the FSA sanctioned the exchange for the poor performance and fined some senior management a percentage of pay. The exchange is bringing in outside consultants to properly assess the shortcomings and ensure it does not happen again. The earthquake that struck last March, a serious human tragedy, was the ultimate test for Japan’s exchanges. They chose not to halt trading and the newly upgrade matching engines went into overdrive churning through huge trading volumes and extreme volatility. History is repeating itself in Japan. Outdated industry and reforms are being revamped and rewritten to compete in the modern world of electronic trading. Momentum brought on by the restoration is growing into an unstoppable inertia that will make Japan a global financial hub once again and raise the profile of Asia as a whole. In hindsight, it is often easy to see the point of inflexion where a market changes trajectory and moves upward characterizing a ‘Golden Age’ such as restoring Emperor Meiji to the throne or Hayato Ikeda’s ascension to prime minister in 1960. Perhaps, today its Atsushi Saito the president and CEO of the Tokyo Stock Exchange who oversaw the upgrade of the exchange matching engine and has agreed with Michio Yoneda, president of Osaka Securities Exchange to merge their two companies. We’ll let history decide.

Asia Etrader z Q4 2012 z www.asiaetrading.com

opinion & analysis

A Brand New Game in Electronic Trading? What to Expect from the Upcoming HK SFC Electronic Trading Regulations By Hongsong Chou, Ph.D.

n July 24, 2012, the Securities and Futures Commission (SFC) of Hong Kong SAR published its “Consultation Paper on the Regulation of Electronic Trading”. In the paper, while acknowledging that “[technological developments] are welcomed as they increase the efficiency of our markets and provide options for investors who participate in our markets”, the SFC also commented that “… effort is required to ensure the integrity of the market and that trading via direct market

access or by the use of trading algorithms are conducted in a fair and orderly manner.” The publication of the consultation paper coincided with a series of high-profile incidents that have led to debates on the merits of algorithmic trading and high-frequency trading on both market efficiency and market operation effectiveness under the current design of market structures. Although the debates have been more centered on U.S. markets than other regions, as a financial center in the Asia-Pacific region that has seen a significant increase in

trading volume via electronic means (such as DMA and sophisticated trading algorithms), Hong Kong definitely considers proper regulatory requirements necessary for the healthy functioning of its markets. In fact, at least to our knowledge as practitioners in the electronic trading field, many of the items in the paper – such as pretrade management and post-trade monitoring procedures – have been discussed, developed and implemented by many firms on both the Buy side and the Sell side. Some implementations

Asia Etrader z Q4 2012 z www.asiaetrading.com

opinion & analysis

were specifically under the suggestions from regulatory bodies such as the SFC. What is different now is that all such suggestions from different regulatory bodies to different trading firms over the past many years are formally proposed and will likely be implemented as regulatory requirements that have to be followed by many market participants and service providers. The compliance and legal gravity is definitely more significantly felt by many people. We believe that potential impacts on electronic trading will be on three fronts: first, key operation steps in electronic trading will be formalized and followed by market participants and service providers; secondly, quality assurance of trading technologies for both trading systems and trading algorithms will be gradually standardized; thirdly, the economics of electronic trading as a business will be modified. We will elaborate on these three points below, with a few suggestions for market participants and service providers on how to position themselves in a likely new regulatory landscape that affects their business operations. Key operation steps in electronic trading will be formalized: As a relatively new means of execution, electronic trading has a high degree of automation in trading process. An issue that the industry has been facing is how much automation the industry should give to electronic trading. On the Sell side, traditional human intervention by sales traders has been considered valuable when managing execution risk, especially for illiquid instruments. However, in recent years such value as perceived by the Buy side has been diminishing as trading volume remains low historically and trading algorithms are becoming more intelligent in risk management. As a result, the basic practice in traditional Sell side sales trading business is evolving toward the role of “trading process manager”, which should be given a set of operation guidelines to ensure the smooth flow of operations to avoid disruption to the process. The SFC consultation paper formalizes such operation guidelines in the following areas: (1) training and certification of electronic trading professionals playing the role of “trading process managers”, especially for relatively sophisticated processes such as algorithmic trading; (2) pre-trade risk management and post-trade monitoring as required operations that electronic trading professionals have to conduct; and (3) responsibility for certifying in-house or thirdparty technology solutions in terms of product capabilities and technology stabilities. All such requirements may indicate that the traditional

role of a sales trader on the Sell side will potentially be replaced by that of a manager of electronic trading products and that of execution consultants, who will be responsible for their clients’ execution performance.

“We believe that

Quality assurance of trading technologies for both trading systems and trading algorithms will be gradually standardized: Standardizing both the development and the quality control of electronic trading products is not only the result of recent development of trading technologies and algorithmic trading software, but also the natural evolution of industry regulations to ensure orderly operation of the markets. Although nobody can ensure perfect stability of trading software, some market participants have already started asking if traditional Sell side brokers, which themselves are not technology specialists, are fully capable of managing highly automated trading systems. The fact that Knight Capital was reported to seek advice from IBM after losing 440 million USD due to trading software error indicates that both rigorous quality assurance and control procedures and outside professional advices and certifications may be needed by Sell side firms who want to provide electronic trading services to their clients, as well as by specialized trading firms whose businesses depend on trading technologies. It seems that the SFC has this in mind when the consultation paper was drafted. The paper suggests key quality assurance steps such as: (1) stress testing of the trading system, (2) testing of trading algorithms in their responses to sudden market dislocations (likely using sophisticated exchange simulators that take into account market participants’ behaviors under stress), (3) safety checks in trading systems due to erroneous trading behaviors such as too many orders in a short period of time or too large orders submitted to the market, etc. The key difference between the current paper and previous caseby-case requirements on individual firms is that such quality assurance requirements will likely have to be both systematically implemented as testing procedures and standardized across different firms, and electronic evidences of meeting such requirements may have to be documented, presented to and filed by regulatory bodies.

electronic trading

The economics of electronic trading as a business will be modified: As stated by the SFC consultation paper, proposals set out in the paper should “…build on the existing regulatory requirements by providing a more coherent and comprehensive set of regulatory framework for electronic trading.” This means

www.asiaetrading.com z Q4 2012 z Asia Etrader

potential impacts on

will be on three fronts.” that many market participants should already have frameworks in place to cope with basic regulatory guidelines. However, it is our belief that extra work has to be performed by many (if not all) firms who provide electronic trading services to their clients in order to comply with these new requirements – assuming these new requirements will eventually be put into law. Extra investment in trading software, hardware and external consulting services may be needed, especially for operation flow design and trading system testing and certification. For the near term, this may lead to elevated cost base for business operations of many firms. To certain degree, the whole market may have to pay such extra price in order to manage the potential downside risk of disorderly market operations. As a result of that, it may alter the business of electronic trading. Firms who cannot afford the extra cost to ensure complete compliance with the new regulations may have to outsource electronic trading services to other firms who can and want to afford. There may be new specialized trading firms who are also technology professionals that can provide products by not only complying with the new requirements but also competing in terms of good execution performance. In recent years, trading cost has been coming down due to increased usage in electronic trading. It may be the case that the downward trend of trading cost will gradually stabilize and even go slightly higher, providing enough incentive for firms to develop more stable and better performing products that have very low probability of dislocating the market. If that is the end result, it will be a “win-win-win” situation for market participants, execution service providers, and the SFC altogether. Acknowledgement: The author thanks Mr. Kun Zhu and Mr. Song Gu for insightful comments and suggestions for this article. * Hongsong Chou is Managing Director and CEO of Charles River Advisors Ltd., a Hong Kong-based advisory firm specialized in algorithmic trading, high-frequency trading and quantitative investment strategies.

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The long arm of the law Asia is facing the encroachment of rules from other jurisdictions; Shri Navaratnam examines the implications

ver since the 2008 financial crisis, regulators have had their work cut out in trying to formulate robust rules to protect investors and prevent a meltdown of financial markets. Policy makers in the US and Europe have had to move rapidly to restore and shore up investor confidence; regulators proposed new rules and rushed to plug existing loopholes that were said to be at least partially responsible for the worst economic crisis since the Great Depression of the 1930s. The landmark Dodd-Frank Act in the US, the most sweeping financial market reform since World War II, has grabbed the attention of global markets with investors, analysts, policy makers and legal experts debating the implications of the new rules for the US and the rest of the world. Regulators in the US, the epicentre of the crippling financial crisis, and Europe continue to fine tune their new rules so as not to impose undue costs and legislative burdens on the investment community. The implications of these rules for Asia are only just beginning to be understood. Investors and policy makers worry of the cost of complying with US regulations, and in some cases, of potential systemic issues. The Commodity Futures Trading Commission (CFTC) and Securities Exchange Commission (SEC), the US agencies leading the overhaul of financial regulation following the 2008 credit crisis, have been busy putting together rules to avoid a repeat of the problems

that led to and stemmed from the spectacular collapse of Lehman Brothers. However, many charge that the rules are too complex, costly to implement, and ultimately damaging to long term economic growth. On 11 July 2012, the CFTC spelled out for the first time when interest rate, credit, commodity and other derivatives will be considered swaps. The definition will set in motion almost 20 Dodd-Frank measures for reporting, trading, clearing and record-keeping. It’s the first time that government scrutiny will be brought to bear on a US$650 billion global swap market that has remained largely unchecked since its emergence three decades ago. It activates rules to raise collateral requirements and strengthen public trading of the instruments by firms such as Goldman Sachs and JPMorgan Chase & Co. Dodd-Frank allowed the Treasury Department to exempt foreign-exchange swaps and forwards from clearing and trading requirements, though the Treasury has yet to complete the exemption process. “The major issue for the near term will be Dodd-Frank, especially on trading of swaps and registration of fund firms with the US CFTC as commodity pool operations and commodity trading advisors,” says Washington-based Joshua Sterling, partner at international law firm Bingham McCutchen. “Addressing these changes will likely involve considerable expense. The costs of doing business in the Asia Etrader z Q4 2012 z www.asiaetrading.com

Cover story 2

US or with US firms will likely rise,” he says.”US-based firms may look to cut costs or take other steps in response to US legal changes that may lead to fewer product offerings. Investors generally can expect more scrutiny, more due diligence and more expense.” One of the requirements under Dodd-Frank is that non-US banks that trade interest rate swaps or other over-the-counter (OTC) derivatives must register as swap dealers with US regulators and meet their rules on capital requirements and risk management. This will alter the way trades are executed and bump up the costs. Already, officials in Asia have begun their own process to deal with the changes afoot in US and European regulations. Market regulators and central banks in Australia, Singapore and Hong Kong recently fired off a letter to CFTC Chairman Gary Gensler expressing concern about the Dodd-Frank Act’s “unintended consequences” for their markets. The letter says that market participants outside the US may get caught in a complex web of domestic rules as well as Dodd-Frank, leading to “market fragmentation and potentially, systemic risk.” The Reserve Bank of Australia, Monetary Authority of Singapore, Hong Kong Monetary Authority and the Futures Commission in Hong Kong have requested the CFTC to liaise with regulators outside the US before it finalises guidance on how its derivatives rules should apply overseas. www.asiaetrading.com z Q4 2012 z Asia Etrader

The letter further asks the CFTC to consider special local factors that could impact decisions to trade derivatives on electronic platforms. “For example, in the case of Hong Kong, Australia and Singapore, we are studying whether local market liquidity can justify implementation of mandatory trading of OTC derivatives products on exchanges or electronic trading platforms, and the form of trading venue which will best suit the purpose of improving pre-trade price transparency,” the regulators said in the letter. Asia’s OTC markets are relatively small, accounting for around 8% of the global OTC derivatives volume, according to the Bank for International Settlements. Still, as many of the region’s capital markets mature investors are looking for business opportunities in the OTC derivatives market and are keen to avoid stiff regulatory hurdles and additional costs of doing business. “Asia is still a fragmented market and just beginning its maturing process and this (US regulation) has the potential at least temporarily to hinder growth in the financial industry. The multi regulatory effect is creating a backlog on development,” says Thomas McMahon, director at Pan Asia Clearing Enterprise and former chief executive officer of the Singapore Mercantile Exchange. Asian regulators worry that CFTC rules may hamper some Asian clearing houses by requiring that nonUS swaps dealers process their trades through US clearing houses or through Asian houses that have US status. On 28 September, underscoring some of the opposition that DoddFrank has had to contend with, the CFTC suffered a setback. Less than two weeks before curbs were to take effect, US District Judge Robert Wilkins tossed out new trading restrictions in the Dodd-Frank Act that were designed to curtail bets in energy commodities. Judge Wilkins said the CFTC rules, which were expected to go into effect on 12 October, needed more study as they weren’t properly justified by the agency. “The DoddFrank Amendments do not constitute a clear and unambiguous mandate to set position limits, as the Commission argues,” Judge Wilkins said in his ruling. The decision marked a win for the Securities Industry and Financial Markets Association (SIFMA) and the International Swaps and Derivatives Association (ISDA), the Wall Street trade groups that filed joint lawsuits in December 2011 against the CFTC. Events such as this demonstrate the uncertainties that financial institutions face while attempting to comply with these rules. For firms based outside of the US things are doubly uncertain. From the start of next year, Asian banks will have to change the way they do business with US counterparties. These non-US banks that deal annually with at least US$8 billion worth of products, such as interest rate swaps, with American counterparties, will be subject to derivatives rules under Dodd-Frank. Although the value of interest rate derivatives traded in Asia is small in the global context, investors are acutely aware of the huge growth in the market’s value in recent years and are keen to avoid costly regulations. Hong Kong, Singapore and Japan traded a combined US$143 billion of interest rate derivatives every day on April 2010 according to the most recent data from BIS – this compares with about US$1.2 trillion traded in the UK and US$642 billion in the U.S. However, turnover in Asia has zoomed almost three times from US$51 billion in 2004. American banks dominate the global OTC derivatives market; , Goldman Sachs, JP Morgan Chase, Citigroup, Morgan Stanley and Bank of America account for about 37% of all outstanding contracts according to ISDA. The US banks operating in Asia will need to review and restructure the way they do business in the region, said a Singapore-based analyst at Australia and New Zealand Banking (ANZ) Group. The analyst, who did not want to be identified, said “the fact that US regulations will need to be adhered to in jurisdictions outside of America is always going to cause complications which require a cooperative approach from policy makers

cover story 2

to avoid hampering business dealings, and by extension, economic development and growth.” An important criterion for Asian banks is to review and identify which of their trades will be classed as being with a US person, something that’s easier said than done. The regulation defines a “US person” in broad terms, which is intended to apply to any person or entity that will have an effect on US commercial interests. In practice, a trade between an Asian bank and a local branch of an American bank will be classed as a trade done with a US person, but this won’t be the case if a trade was executed with a local subsidiary of an American bank. At present, most banks operate as branches and this means they will come under the purview of Dodd-Frank when trades are executed with Asian banks.

US tax law implications Besides the Dodd-Frank Act, Asia will also have to contend with changes to US tax law. The biggest US tax change to impact Asia’s financial markets is the Foreign Account Tax Compliance Act (FACTA). The law is aimed at foreign financial institutions (FFIs) and other financial intermediaries to prevent tax evasion by US citizens and residents through use of offshore accounts. Under the provisions of FACTA, FFIs may sign an agreement with the Internal Revenue Service, America’s tax authority,

to identify and provide information on US account holders. If an FFI does not enter into an agreement with the IRS, all US sourced payments such as dividends and interest paid by US companies will be subject to a 30% withholding tax. It would be applied to payments on proprietary and customer holdings. FACTA will become effective for new account holders on either 1 July 2013, or on 1 January 2014. Jim Calvin, Asia-Pacific financial services tax leader at Deloitte, says the effective date depends on final regulation, or on government to government agreements being signed. Deloitte expects final regulations by the end of October 2012. “I and others expect that FACTA is the beginning of a global trend toward requiring financial institutions to become tax intermediaries. The US was the first mover; however, it is becoming clearer that other jurisdictions and international organisations support the development,” Calvin says. He believes investors in Asia should not be unduly affected by the US tax changes. “Investors in Asia should not be affected by the changes if their financial counterparties are prepared. Investors should ask questions of their banks, brokers, funds, and insurance companies to ensure that there are plans to be ready for the effective dates,” he adds. Asia Etrader z Q4 2012 z www.asiaetrading.com

Cover story 2

Calvin observes that the serious nature of tax evasion and the consequent problems arising from it are not unique to the US or Western Europe. He says that one of the frequently asked questions is whether governments in Asia and elsewhere will direct their financial institutions to defy FACTA, thereby undermining its purpose. “The answer appears to be no,” he says. “An automatic exchange of tax information such as FATCA would benefit many governments in Asia to a much greater extent than the United States or Western Europe. Various statistics and studies show that wealth is being created in Asian countries at rates exceeding those in the US and Western Europe. Moreover, some tax authorities in Asia, relative to their US and Western European counterparts, may not have the capacity, resources, or systems to identify and tax the offshore assets and incomes of their citizens.” Calvin believes some governments may allow the US to require financial institutions to install “plumbing” of FACTA, allowing their own tax authorities to simply plug into it in search of their citizens’ hidden assets.

“The major issue for the near term will

European regulations

Asia needs to watch AIFMD

In Europe, lawmakers on 26 September backed rules that will limit the controversial share-trading practice of high frequency trading (HFT) under the revised Markets in Financial Derivatives legislation, known as MiFID 2. HFT uses sophisticated algorithms to place thousands of tiny trades per second, often exploiting small gaps in pricing to make profits. The latest ruling supported a range of curbs on HFT, including a rule that orders must be kept for at least half a second before they are canceled, as well as requirement for traders to face higher fees if they withdraw excessive number of orders. Policy makers have been alarmed by potential issues in computerised trading, especially after a series of incidents in the US from the ‘flash-crash’ of 2010 to a glitch in an algorithm used by US broker Knight Capital in August. German exchange operator Deutsche Boerse’s market policy head Stefan Mai says the trading restriction will result in lower liquidity, rising spreads and additional costs for investors and the real economy. The European vote has broad backing for restricting certain aspects of rapid-fire trading, but the idea of enforcing a delay is opposed by a number of governments in the 27-nation EU, meaning changes are expected before the final text is agreed and it becomes law in 2015. Asian financial institutions would be affected to the extent that their counterparties will have to abide by the latest edict, though many of their own governments in the region are already looking at imposing restrictions. While markets in Asia have not been hit by the type of sharp price spikes and fragmentation evident in high frequency trading that has become common on US and European markets, regional regulators are intent on putting in place rules to prevent such occurrences and contain volatility. In a recent consultation paper, the Australian Securities and Investments Commission (ASIC) proposed a range of measures, including clampdowns on algorithm and high frequency trading. In Hong Kong, market regulator the Securities and Futures Commission (SFC) completed a two-month public consultation as it looks to update electronic trading regulation. www.asiaetrading.com z Q4 2012 z Asia Etrader

be Dodd-Frank, especially on trading of swaps and registration of fund firms with the US CFTC.”

For Asia, investors will have to consider the implications of another more important regulation in Europe. This regulation, the Alternative Investment Fund Managers Directive (AIFMD), will be transposed into national law of member states by July 2013. Hedge fund managers are likely to be conversant with its requirements, but they may not be cognizant of its commercial implications. AIFs are broadly categorized as hedge funds, private equity funds, real estate funds and a variety of other funds. The pending implementation of AIFMD is forcing a majority of Asia-based asset managers to turn away from Europe as an investment destination, according to a recent survey by financial publication Asian investor and international law firm Clifford Chance. The survey showed that only 9% of the respondents were willing to consider investing in Europe, a sharp drop from 20% last year. Another survey from Deloitte in July also produced similarly sobering results; more than two-thirds surveyed believe that AIFMD will reduce competitiveness of the European Union’s AIF industry, and the same number expect the directive will result in fewer number of non-EU managers operating in the EU. In a more recent survey by Deloitte, nearly 75% of respondents believe the new directive could become a business threat. Stuart Opp, lead investment partner at Deloitte, said that managers are facing significant organisational and operational change under AIFMD. “The cost of doing business in Europe is set to rise disproportionately for smaller managers who have less internal resources to deal with the compliance responsibilities,” he said. Anne-Marie Godfrey, partner at the international law firm Bingham McCutchen, says that Asia-based funds should carefully study the rules, compliance, and long term implications for strategy. “There are several areas to look into for non-EU funds, and the implications for their operations are broad,” she adds. While the costs of complying with the new rules will be high, there are also some other key factors for fund managers to consider, including such issues as commercial implications of the requirement to appoint a single depositary for each fund, relationships with primary brokers and the impact on business strategies. For many funds, including EU and non-EU funds, looking at the broader picture of Europe’s regulations and undertaking a comprehensive review of strategy in the context of compliance, long term goals and business development should allow for a less bumpy ride.

coVER stoRy 2

www.asiaetrading.com z Q4 2012 z Asia Etrader

derivatives

Intensifying competition in derivatives trading in India By Rekha G. Menon

he Indian equity derivatives market growing at a compound annual growth rate of 45% and ranked among the top five markets globally in terms of number of contracts traded, is set to witness intensifying competition in the coming months. New stock exchange MCX-SX, received the regulatory go-ahead in July this year to deal in equities, equity derivatives, interest rate derivatives and wholesale debt segment, after four years of legal tussles, and is already shaking the market with its competitively priced fee structure. Its transaction fees, for instance, is nearly 50% lower than that of the market leader National Stock Exchange (NSE), forcing the latter to come up with its own differentiated pricing model. The fee structure apart, it is the new entrant’s technological and trading prowess that is expected to pose a threat to the incumbents NSE and the BSE (Bombay Stock Exchange). MCX-SX is promoted by the Financial Technologies (India) Ltd (FTIL) group which offers front-end trading solutions to brokers and runs India’s largest commodities bourse MCX (Multi-Commodity Exchange of India Ltd). MCX holds an over 85% market share of the Indian commodity futures market. MCX-SX, on the other hand, has a nearly 50% market share of the currency derivatives market where it has been operating since 2008. “We are extremely excited about MCX’s entry. It is a formidable player. It has been extremely successful in the commodities and forex markets and will certainly shake up the derivatives market,” notes Sanjay Das, chief technology officer at Symphony Fintech, a vendor of Algorithmic Trading Systems. He says, “We are waiting to see what types of incentives they will offer to brokers. Moreover, lots of derivatives volumes come from algo trading in which MCX-SX has invested. It needs to be seen how attractive the infrastructure that they provide to agency traders is.” Derivatives were launched in the Indian market way back in 2000 when both NSE and BSE started trading in equity derivatives. NSE took an early lead and today derivatives turnover on the exchange has surpassed its equity market turnover. The turnover of derivatives on the NSE increased from Rs 23,654 million (~US$ 443 million) in 2000–2001

to Rs 292,482,211 million (~US$ 5.5 trillion) in 2010–2011. Over the space of a decade, NSE has effectively dominated equity derivatives trading with nearly 99% market share at times. Last year however, BSE initiated attempts to change the status quo through a liquidity enhancement scheme - a broker incentive scheme designed to prompt them into acting as the counterparty to an investor. Under the scheme, these brokers are paid cash for their participation as per prescribed terms and conditions. BSE has allocated Rs 1070 million (~US$ 20 million) for this project and has already spent over 50% of this money. As a result of this incentive scheme, BSE equity trading volumes have grown substantially and it is estimated that nearly nine months after the launch of this liquidity scheme, BSE’s share in equity derivatives market grew to over 20%. BSE’s strategy is similar to what many alternative trading platforms and exchanges around the world have used for cash equity markets in particular, notes Anshuman Jaswal, senior analyst at analyst firm, Celent, “It is an important means of developing a market and BSE must be given credit for trying to challenge the well-entrenched NSE in this regard.” However he states that it will be difficult for BSE to retain its market share once the liquidity enhancement scheme ends. “The entry of MCX-SX would make matters more complex still. NSE for its part is also expected to be more aggressive to wrest its earlier market share levels back.”. “It is a risky move for BSE,” warns Das. Traders, he says, will look at this scheme from a short term perspective, “Once the incentive ends, they will go back to where they can find liquidity.” What BSE needs to do, according to Das, is to come up with differentiated products as well as invest in sophisticated software tools and systems. Jaswal observes that while the liquidity enhancement scheme has been an important strategic initiative, going forward, BSE needs to provide incentives to its clients and also ensure that the quality of service in terms of connectivity, co-location and low latency is as good as or better than the competition. As such, he says, BSE’s improved performance over the past few months means that MCX-SX has two good competitors in the equity derivatives

“BSE must be given credit

for trying to challenge

the well-entrenched NSE”

space instead of only one,the NSE, as would have been the case a year back. The going for MCX-SX, he opines, will not be smooth. Apart from competition from existing players, the various challenges facing the new exchange will be the slower Indian economy, the need to establish its brand in the equity space, and ensuring it has the appropriate infrastructure to attract large brokers and investors, “MCX-SX has fancied its ability to reach smaller towns and rural areas and leverage its commodity derivatives market infrastructure. It now has to show that this is something it is capable of achieving,” says Jaswal. For NSE, he advises that to retain its leadership position, it should continue improving its infrastructure and take advantage of the fact that most large and domestic financial institutions are most comfortable trading on its market. Moreover, it can from time to time consider incentive schemes such as those used by BSE to negate its competitor’s edge in this area. While industry experts unanimously agree that the NSE will continue being the leader in equity derivatives, opinions are divided on which exchange will be the second runner. Some believe that BSE will give a good fight to MCXSX, but others expect it to play a minor role in the coming months. Whatever is the outcome, the increased competition is a welcome development, and a sign of the evolution and growing maturity of the Indian markets.

Asia Etrader z Q4 2012 z www.asiaetrading.com

dERIVAtIVEs

www.asiaetrading.com z Q4 2012 z Asia Etrader

derivatives

Product

Q3 Vol

Q2 Vol

Difference Type

Dalian Commodity Exchange

Soy Meal

318,188,616

141,405,400

176,783,216

Agriculture

National Stock Exchange of India

US Dollar/Indian Rupee

152,458,128

149,060,527

3,397,601

Currency

Shanghai Futures Exchange

Steel Rebar

144,824,286

38,603,280

106,221,006

Metal

Multi Commodity Exchange

US Dollar/Indian Rupee

129,558,609

138,299,625

-8,741,016 Currency

Zhengzhou Commodity Exchange

White Sugar

122,057,382

71,162,772

50,894,610

Commodity

Zhengzhou Commodity Exchange

Pure Terephthalic Acid (PTA)

97,607,446

44,188,344

53,419,102

Commodity

Dalian Commodity Exchange

Soy Oil

41,687,518

32,517,342

9,170,176

Agriculture

Dalian Commodity Exchange

No. 1 Soybeans

40,405,588

12,093,468

28,312,120

Agriculture

Shanghai Futures Exchange

Rubber

39,971,194 26,383,670 13,587,524 Commodity

Dalian Commodity Exchange

Linear Low Density Polyethylene (LLDPE)

38,798,966

Shanghai Futures Exchange

Copper

29,488,336 34,741,296 -5,252,960 Metal

Dalian Commodity Exchange

Corn

23,082,664 24,692,472 -1,609,808 Agriculture

Dalian Commodity Exchange

Palm Oil

22,342,196

Dalian Commodity Exchange

Coke

19,644,634 426,202

19,218,432 Commodity

Multi Commodity Exchange

Crude Oil

17,973,343

13,258,858

4,714,485

Zhengzhou Commodity Exchange

Strong Gluten Wheat

16,301,462

16,617,090

-315,628 Agriculture

Korea Exchange

US Dollar

13,427,485

15,074,724

-1,647,239 Currency

Shanghai Futures Exchange

Silver

13,269,850 12,443,308 826,542

Multi Commodity Exchange

Silver Micro

12,109,953

13,816,331

-1,706,378 Metal

Australian Securities Exchange

3 Year Treasury Bond

11,861,576

11,761,826

99,750

Zhengzhou Commodity Exchange

Cotton No. 1

11,450,478

17,355,272

-5,904,794 Commodity

Shanghai Futures Exchange

Zinc Futures

9,351,850

10,108,028

-756,178 Metal

Multi Commodity Exchange

Silver Mini

8,583,456

9,604,576

-1,021,120 Metal

Multi Commodity Exchange

Natural Gas

8,359,714

6,473,757

1,885,957

Multi Commodity Exchange

Copper

7,830,346 9,767,287 -1,936,941 Metal

Multi Commodity Exchange

Gold Petal

5,869,972

10,146,158

-4,276,186 Metal

Australian Securities Exchange

90 Day Bank Bills

5,097,534

6,178,550

-1,081,016

Multi Commodity Exchange

Gold Mini

5,075,627

5,913,675

-838,048 Metal

Multi Commodity Exchange

Copper Mini

4,788,694

5,196,578

-407,884 Metal

Australian Securities Exchange

10 Year Bond

4,483,751

4,878,661

-394,910

Multi Commodity Exchange

Silver

4,163,053 4,536,372 -373,319 Metal

Multi Commodity Exchange

Nickel

4,092,526 3,608,958 483,568

Metal

Dalian Commodity Exchange

Polyvinyl Chloride (PVC)

3,448,870

3,161,222

287,648

Commodity

Tokyo Financial Exchange

Euro/ Japanese Yen

3,443,521

4,352,112

-908,591 Currency

Zhengzhou Commodity Exchange

Rapeseed Oil

3,240,994

5,687,122

-2,446,128 Agriculture

Shanghai Futures Exchange

Gold

2,948,424 3,144,420 -195,996 Metal

Zhengzhou Commodity Exchange

Rice, Early

2,936,598

1,701,792

1,234,806

Tokyo Financial Exchange

Australian Dollar/ Japanese Yen

2,906,943

5,085,512

-2,178,569 Currency

Zhengzhou Commodity Exchange

Methanol

2,713,964 1,821,166 892,798

Tokyo Commodity Exchange

Gold

2,656,737 2,729,826 -73,089 Metal

Multi Commodity Exchange

Gold

2,600,785 2,624,932 -24,147 Metal

Multi Commodity Exchange

Nickel Mini

2,563,006

Shanghai Futures Exchange

Aluminum

2,528,494 2,367,616 160,878

Metal

National Commodity & Derivatives Exchange

Ref Soya Oil

2,130,960

1,839,497

291,463

Agriculture

Tokyo Stock Exchange

10 Yr Japan Government Bond

2,116,675

2,422,461

-305,786

Interest Rate

Bursa Malaysia

Crude Palm Oil

2,048,183

1,896,549

151,634

Agriculture

National Commodity & Derivatives Exchange

Soybeans

1,585,507 1,579,639 5,868

Agriculture

Tokyo Financial Exchange

3 Month Euroyen

1,483,409

1,151,016

332,393

Interest Rate

Tokyo Financial Exchange

US Dollar/ Japanese Yen

1,298,601

2,208,607

-910,006 Currency

National Commodity & Derivatives Exchange

Cotton Seed

1,259,758

1,422,729

-162,971 Agriculture

National Stock Exchange of India

Euro/ Indian Rupee

1,236,101

1,074,989

161,112

National Commodity & Derivatives Exchange

Chana

1,147,300 1,108,870 38,430

Tokyo Commodity Exchange

Platinum

875,304 746,196 129,108 Metal

Tokyo Financial Exchange

British Pound/ Japanese Yen

737,110

1,208,037

-470,927 Currency

United Stock Exchange

US Dollar/Indian Rupee

735,070

580,719

154,351

Total

33,427,790

14,819,420

2,109,690

1,432,848,547 990,586,336

5,371,176

7,522,776

453,316

442,262,211

Commodity

Agriculture Energy

Metal Interest Rate

Energy

Interest Rate

Agriculture Energy

Metal

Currency Agriculture

Currency

Source: Exchange Websites

TOP 55 Futures Contract By Volume In Asia For Q3 2012

* Estimated

Exchange

derivatives

Exchange

Product Net

Top 5 Decliners

US Dollar/Indian Rupee Cotton No. 1 Copper Gold Petal Rapeseed Oil

Multi Commodity Exchange Zhengzhou Commodity Exchange Shanghai Futures Exchange Multi Commodity Exchange Zhengzhou Commodity Exchange

-8,741,016 -5,904,794 -5,252,960 -4,276,186 -2,446,128

Exchange

Product Net

Top 5 Gainers

Soy Meal Steel Rebar Pure Terephthalic Acid (PTA) White Sugar No. 1 Soybeans

Dalian Commodity Exchange Shanghai Futures Exchange Zhengzhou Commodity Exchange Zhengzhou Commodity Exchange Dalian Commodity Exchange

176,783,216 106,221,006 53,419,102 50,894,610 28,312,120

Exchange

Product Volume

Top 5 Agriculture Futures

Soy Meal 318,188,616 Soy Oil 41,687,518 No. 1 Soybeans 40,405,588 Corn 23,082,664 Palm Oil 22,342,196

Dalian Commodity Exchange Dalian Commodity Exchange Dalian Commodity Exchange Dalian Commodity Exchange Dalian Commodity Exchange

Total

192,517,848

Exchange

Product Volume

Top 5 Commodity Futures

White Sugar 122,057,382 Pure Terephthalic Acid (PTA) 97,607,446 Rubber 39,971,194 Linear Low Density Polyethylene (LLDPE) 38,798,966 Coke 19,644,634

Zhengzhou Commodity Exchange Zhengzhou Commodity Exchange Shanghai Futures Exchange Dalian Commodity Exchange Dalian Commodity Exchange

Total

318,079,622

Exchange

Product Volume

Top 5 Currency Futures

US Dollar/Indian Rupee US Dollar/Indian Rupee US Dollar Euro/Japanese Yen Australian Dollar/Japanese Yen

National Stock Exchange of India Multi Commodity Exchange Korea Exchange Tokyo Financial Exchange Tokyo Financial Exchange

Total

152,458,128 129,558,609 13,427,485 3,443,521 2,906,943 301,794,686

Exchange

Product Volume

Top 5 Metal Futures

Steel Rebar 144,824,286 Copper 29,488,336 Silver 13,269,850 Silver Micro 12,109,953 Zinc Futures 9,351,850

Shanghai Futures Exchange Shanghai Futures Exchange Shanghai Futures Exchange Multi Commodity Exchange Shanghai Futures Exchange

Total

Volume Q2

Net

Stock Index Futures Index

Volume Q3

Osaka Securities Exchange China Financial Futures Exchange National Stock Exchange India Korea Exchange TAIFEX TAIFEX Hong Kong Exchanges Osaka Securities Exchange Hong Kong Exchanges Tokyo Stock Exchange Australian Exchange BSE Thailand Futures Exchange Bursa Malaysia

Nikkei 225 mini CSI300 S&P Nifty KOSPI 200 TAIEX mini-TAIEX HSI Nikkei 225 HHI TOPIX SPI 200 SENSEX 30 SET 50 KLCI

30,243,360 33,856,526 -3,613,166 27,930,849 20,409,044 7,521,805 17,329,793 22,278,355 -4,948,562 17,104,867 16,897,408 207,459 11,482,810 14,930,176 -3,447,366 7,139,294 9,607,976 -2,468,682 4,924,352 5,405,446 -481,094 4,389,045 5,206,854 -817,809 3,813,494 3,973,006 -159,512 3,729,113 4,008,210 -279,097 2,587,721 2,777,048 -189,327 1,163,366 2,915,268 -1,751,902 957,217 1,333,515 -376,298 514,991 630,434 -115,443

Total

133,310,272

144,229,266

-10,918,994

Source: Exchange Websites

Exchange

* Estimated

209,044,275

buy-side

The high-touch, low-touch desk Algorithm advisory desks offer traders support but some see the desks as crossing the line with sales trading

dvising on which algorithm to use can broach high-touch sales trading, but without the cost. As brokers struggle to make ends meet in tough markets, there is greater pressure to offer competitive services to buy-side clients. Challenging trading conditions typically polarise buy-side firms in the scope of algo use: volatility makes some firms pull away; others will dump low cost algos when their overall turnover falls because they need to pay higher commission rates to cover the amount of advisory they are consuming. “With trading slowing down buy-side firms still have bills to pay with regard to research so to some extent the buy-side is pushed towards using full service sales trades at higher commission,” says Joel Hurewitz, head of product strategy, Asia at agency broker Instinet. “On the flipside as there are fewer orders on each buy-side desk they have more time to trade the order themselves either by DMA or through an algo. With liquidity drying up on exchanges they are accessing the alternative venues more and more. They are generally accessed via smart order router or though algorithms like our [liquidity seeking algo] Nighthawk.” “Despite the ups and down of individual shops, in aggregate the overall use has grown,” says Gabriel Butler, executive director at Morgan Stanley Electronic Trading, for fullservice broker Morgan Stanley. “There has been a strong trend in that direction in Asia, despite predictions after the financial crisis that it would go in reverse, and we see more use of traditional high-touch trading. The emphasis of buy-side traders taking responsibility for trades has continued, with more trades being kept on the asset managers’ desks.” Keeping the trades on track in this low volume, high volatility environment is critical as market sudden price movements are liable to make certain algos unviable. Advisory desks have always been offered by sell-side firms but their guidance can be particularly useful when buy-side firms are self-trading in a hostile market. “Our product sales and trading (PST) group not only monitor DMA flow but they also are responsible for our products and trading and

On the ball

“Vendors are begin to be more proactive when it comes to monitoring algos and advising customers on the best way to parameterise algos,”

– David Jenkins, head of business development Fidessa

monitoring order flow,” says Hurewitz. “To that extent there are a number of things that we do on this desk; we need to understand each client’s style of trading, we watch and monitor their flow and check that orders sent to a specific algo are suited to that algo. We watch with regard to IV issues and volume caps. From the inset perspective we definitely feel that more is required of us and that is a service that we feel clients value.”

These services are not only provided by brokers themselves, but also by vendors of algortihmics systems, claims David Jenkins, head of business development at trading system supplier Fidessa. “Vendors are beginning to be more proactive when it comes to monitoring algos and advising customers on the best way to parameterise algos,” he says. “A common trend in the industry is general outsourcing of algos by brokers to other firms. If you are not one of the big order flow trading shops then you don’t really have the capability to advise clients in-house and provide them with that level of service. So brokers are expecting firms like Fidessa to provide more sophistication there.” He says that real-time performance can monitoring can be provided with execution measured against benchmarks trading takes place, and also analytics can be provided around market cost, checking if the trader is crossing the spread too often. “In Asian markets that are illiquid it can be very costly to cross the spread,” he warns. “Analytics can estimate the market costs you are incurring. It won’t be 100% spot on but you’ll get a good estimate.” Such a service is especially valuable for traders using new or adapted algos, or those in a volatile market. Hurewitz observes that as clients become more mature in their use algorithms they are able to customise them to a greater extent, according to their needs. “Now the buy-side is getting up to speed with the algos they are more in touch with what they like and don’t like,” he says. “We regularly tweak and build algorithms for clients.” As technology improves and interventions can be made more easily based on performance the expectation of the services that an algo trading desk provides is also changing.

Overstepping the mark Some buy-side traders are pushing for the algo desks to support them with ever more involved advice that some would say verges on sales trading.

Asia Etrader z Q4 2012 z www.asiaetrading.com

buy-side

Gabriel Butler

Executive Director Morgan Stanley Electronic Trading

Head of Asia Pacific Trading Alliance Bernstein

Emma Quinn

Joel Hurewitz

“The emphasis of buy-side traders taking

“I’m sure some buy-side traders would be happy

“The buy-side is pushed towards using full

responsibility for trades has continued”

to see sales traders and algo desks merged”

service sales trades at higher commission”

“There’s a lot of dispersion in Asia on what buy-side firms expect from their algo desk,” says Butler. “The most sophisticated use it as a low touch desk with very few people involved, just to check that everything is running OK. There wouldn’t be many people giving real-time advice, telling you to change parameter settings in real time or from VWAP to per cent of volume or to DMA. That sort of advice and real-time intervention has become more common over time as staffing levels have blossomed on the algo desk.” The head trader for Hong Kong at one global investment manager, who asked to remain nameless, said that not all buy-side firms were comfortable with the extended service. “There is a debate at the moment around offering more full service advice on the algo, the sort that would have been offered by a sales trading desk, rather than just correcting errors,” he says. Emma Quinn, head of Asia Pacific trading at asset manager Alliance Bernstein says, “There’s a clear distinction between the two different models, and there won’t be one size that fits every asset manager. Some sell-side firms are catering to one group, some are catering to the other. What will be interesting is

We put it to the brokers

whether the model can be maintained; I’m sure some buy-side traders would be happy to see sales traders and algo desks merged.” “We’re against that sort of cross-over because if they provide advice while having visibility of order flow then they are conflicted, even if they don’t take advantage of it,” adds the head trader. “We put it to the brokers that if someone is in the position of observing our order flow on the algo desk we don’t want them providing advice to clients in a full service way. We are using algos to be under the radar, we don’t want to have that risk of leakage.” Quinn agrees that she would not want brokers to provide advice based on anything other than order criteria. However she notes that certain levels of risk only exist if the asset manager has not done their homework on both the broker and the algorithms. “I allow my brokers to see what I’m trading,” she says. “Firstly if I didn’t trust the sales trader I shouldn’t be trading with them in the first place. Secondly the orders I run through algorithms are very different to what I would send to a dark pool for example, which I differentiate from algos. So if a sales trader wanted to front run the order, good luck to them; the market value won’t be that big.”

that if someone is in the position of observing our order flow on the algo desk we don’t want them providing advice to clients in a full service way

www.asiaetrading.com z Q4 2012 z Asia Etrader

Head of Product Strategy Instinet

REGuLAtIon

shut ‘em down Will Australia and Hong Kong ban some electronic trading?

n 1 August, an automated trading system lost US broker Knight Capital US$440 million on the New York Stock Exchange in 45 minutes. “It made everyone nervous and they have fallen back to blaming HFT and algo trading,” says Rob Hodgkinson, director Asia Pacific at trading system supplier First Derivatives. “I think the deficiency has been with the exchange controllers – regulators and exchange operators – who have been slow to pick up on and monitor HFT technology.” This year has seen numerous technologybased problems on the financial markets including Tokyo’s outages on 7 August and 2 February, the aborted BATS initial public offering due to its own system failure and Nasdaq’s technical problems around the Facebook IPO, which Swiss investment bank UBS claimed had cost it US$350 million and Knight Capital said cost it US$35 million. The risks of trading have been conclusively demonstrated over the last two decades: the collapse of Barings in 1995, due to unauthorised trading losses on the Singapore International Monetary Exchange; Société Générale’s e5 billion loss in 2008 caused by trader Jerome Kerviel; UBS’s e1.8 billion loss in 2011, which has triggered an ongoing court case against trader Kweiko Adoboli . Each was apparently a result of bank staff not adhering to checks and balances. Now the potential cost of combining trading and technology, as demonstrated by Knight’s technical problem, is spurring regulators on to clamp down on automated trading strategies. On 31 August, speaking to the Trading Architecture Asia conference, Mark Steward, executive director for enforcement at Hong Kong’s regulator the Securities Futures Commission (SFC) , said that his organisation had issued 18 Compliance Advice Letters to intermediaries after disruptive price or volume changes or other trading glitches had arisen, primarily as a result of algorithmic trading, since 2009.

Asia Etrader z Q4 2012 z www.asiaetrading.com

regulation

“In many cases, it was apparent the operators had little idea of what they were doing,” he said. “Some excuses sounded like the trader’s equivalent of the schoolboy’s excuse for being late, e.g. the tram had a flat tyre. In each of these cases, we required the intermediaries to implement remedial steps to overcome the causes. A series of micro-reforms without any explicit set of ongoing responsibilities to support them was not enough as electronic trading volumes doubled. These new realities require a new set of responsibilities to be established within the existing regulatory framework.”

The middle man The SFC launched a two-month consultation from 24 July on a set of proposed rules around electronic trading. It sets out requirements for: taking responsibility all forms of electronic trading, management and supervision, adequacy of system and record keeping; the provision of risk management and supervisory controls to monitor orders stemming from internet trading and DMA services with automated pre-trade controls and regular posttrade monitoring; and requirements related to testing of the algorithmic trading system and trading algorithms, user qualification and risk management controls. It places the emphasis on intermediaries to check on the design training and use of trading systems, testing of the platform and monitoring of algorithms with the obligation to prevent erroneous orders and risk to clients. Reviews must be made of activity, with records kept. Several sources expressed worry that the shift of liability onto intermediaries was in some senses letting the regulator off the hook for identifying bad behaviour. “In some ways I see this as being an easy way for HKEx to stand aside so it can build its new trading platform and say we don’t have to worry about the types of trading because it is [intermediaries’] responsibility,” said one market participant, who asked not to be named. “If intermediaries have to oversee the firms from whom they derive income there is a natural conflict of interest there; they will have to balance independent oversight while supporting their fiduciary duty,” says Alex Frino, professor of finance at The University of Sydney and CEO of the Capital Markets Cooperative Research Centre.

Fully automatic Australia’s market regulator, the Australian Securities and Investments Commission (ASIC), launched a similar one-month review of its proposals around automated trading on 13

“In many cases, it was apparent the operators

had little idea of what they were doing.”

August. Consultation Paper 184 (CP 184) built on two previous consultations on electronic trading and market integrity conducted as CP 145, released November 2010 and CP 168 released October 2011, which first set out planned rules and penalties for non-compliance with those rules. The latest consultation supplements those rules, by demanding that market participants stress-test algos and are able to exhibit direct control over filters applied to order flow. “Pre-trade filters are quite a bit different to responses in other jurisdictions, such as circuit breakers in the US,” says Frino. “Filters add latency – which might only be microseconds – by checking the market conditions and then deciding on approval of a trade. But that latency can harm some useful models of high-frequency trading (HFT) and make them non-viable.” The ASIC rules make specific reference to characteristics of HFT strategies which are to be prevented, including “continuing patterns of order deletions, order amendments, over trading or wash trading” which may lead the regulator to “cease, suspend, limit or prohibit automated order processing (AOP).” Frino splits HFT into separate three categories: market makers, which he characterises as the ‘good guys’ and providing a valuable economic role; arbitrageurs which play across different markets, and also play a valuable role in price discovery by keeping prices efficient; and then position takers, who invest in where the market will go in the next few seconds, minutes or hours. “The problem with pre-trade filters is that they will affect arbitrageurs or market makers more than position takers,” Frino says. “A common

www.asiaetrading.com z Q4 2012 z Asia Etrader

strategy for position takers is to try and second guess whether a large order is coming into the marketplace. They then buy ahead of a large buy-order, pushing the price up, then sell to it or sell ahead of a large sell order, pushing the price down and then buy from it. In doing that they can mess up the execution point for the large-order trader.” His posits that introducing latency may slow down the ‘moving target’ of the large order. In addition market makers, who trade large volumes of shares based on incremental price changes, may find they are unable to adjust their prices as rapidly as they need to making their strategy more risky and potentially less viable. “The pool of liquidity that can be described as high frequency trading (HFT) generally has a positive impact on liquidity,” he adds. “The good HFT guys outnumber the bad, but if we upset this balance my concern is we might end up with a toxic pool of HFT.” However others on the buy-side are more supportive of the rules and less of HFT. In response to the consultation Zachary May, director of regulatory policy at Industry Super Network, an industry association for superannuation retirement funds, said he had serious concerns about HFT which he hoped ASIC would address. They were based around three points: the risks HFT poses to market integrity, by eroding liquidity and contribute to a breakdown in orderly markets, particularly the capacity of high frequency traders to flood the market with orders magnifies the risks to market integrity arising from automated trading in general; the structural advantages it holds that unfairly redistribute profits from traditional long term investors to HFT traders, using the business procedure of making offers to buy and sell that are not bona fide; and its risk of undermining the efficiency of the market, particularly its capacity to facilitate the allocation of society’s scarce resources at low social costs. However he also expressed concerns about the filter system, saying that “reliance on filters and controls alone, even for market integrity purposes, may be suboptimal because these do not address the incentives of market participants. It is implicit in the strategies of some HFT firms and their quotation behaviour that some HFT firms are sufficiently selfinterested that they are antisocial. As a result, ASIC should anticipate that such firms may undertake efforts to game or deceive the filters and controls themselves, just as such firms have sought to game and deceive the algorithms of other market participants.”

exchange spotlight

China’s first step in exchange acquisition waltz HKEx/LME deal shows expansion necessary for growth

ong Kong Exchange and Clearing (HKEx) acquisition of the London Metal Exchange (LME) was Asia’s first successful international exchange merger. For trading venues and market infrastructure, the first decade of this Millennium was like a huge M&A dance, chaperoned by parental regulators and government officials. A series of mergers, some successful some otherwise, led to the formation of NYSE Euronext (including the LIFFE derivatives market), Nasdaq OMX and BATS Chi-X Europe, while Deustche Börse took complete control of Eurex, its derivatives joint venture with the Swiss Exchange launched in 1998. European equity markets were all too small to stand alone against the bigger countries like Brazil, China and Russia; in many cases these giants were consolidating derivatives and stock markets at a national level to form superexchanges such as Brazil’s BM&F Bovespa. Germany’s ownership of the Eurex operation gave Deutsche Börse Group a welcome nonequity revenue stream in the form of post-trade and derivatives revenues. Likewise Singapore Exchange (SGX) was able to position itself well with derivatives and post-trade offerings, having partnered with various overseas markets. Its failed merger with the Australian Securities Exchange (ASX) left the latter facing competition at home without the prospect of overseas revenues shoring up its balance sheet. The London Stock Exchange also took a hit when it was unable to merge with Canada’s TMX Group, a deal that had promised to combine London’s liquidity with Toronto’s affinity for mining firms, potentially generating Asia Etrader z Q4 2012 z www.asiaetrading.com

exchange spotlight

Local demand

Frederic Ponzo, Managing Partner, GreySpark Partners

some interesting products on the back of rising commodity demand. On 25 July 2012 market operator HKEx dipped its toe into Europe’s warm waters, showing that it too saw the value in the commodities markets, with its acquisition of the LME, which claims to process trading in over 80% of the world’s global non-ferrous metals business. The deal, worth £1.38 billion (US$2.1 billion) was voted through by 64 out of 67 LME shareholders, representing 99.63% of the holding. Some of the big brokers who were major shareholders, including Goldman Sachs and JP Morgan whose combined stake was over 20%, will have received big pay-outs from the deal. Trading on the LME is conducted in one of three ways: electronically on LMEselect; in ‘the Ring’, an open outcry market; and by telephone 24-hours a day. “Coming after SGX’s attempt to buy ASX, this deal shows that Asian markets are looking at acquisitions to maintain their growth, which suggests that cannot sustain their existing growth rates organically anymore,” observes Fred Ponzo, principal of GreySpark Consulting. “Until now Asia has been able to progress just by working on their domestic markets. The big ones, Hong Kong, Singapore and to some extent Tokyo, cannot do that anymore so they are looking at acquisition.”

Since 2004, economic growth from China and emerging markets has increased demand for metals at a record pace. China currently accounts for about 42% of global metals consumption according to HKEx. Improving access to the LME’s market for Chinese users could significantly boost the LME’s business and that of its existing members through increased trading volumes. HKEx has links with, and an understanding of, China’s end users, brokers and regulatory regime and could use this to unlock the significant opportunities for the LME in Asia. The deal was not uncontroversial – the price tag has been cited as expensive by many market commentators – but it has been widely welcomed by the trading community. “I think it will positively impact trading as China controls 80% of the world’s industrial futures metals,” said one base metals trader at a major London interdealer broker. “It will open the market up to a lot of Chinese and Asian business as London-based traders will be able to access warehouses in those markets and see their demand for the futures trade increase. As a result trading volumes are likely to increase massively. It will also probably hit the price of copper as China has 40% of the copper market, so there might be some strong prices following the deal.” HKEx has said that it plans a number of key initiatives: • Enhancing market data distribution and connectivity into Asia, including China; HKEx will utilise its data centre, established Asian infrastructure and its planned market data hub in Shanghai to enhance distribution of market data to Chinese clients. • Supporting the LME in expanding its warehouse network in Asia, including China; HKEx will assist the LME in consulting with relevant authorities and warehouse operators, with a view to expanding the network of LMEapproved warehouses in Asia, including China. • Introducing new products and services: HKEx will extend its track-record of product development to the LME by leveraging its RMB trading, clearing and settlement infrastructure in Hong Kong and its membership of the recently formed BRICS Exchanges Alliance. • Expanding the number of mainland Chinese participants and clients: As the leading offshore trading venue for mainland Chinese market participants, HKEx expects to increase the active participation of Chinese clients on the LME through leveraging its own resources, relationships and network in mainland China.

www.asiaetrading.com z Q4 2012 z Asia Etrader

“Coming after SGX’s

attempt to buy ASX, this

deal shows that Asian

markets are looking at

acquisitions to maintain

their growth.”

A spokesperson for HKEx said, “Product innovations that HKEx will seek to introduce include: value chain products, such as composite metal (including stainless steel, iron ore and coking coal) and production component contracts; index products, such as BRICS and Asian commodities indices; and new products, such as RMB denominated contracts.”

Tough to beat The effect on other markets could be substantial given the strength of China and Hong Kong’s unique position as the gateway between it and the rest of the world. That could also spell trouble for the Hong Kong Mercantile Exchange. It launched with precious metals contracts in 2011 but has plans to move to base metals, as traded on the LME. It signed a memorandum of understanding with Jiangxi Copper, which claims to be China’s largest copper producer in June 2012 to further this aim. One London-based trader who declined to be named said, “In terms of metal futures I think that HKEx will dominate as the LME has been going for so long and is so successful. So the HKMerc may see lower than expected volumes.” Singapore Exchange (SGX) launched LME mini contracts (trading at 20% size of standard

exchange spotlight

LME contracts) in February 2011 for aluminium, copper and zinc. Similar mini contracts were first launched on the LME in 2006 but failed to achieve the hoped for trading volumes. Despite initial success on SGX with nearly 40,000 lots trading in March 2011, trading volumes fell to less than 2000 lots per month from June 2011. The effect of the HKEx deal on this arrangement has not been made public. The deal also offers HKEx a way of expanding revenues from post-trade services notes Ponzo. “Why is it buying a commodities exchange when it only trades equities and equity derivatives?” he asks. “The LME is the last pre-electronic exchange operating in London and one of the few left in the west, so the deal doesn’t bring any technology that HKEx didn’t already have access to. Our view is they are interested in the clearing side. Clearing is where the big money is. LME planned to launch its own clearing house in 2014; I would suggest that this will be accelerated once the deal is concluded.” A spokesperson for the group confirmed that, “HKEx will make its expertise as an operator of three clearing houses available to support the development and successful implementation of LME Clear. Additional benefits that HKEx expects to bring to the operation of LME Clear include risk management expertise, expertise in RMB infrastructure to support the future clearing of RMB products and recent experience in developing an OTC clearing house.” It would be a mistake to write the LME off as being a Luddite organisation because of its preservation of a trading pit. In November the exchange announced a major upgrade to its electronic trading platform, LMEselect, launching a proximity hosting service at the same time. These two electronic trading upgrades are advantageous to the high frequency trading (HFT) community. With LMEselect volumes up 25% last year-on-year in 2011 according to its annual report, the LME said it expected its new faster service to further stimulate volumes in 2012. Appealing to the HFT market would seem an obvious move for a market that has struggled to expand revenues away its traditional nonferrous metal market, however the somewhat political issue of HFT can prove polarising amongst other market participants. In addition, despite these apparently encouraging moves the LME, like HKEx, has also introduced inhibitors to HFT trading. Its throttling system introduced on 28 April 2011, limits the maximum number of order entry/ updates that can take place to 40 per second for each LMESelect FIX key or graphical user interface (GUI) user.

Order entry/updates submitted in excess of the throttling limit in any given second will be queued by the system and smoothed over the following seconds according to the throttling limit maximum, so a burst of 80 order entry/update instructions in one second would result in acceptance of the first 40 instructions during one second with the rest getting smoothed evenly over the following second. Orders submitted subsequent to the burst would be added to the queue and smoothed accordingly. The LME says the system is intended to ensure orderly conduct of trading on LMEselect and to protect LME and member systems. On the same day it also introduced a scale against which firms would be punished for generating excessive numbers of orders compared to trades completed, a hallmark trading strategy for HFT firms. A series of punishments will be meted out, dependent on the scale of the offense. If the ratio of orders to trades generated by a FIX key or GUI user exceeds 20:1 as an average during a trading day, the exchange will charge the member responsible for the FIX key or GUI user a daily fee of £2,500 if the ratio exceeds 25:1 as an average during a trading day the charge goes up to a daily fee of £10,000; and if the ratio goes past 30:1 as an average during a trading day the exchange will suspend access to LMEselect for the user “until such time as the member responsible for that LMEselect FIX key or GUI user has satisfied the Exchange that sufficient controls have been put in place to ensure that the order to trade ratio generated from that LMEselect FIX key or GUI user will not exceed 30:1.” How much this disciplinary model will be maintained by HKEx when it takes over is unclear, however the Hong Kong market operator has said that it would invest and apply its technological expertise to enhance the IT infrastructure of the LME, to support a strategy of “progressively upgrading its core IT platforms to drive business growth”. Depending on how this is applied, it could suggest some fairly progressive developments at this most staid of exchanges, although the LME’s users believe it is unlikely they will see anything dramatic take place. “They said they will keep the existing business model until 2015,” said the London-based trader. “HKEx does not have any experience in dealing with an open outcry trading floor, which is currently the most efficient way of trading futures, so I can’t see any benefit for HKEx to change things around at the moment.” Asia Etrader z Q4 2012 z www.asiaetrading.com

exchange spotlight

HKEx LME Merger Fact Sheet LME l

LME traced back to 1571 when the Royal Exchange opened

LME founded in 1877

l LME

World’s largest base metals futures market with 80%

of the market l

In 2011 had 100% of market in Aluminum Alloy and Tin

LME used as the global benchmark for physical trading

l LME

trade 146.6 million in 2011, totaling US$15.4 trillion

in notional value l 732

LME-approved warehouses are found across 37 locations

in 14 countries l

Since 2007 LME volume has grown at 12.1% CAGR

l 2011

Aluminum and Copper trading volume represent 43%

and 26%, respectively of total l

After-tax profit was down 18.8% in 2011

HKEx l

Association of Stockbrokers in Hong Kong founded 1891

l 6

March 2000 HKEx was formed from the merger of SEHK,

HKFE and HKSCC l

The Stock Exchange of Hong Kong was incorporated in 1980

Hong Kong Commodity Exchange was established in 1976

HKEx is the worlds largest exchange by market capitalization

HKEx has been the leader in IPOs for 3 years

Merger enforces Hong Kong’s position as the gateway to China

Merger allows HKEx to expand into Commodities

After-tax profit was HKD5,093 million (US$657 million) in 2011

Merger l HKEx

paid HKD 16,673 million (US$2.15 billion) to acquire

100% of LME l

LME’s current management team remains

l LME

will stay FSA regulated Recognised Investment Exchange

based in London l Borrowing

at least US$1.78 billion from China Development Bank,

Deutsche Bank, HSBC and UBS

www.asiaetrading.com z Q4 2012 z Asia Etrader

25 July LME Holdings Limited voted in favour of the acquisition

67 voted – 64 for and 3 against

For voters represented 99.63% of the LME holdings

Closing date of merger Q3 2012

risk

Roads to strengthening barriers against trading technology risk By Roger Aitken

While a ‘silver bullet’ to eliminating trading risk and accidents within and between financial institutions might not be available or even realistic today, buy- and sell-side firms can take measures and deploy cutting-edge technology to protect themselves and their brands from potentially disastrous scenarios. Roger Aitken explores some of the issues.

echnology risk is a “factor that trading firms must live with and manage”, but both creators and users of technology have long recognised that there is “no silver bullet” for eliminating such risk entirely. Thus contended a new whitepaper titled ‘Strengthening Barriers Against Trading Technology Risk’ published this September by Corvil, a Dublin-headquartered vendor focussed on technology risk. According to Chartis Research, an independent provider of analysis on financial and operational risk management systems, risk technology spending globally is forecast to exceed an eye-popping $23bn by 2013 in financial institutions. Their latest RiskTech100 report (6th edition) points to “compliance and integration” driving risk technology expenditure, with much of it driven by the proliferation of regulations including Dodd Frank, Basel III and Solvency II. “There is a quiet revolution taking place in the financial services industry, where the disciplines of risk and finance are converging,” notes Peyman Mestchian, managing partner of Chartis Research. This he says is characterised by “better alignment of the chief financial officer (CFO) and chief risk officer (CRO)” and is leading to a re-think of organisational structures, business processes and underlying technology architectures. He points also to a trend towards “value-based compliance” moving away from the traditional “tick box” mentality. Fergal Toomey, chief scientist and cofounder of Corvil, commenting in the wake of the vendor’s latest whitepaper says, “Finding a ‘silver bullet’ is not a realistic end-goal for dealing with technology risk, because it’s never possible to completely eradicate the risk of ‘accidents’.” Using the analogy of the aviation industry, Toomey explains: “Safety in aviation is lifecritical and arguably far more sensitive than in

electronic trading,” he argues. “A great deal of time, effort and experience has gone into improving safety in aviation, and yet the risk of accidents has not been completely eliminated. Instead, the industry has managed and reduced its risks to a point where stakeholder confidence can be sustained.” Electronic trading may not require the same level of safety as in the aviation sector, but as Toomey says a similar outcome of “sustaining confidence by managing and reducing risks is a realistic and achievable goal.” That said, trading technology is a complex area involving many different application components that communicate over high-speed networks using a range of different protocols. “To monitor these systems ‘end-to-end’ one needs a multi-functional solution that understands trading and market data protocols and monitors both the application and network layers,” he says. “Broad visibility allows you to spot latent technical faults and problems. Such latent faults play a key role in contributing to the failure of complex systems.” The vendor’s CorvilNet solution, which was unveiled just days after the whitepaper’s release, is touted as cross-asset class with the vendor’s technology understanding all of the major protocols used in equities, derivatives and FX used by exchanges and trading firms in all three areas). It monitors trading positions, fill-rates and order-flow patterns in real-time, as well as a host of infrastructure performance metrics. Wallace Wormley, principal of OSPARA, a private firm engaged in investment consultancy practice advising institutional and family offices, and an ex- deputy president CIO for Prudential Investment Management in Japan, contends, “The trading of multi-asset and multi-strategy programmes requires not only a risk catalogue, but a clear approach for identifying and monitoring operational failures in three category areas: people, process and technology.”

Toomey explains, “[Our system] helps firms spot anomalous trading patterns and identify infrastructure faults that may be causing them. We also capture and store all of a firm’s order/ quote traffic during anomalous events, which allows them subsequently to go back and analyse exactly what happened.” Whilst risk management related to technology is not new, Corvil’s paper refers to ‘Technology Risk Management’. Toomey says: “I don’t believe it’s a new term, but it’s a form of risk that has moved rapidly up the priority list for many firms over the past year, as compared with other forms of risk with which traders are more familiar such as market risk or execution risk.” The paper also highlights trading firms having come to rely on a “defense-in depth” approach based on “multiple layers of protection” during both system design and operation. Nearly all trading firms will have some level of protection in place from each of the categories listed below. As more barriers/layers of protection are added there is a danger that a point of diminishing returns as additional layers may be just replicating what is already in place. “That’s most likely to happen when firms concentrate too much on adding to one particular category, such as software testing,” he points out. And, Toomey stresses: “Understanding the roles played by different barrier categories and diversifying across them can help firms avoid this mistake. Adding lots of software tests is great but eventually the effort required to find additional defects in testing starts to rise. At that point, focusing on other areas such as automated risk checks or network policing controls, can produce better returns.”

Operational Risk ‘Crux’ Kevin Covington, CEO of ITRS Group, a vendor with an ongoing commitment to proactive, enterprise wide, monitoring of every aspect of an institution’s IT and trading infrastructure in real

Asia Etrader z Q4 2012 z www.asiaetrading.com

risk

Kevin Covington

CEO ITRS Group

chief scientist and co-founder Corvil

Fergal Toomey

Gary Wright

“The challenge is to be able to access, evaluate

“Focusing on other areas such as automated

“To standardise front offices has proved

and interpret information across the whole

risk checks or network policing controls, can

impossible despite the introduction of

technology infrastructure.”

produce better returns.”

new technologies.”

“There is a quiet

order management systems, trading engines, servers, network hardware, interfaces and proprietary appliances. From ITRS’ experience of working with clients in Asia Covington reveals “there is less dependency on old technology, which has allowed them to focus more on optimising and managing speed and connectivity, as the uptime reliability can be less of an issue.” ITRS, recently acquired by private equity firm Carlyle Europe Technology Partners, today services a worldwide client base of over 600 Geneos installations implemented at around sixty leading financial institutions and eight of the top 10 global investment banks. One major issue confronting financial institutions in Europe and North America is that their “technology stack is often comprised of legacy systems connected to a multitude of the latest ‘must have’ apps.” Application performance monitoring and management therefore must be able to see everything – in real-time and all the time, or as Covington asserts “it’s a waste of time.” Gary Wright, CEO of BISS Research, a UK-based benchmarking firm, and a former head of UK and European settlements at JPMorgan Fleming, says: “The domestic and international financial markets are fragmented

in many ways not least by legal, regulatory, culture, structure, technology, products, processes and investors.” He adds: “To standardise front offices has proved impossible despite the introduction of new technologies and almost impossible to harmonise without political and regulatory compulsion. The need for all types and size of financial institutions is to develop inhouse technology solutions that provide a single holistic view of each investor/trading account with a standard recognition of each financial product.” Reducing risks in the trading room has to be a combined effort of industry initiatives to standardise data and in-house innovation to create an in-house picture of each client’s risk by market, product and also activity. “The industry and its users have to build ‘big pictures’ that allow not just the firm but also the regulator and other Government agencies to monitor and take remedial action when required,” Wright concludes. Wormley adds,“While good risk management is easier discussed than effectively done, a holistic overview with integrated systems is essential for sound corporate governance and proactive senior management involvement to mitigate risk.”

revolution taking place in the financial services industry, where the disciplines of risk and finance are converging.” time, says, “Operational risk is the foundation, which underpins any competitive financial enterprise and trading institution. All other risk categories such as counterparty, settlement and reputational risks have a fundamental reliance on robust, reliable and fast technology.” Covington adds, “The challenge is to be able to access, evaluate and interpret information across the whole technology infrastructure, internal systems and external data suppliers, exchanges and third-party settlement and clearing entities.” The vendor’s monitoring solutions span applications, databases,

www.asiaetrading.com z Q4 2012 z Asia Etrader

CEO BISS Research

Opinion Who’s Who & Analysis

Kotaro Yamazawa Kotaro Yamazawa, managing director at Osaka Securities Exchange, talks to Asia Etrader about the merger with the Tokyo Stock Exchange, exchange competition, and Japan’s future as a trading hub.

Asia Etrader: How did you get started in Japan’s electronic trading industry? Kotaro Yamazawa: I was working at Bank of Japan for around 30 years and then moved to Osaka Securities Exchange (OSE). Now I am in charge of the business development of the OSE. In addition I’m in-charge of the rolling out of OSE colocation to international users and international tie-ups with the CME, Nasdaq OMX and other exchanges. I was in-charge of developing our new derivatives trading system, J-Gate. Now, my major job is to succeed in the merger with TSE. AE: Why has the OSE decided to merge with the Tokyo Stock Exchange (TSE)? KY: There are many reasons. Firstly, the TSE has more than 90% share of cash equity trading in Japan and OSE is the leading exchange for Japanese derivatives with the Nikkei 225 futures, Nikkei 225 mini and Nikkei 225 options. We have complementary businesses that can be put together with the merger of the TSE. Secondly, the merger of the exchanges offers a big cost synergy, especially from the system integration aspect. The TSE has its own three major systems, for cash trading, derivatives trading, and clearing. We have a very similar set of three major systems. By merging together we consolidate the three, allowing a very big cost synergy. From the perspective of the participants, they can save from the connectivity piece. At present, when the OSE and TSE introduce new products our participants have to adapt to our systems, costing them a lot. The

merger will benefit the participants enormously. At present the OSE spends around ¥10 billion every year on IT including depreciation and running cost; and the TSE spends around ¥20 billion per annum. Conservatively estimated, we can save ¥7 billion every year by merging our systems together. With these kinds of cost savings we can lower the fees of our participants. Thirdly , we can benefit from integration of all derivative products to OSE. Given the high correlation of TSE’s TOPIX futures and OSE’s Nikkei 225 products, through merger of margins and clearing houses, our investors can enjoy much more efficient trading. In addition to that, through providing all derivative products on the same trading platform, we can minimise legging risk of investors, who would like to arbitrage between TOPIX and Nikkei 225. Also, participants will save around 70% of the unmarked margins if they trade Topix futures and Nikkei 225 futures concurrently. We must also activate the Japanese capital market to compete with our Asian rivals such as Hong Kong and Singapore; maybe Shanghai is opening up and becoming very competitive in futures. By merging with TSE and OSE we can have a very strong and efficient and competitive exchange in Japan. AE: Have you decided which exchange technology you will use? KY: At present we use a cash trading system developed by Hitachi Corporation, while the TSE developed its ‘arrowhead’ system in-house with Fujitsu Corporation. In terms of the derivatives

“We have complementary businesses that can be put together with the merger of the TSE. ” trading systems, we have J-Gate developed by NASDAQ OMX and the TSE exchange has Tdex+ developed by NYSE Technologies. At this time we have not yet decided which system we will select because we have just received approval from the Japanese Fair Trade Commission (FTC) and before that it was quite difficult for us to talk about the merger and exchange information with each other. Our shareholders, as well as our participants, are requesting that we merge our systems together as soon as possible, so hopefully by October we can disclose the technology we will use. At the beginning of next year, we will set up a holding company called the Japan Exchange Group (JPX) where we will place the OSE and TSE. In the second stage we will shift all of the derivatives product to OSE and the cash equity products including JASDAQ to TSE. At this time we are likely to merge the systems together. We have not decided the timing of the second stage or which system will remain.

Asia Etrader z Q4 2012 z www.asiaetrading.com

Opinionwho’s & Analysis who

“we can save ¥7 billion every year by merging our systems together.”

From the accounting point of view, the write-off of one of the platforms will seem high but we do have running costs associated with supporting the technology so the sooner we implement the system integration better for us from the financial point of view. AE: Would a merger with an international exchange made more sense providing access to each other’s markets? KY: The international market is quite important and we have been introducing colocation services to foreign proprietary trading houses and hedge funds for five years, and up to now, maybe 60% or 70% of our orders are derived from foreign participants. We are also making alliances with CME and NASDAQ OMX. We tried to set up some alliances with ISE and Eurex two or three years ago. Only from the business point of view, I am not surprised if someone says OSE’s shareholders would be better off if we merged global derivative exchanges. But we have to take account the activity of Japanese exchanges are very strictly restricted by the Financial Instrument and Exchange (FIE) Act. It says that only a domestic exchange or exchange holding company can have more than 20% ownership of Japanese exchanges making it quite difficult for us to merge with a foreign exchange group. We could buy a foreign exchange but the global exchange groups are too large and the exchanges in Asia have their own regulatory ownership limitations. There is also the nationalism aspect which makes the merger between Asian exchanges quite difficult, because these exchanges are seen as key infrastructure of the country.

by the Ministry of Agriculture and Fishery (MAFF) and the Ministry of Economy, Trade and Industry (METI). It is quite difficult for us to enter the commodity field because regulation has not been unified. This is one reason that there are so many exchanges in Japan. But the Japanese government has decided to change that situation because the profile of the Japanese financial market is decreasing and they would like to increase the

“the write-off of one of the platforms will seem high but we do have running costs associated with supporting the technology.” competitiveness of our capital markets. Japan is a rapidly aging society and only manufacturing cannot support the living standard of the Japanese. This demographic change is forcing the Japanese government to address the structure of regulations. The upper house of Japan is now discussing changes to the FIE act. With the successful passing of the

AE: What is your view on the exchange competition going on in Japan and around the world? KY: Up till now, partly because regulation is also fragmented, they are many exchanges in Japan. Liquidity is very fragmented across the country’s nine exchanges and the trading volume is not so high. Securities exchanges and the financial exchanges are regulated by the Japanese Financial Services Agency (FSA), while the commodity exchanges are regulated www.asiaetrading.com z Q4 2012 z Asia Etrader

new regulations, a comprehensive exchange covering all of the security, financial and commodity products can be realised. With the change of the regulatory framework, maybe the competition between commodity exchange and security exchange will be stronger. The structure of the competitive arena will be changed very drastically. On the other hand, I am doubtful that PTSs will get a large share of trading volume like in US or Europe, because exchange trading fees are very low and Japanese investors may prefer to the exchange stamps for trading. Regarding international competition between exchanges I would like to make three points. Firstly, is I believe that the rise of the Asian exchanges, especially India and China, will lead to a power shift toward the Asian time zone. Japan, as a relatively large market with global best practices and solid regulatory governance will benefit from this changing dynamic. Secondly, consolidation of international exchanges is likely to proceed in the future. Consolidation does not mean only mergers; it also includes alliances between exchanges. I believe the alliance of the exchanges will proceed in a similar manner to the alliance between airline companies, which have formed three major groups. I am not surprised to see three to four international exchange groups with global distribution capabilities in five years. Lastly, if the merger goes through with the TSE many people expect us to increase our international presence. It is quite important for us to increase and deepen the ties with the foreign markets.

Who’s Who

“participants will save around 70% of the unmarked margins if they trade Topix futures and Nikkei 225 futures concurrently.” AE: Why is Tokyo Commodity Exchange (TOCOM) sharing some services with the OSE? KY: We signed an MOU with TOCOM in February 2008 which included the development of common products and information sharing about technology, because their new systems were made by NASDAQ OMX as well. Connected to that, our board and TOCOM’s board decided in December 2010 to share a disaster recovery site together. We have deepened our cooperation with TOCOM in many ways. We have already listed three ETFs whose price is linked to TOCOM’s commodity

futures prices. We have not decided anything over the merger or the business combination with TOCOM, but I believe there is some possibility we can further deepen our alliance with them. It is important for us to enter the commodity field; one option is merging with TOCOM. In that case, the integration of the clearing houses is also very important...In terms of our derivative products, we have our own clearing house and after merging with the TSE we will have the JSCC clear those products. After that we have to think about the relationship with TOCOM’s clearing house and of course from the standpoint of our investors, merger between JSCC and JCCH,TOCOM’s clearing house, sounds most attractive. AE: Japan largely missed out on the global commodity boom, why do you think that is? kY: It’s a very good question. In 10 years, the global trading volume of the commodity exchange has increased about five times. In Japan, the trading volume of the Japanese commodity exchanges has decreased by 1/5 over the same period. I believe that Japanese commodity futures market is very biased to the individual layer and the distribution channel is not well developed. Because there have been malpractice and fraudulent behaviour in the

past, the regulators tightened the regulations to the brokers, and after that, the trading volume decreased very drastically. I believe TOCOM and Tokyo Grain Exchange (TGE) are behind the curve in changing the market structure and introducing the new technology. In addition, their clearing houses are not strong financially which prevents some foreign investors from participating in their market. The decreasing participation of the Japanese retail layers, the trading volume of the Japanese commodity exchange is dropping very drastically. The increase of the growth of the international exchanges is coming from the increase of prop houses and hedge fund. Japan’s commodity exchanges could not persuade these members to come to their market with out-of-date technology, high latency and poor clearing mechanisms. Japan is a very big user

“We could buy a foreign exchange but the global exchange groups are too large.”

of commodity products, maybe second to China in the world. As our domestic industries consume so much and with low liquidity in Japan they are using the global markets or the OTC market. There is a very big need in Japan for commodity price at exchanges but the commodity exchanges are not prepared to support them. AE: You owned the J-Gate project can you tell us a bit about it and what it hopes to achieve? KY: J-Gate is our derivatives trading system that we launched on 14 February 2011. It was a big project for us because derivative trading is a major product within our exchange. We moved the location of our data centre from Osaka and Tokyo. Our colocation service has been very successful but formerly there was a space limit in our Osaka data centre. The move allowed us to offer a much larger number of rack space to our colocation users. Before introducing J-Gate system, latency was around 100 milliseconds but now latency is around one or two milliseconds. Of course, two milliseconds is not the fastest benchmark when compared to the Genium or Millennium systems that are available but at the present we are very satisfied with functionality and the performance of J-Gate. Just after the launch we extended Asia Etrader z Q4 2012 z www.asiaetrading.com

who’s who

“I am doubtful that PTSs will get a large share of trading volume like in US or Europe” trading hours until three o’clock in the morning covering more than half of the New York Trading hours. Recently, the share of the trading volume on the night session is around 30%- 40% of daily turnover and is a big success from our business point of view. AE: The exchange has been launching new products such as the Nikkei 225 VI and the DJIA Future can you tell us why you are bringing these products to market and what new ones are expected? KY: The Nikkei 225 VI is our first experience with this relatively new but quite successful global asset class. It is a very promising product. Many people would like to hedge portfolio risk and the investment banks are selling synthetic products which will also help them hedge those assets as well. We may also list an exchangetraded fund based on the volatility index at some point. The DJIA future is the first joint product with the CME group. The DJIA index is very popular among the Japanese retail players and they would like to trade this product mainly during the New York trading hours. The CME has a wide range of products that we may introduce into Japan including the S&P500 and the NASDAQ100. We are also talking with the BRICS exchanges to list their index products as well. AE: How has Japan’s regulatory environment been changing to support a competitive Japan? KY: Frankly speaking, I have sometimes heard some claims to our regulator from our foreign investors. They say Japanese FSA is slow to move and inflexible. Recently, however, I believe it has been improved drastically. With the declining presence of the Japanese capital market, it has to change the style of regulation to promote the Japanese securities business. I think it’s a very good thing to see them change. AE: What structural issues do Japan’s capital markets need to address? KY: There are issues with middle and back office operations at the broker level. As you may know, having new products and implementing changes is somewhat costly in Japan. Actually

the system cost is expensive in Japan. One reason is that the Japanese regulation or regulatory framework is too severe with respect to system issues. Of course, a very stable and robust system is quite important for the capital markets. But we may have to listen to the voices of our participants. Perhaps they request us to have three sigma stable systems, but they may not require a six sigma system with very high operating cost. I think it’s quite important for us to rethink about the requirements for trading technology. We have to be more sensitive about the cost of the trading technology for the industry. Another issue is the risk management and compliance practice matters. Our domestic proprietary trading community account for roughly 25% of our volumes, but a Japanese proprietary trader has to stop trading in the absence of a compliance officer. If this policy was lifted or loosened the trading desks could participate in the night session. A variety of participants is quite important. I don’t want 100% of trading dominated by foreign participants. The domestic traders need to increase their presence in the market through change of some kind of in compliance practices. AE: How has the industry been affected by the Tsunami last year? KY: After the tsunami participation declined in the options market, particularly the nikkei-225 options from the retail layer, because participants suffered big losses when the price of put options surged because the market was moving too fast to buy back. But this has started to recover. On the other hand, many international players moved their operations out of Japan because they were afraid of radiation problems from the Fukushima reactor. But now they are coming back from the Singapore and Hong Kong to Japan. There is still damage in Japan left by the earthquake and devastating tsunami, but the industry is coming back. AE: What precautions have you put in place in the event of another natural disaster? KY: Our data centre for derivatives trading was relocated from Kansai to Tokyo area and our disaster recovery site is also in Tokyo area. We have to be more cautious about disasters after merging with the TSE and prepare for natural disasters more cost efficiently. Through hot standby-types of disaster recovery site should be located near the main centre in Tokyo area, we can add a cold standby-type disaster recovery site in Kansai area with low cost because we have our data centre there for cash equity trading. In the nutshell, we can

www.asiaetrading.com z Q4 2012 z Asia Etrader

prepare through merger with TSE, a more robust disaster recovery architecture to address unforeseen events. AE: How has Japan’s electronic trading industry changed in the past five years? EY: It has changed very dramatically. We have seen the exchanges introduce new technology, global standard systems, with latency and throughput being improved substantially. Colocation services have now been brought to the international prop houses and hedge funds. The market structure has changed a lot with the share of trading from domestic proprietary traders down and international participants rise rapidly. We have seen the drastic rise of the shares of the international players in these 5 years.

“in five years I will not be surprised if we see three to four international exchange groups with global distribution capability.” AE: What will the electronic trading industry in Japan look like in five years? KY: Firstly, in five years I will not be surprised if we see three to four international exchange groups with global distribution capability. I would like to see the Japanese exchange groups play a vital role in this global environment. For Japan, I hope we can leverage the strong skill set of our domestic users and see them incorporate new technologies into their day-to-day trading strategies. Secondly, the Japanese trading landscape will further internationalise. Foreign participation is increasing drastically largely from European countries or the United States and are setting up their trading facilities in Hong Kong, Singapore or Sydney. Now we are approaching China, Taiwan and India to further internationalise trading in Japan. Thirdly, given the competition of financial centres the presence of multi-asset, comprehensive exchanges with global reach will become a crucial asset for Tokyo and Japan. With this kind of competitive exchange Japan can hopefully change the image of its capital market and become an international financial trading destination.

equities

China and Hong Kong compete with Korea as ETFs blossom Three markets hold great promise

Jackie Choy, ETF strategist at research provider Morningstar

volatile and uncertain global economic environment has challenged investors constantly in search of the best place to put their money to work. In recent years Asia has been on almost every investor’s radar as it has offered a range of investment opportunities, and that has not changed much despite Europe’s debt crisis causing some ripples and hobbling growth in the region. One recent attraction has been the growth of Exchange Traded Funds (ETFs). Although ETF development is still in its early stage in Asia, some markets are showing great promise. China, Hong Kong and South Korea are leading the way in ETF development. As has been the case in recent years, China has captured the attention of investors as Beijing has stepped up efforts to deregulate its capital markets.

“The positive directional improvement in terms of regulation in China provides for a great avenue to invest into China,” says Hong Kongbased Jackie Choy, ETF strategist at research provider Morningstar. “[China] is offering more new products to investors, and the quotas have been quickly covered, clearly highlighting the strong demand for ETFs,” he said. “This is the way to go in developing the ETF market,” Choy adds. A key development was the launch in July of renminbi qualified foreign institutional investor (RQFII) ETFs – Hong Kong-listed ETFs investing directly into China A-shares. The first, China AMC CSI300 ETF, was followed in August by two more ETFs under the RQFII scheme – a CSI 100 tracker from E Fund Management and a FTSE China A50 fund from CSOP.

Choy notes that the RQFII ETFs are the first offshore ETFs that invest directly into China A shares and could challenge the existing A-share products that use derivatives to gain exposure. While it is too early to make a call, flows suggest the RQFII ETFs have got off to a decent start, he says. Analysts also expect the RQFII ETFs to drive more activity in renminbi and help to internationalise the Chinese currency over the longer run. “By trading A-share ETFs in Hong Kong investors get access not only to the underlying A-shares but they are also implicitly long the yuan. Hence providing more investors with access to the Chinese market does foster further internationalization of the yuan in my view,” says Hong Kong-based Manuel Schlabbers, head of Asia Pacific Delta One Index & ETF Trading at Credit Suisse. Furthermore, the ETFs act as another tool in the continuing crossborder relationship building between China and Hong Kong. “I believe the ETF’s are a great access tool for mainland China and Hong Kong,” Schlabbers adds. “They are easy to trade for both institutional as well as retail investors, and allow foreign investors to get access to mainland China. I expect the well-established products will continue to receive the majority of client interest as evidenced by their high trading volume.” Local reports and market chatter indicate that Beijing is considering the launch of physicallybacked gold ETFs, as well as bond ETFs, in China. This would widen the product offering in the local ETF market as currently all the ETFs listed in China track only equity indices. “Regulators are on the right track, but I think they could do more by encouraging further product offerings in the China domestic market, such as commodity and bond ETFs; this would enhance the ETF market’s attraction,” Morningstar’s Choy says. He expresses confidence that either Shanghai or Shenzen will get its first goldbacked ETF soon, especially as regulators have lifted rules prohibiting such products. Jane Leung, head of iShares Asia Pacific at asset manager BlackRock, describes the growth in the global ETF market as “phenomenal.” Since the first ETF was launched in 1993, Leung notes the industry has grown to over US$1.53

Asia Etrader z Q4 2012 z www.asiaetrading.com

EQuItIEs

trillion in assets with over 3,100 ETFs available globally. She says Asia has experienced robust ETF growth too – 10-year compound annual growth rate (CAGR) for Asia Pacific exchange traded products, assets under management (AUM) is 35%, and the 5-year CAGR is 23% as of July 2012. BlackRock is the world’s largest ETF manager, with over US$670 billion in assets under management. “Overall, there is increasing recognition in the Asia region that ETFs are effective tools for investors who want to access new markets or to implement active allocation decisions in an efficient, transparent and liquid manner,” Leung says. “Asian investors are also seeking out dynamic and diverse ways of investing that use both active and index investment strategies to boost returns. This highlights the tremendous growth opportunity of the Asian ETF market ahead.” According to Morningstar, there were 76 new ETFs listed in Asia ex-Japan year-to-date, compared with around 100 for the 2011 year. The industry is still relatively small, with ETFs listed in Asia ex-Japan accounting for around US$68 billion of assets under management versus nearly US$1.2 trillion for US ETFs. Despite the promise in Asia, Morningstar’s Choy and others are quick to caution investors

against rushing in to invest in the region’s ETFs, especially the China-linked ETFs. There is foreign exchange risk as the yuan exchange rate is subject to control, says Choy, noting that in recent months the yuan has depreciated in value. There are also the quotas to watch out. “The RQFII ETF managers are subject to quotas, and this means that where a manager’s quota is reached and additional quota is not granted, unit creation could get disrupted and the ETF may trade at a premium,” Choy says. Credit Suisse’s Schlabbers also cautions about some pitfalls in Asia. He says there is a danger of listing too many products on different exchanges, which could lead to further fragmentation of the ETF market in the region. “One reason why the US ETF on-screen liquidity is so much higher than in Europe is that the market there is much more fragmented. The same applies to Asia; I view the fact that certain ETFs in the US are closing as quite a healthy development,” he says. In Asia, Schlabbers expects on-screen liquidity will continue to pick up with Asian markets, particularly Hong Kong, South Korea and China expecting increased participation from retail investors. South Korea remains a key market for ETF trade, and in August it led Asia with seven

www.asiaetrading.com z Q4 2012 z Asia Etrader

new ETF listings versus two in Hong Kong. According to Deutsche Bank data, in the last week of August alone, South Korea accounted for nearly 50% of turnover by value, despite only making up around 10% of regional ETF trade. Analysts say the keen interest in ETFs in Korea has been underpinned by liquidity, the tax-exempt structure of ETFs and an ongoing education process for investors and advisers. Morningstar’s Choy adds that the active Korean ETF market “is also driven by retail buyers who have a bias for derivatives and leverage.” Blackrock and Morningstar both predict Asia has strong growth prospects in the ETF market. However, it will take some time to reach the level of sophistication seen in other markets such as the US “The market in Asia is developing differently [in terms of transparency] to the development seen in the US and Europe,” BlackRock’s Leung says. ”As the diversity of available products and providers, as well as the level of sophistication and knowledge among investors grows, we expect investors here, similarly to those in other parts of the world, will want ETFs that have higher levels of transparency and liquidity. That is, investors want industry best practice.”

EQuItIEs

Fragmentation in Asia Q3

apan is in an interesting dichotomy. Liquidity fragmentation continues to grow and be supported by both the regulator and the industry, yet at the same time consolidation is taking place as brokers are facing lower volumes and commissions. Late last year Kabu.com exited the proprietary trading system (PTS) space, Daiwa and Credit Suisse have been cutting head count over the past twelve months and, more recently, Nomura completed its restructuring of subsidiary agency broker Instinet, which has closed its Japanese exchange membership, to operate solely as a brand under licence of the parent. The big news, however, is that the Takeover Bid (TOB) Rule is expected to be amended this month (October) giving PTS legitimacy a boost. This will remove the requirement for firms buying 5% of a company off-exchange over any given 60 day period will be obliged to formally enter into a takeover. Some restrictions do apply such as the venue must offer continuous quotes and provide realtime market data. We expect the larger Japan buysides to look more closely at PTSs for liquidity and cost savings. SBI Japannext (SBIJ), the leading PTS in Japan, continued to capture market share at the expense of both Chi-X Japan and the Osaka Securities Exchange (OSE) though at a slower rate than the previous quarter. SBIJ managed to attain a record 3.99% of overall market share by value according to Thomson Reuters Equity Market Share Reporter and surpassing the OSE for the first time but reported in a press release it had realised 4.5% excluding ToSTNeT. It also confirmed a record high month in August of ¥925.2 billion (US$11.86 billion) but conceded that there were 23 trading days in the month. On 8 August , it achieved a daily record of ¥71.2 billion (US$912.7 million) or 5.8% ex-ToSTNeT. Interestingly, the last month of the quarter saw all venues except SBIJ gain market share. One possible cause is that on 24 September, SBIJ went live with its news NASDAQ OMX INET X-stream matching engine. This platform promises handling 40,000 messages per second with a latency of 500 microseconds. SBIJ’s weekly report ending 28 September showed an average price improvement of just over 10bps. Mizuho (8411), as their 3rd most traded stock that week (Toyota (7203) and Nissan (7201) were first and second, respectively) captured 10% of overall market share with a price improvement of 34.80bps.

SBIJ averaged ¥428,045 (US$5,487) and 757 shares per trade in Q3. Chi-X Japan had a tough quarter with July being its worst month of trading, achieving just 1.34% of market share. In Q3 it averaged only 1.77% of TSE turnover by value from a Q2 average of 2.07% as recorded by Thomson Reuters Equity Market Share Reporter. Chi-X Japan had the lowest trade size in both dollar value and number of shares down by more than 30% to ¥319,242 (US$4,092) and lower by almost 15% to 601 shares per trade. However, Chi-X Japan’s September report has the market

share as 2.5% of the Nikkei 225 with average trade sizes of 487 shares or ¥29,335 (US$376) per trade. No price improvement data was provided in the monthly report but in the last weekly report of the quarter 85.9% of trades had an average price improvement of 9.1bps. Among the large caps Mitsubishi Motor (7211) saw 11.5% market share yielding 45.8 bps in price improvement. The primary maintained a 90.74% market share this quarter up from 90.39% in Q2. Average trade sizes were lower at 2,128 shares or ¥1,267,434 (US$16,245) per trade from

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“SBIJ managed to attain a record 3.99% of overall market share by value... surpassing the OSE for the first time.”

2,142 shares and ¥1,288,586 (US$16,516) respectively. The OSE continued to see its market share fade attaining a Q3 average of just 3.71% down from 4.07% Trade size did increase to 788 shares from 761 shares but decreased on a dollar value up from it Q2 average of ¥527,730 (US$6,764) to ¥508,446 (US$6,517).

Australia Fragmentation in Australia continues to grow at both Chi-X and Centre Point, the ASX’s dark matching venue. Chi-X’s report for week-ending 28 September claims an overall market share

of 6.57% but the Thomson Reuters Market Share Reporter claims just 2.76%. The former is reporting against securities it trades in while the latter uses the total ASX volume, whether or not Chi-X trades in them. Chi-X reported price improvement of 20.39% of trades averaging 20.73bps for the last week of September. Westpac (WBC), BHP Bilton (BHP), ANZ (ANZ) and Rio Tinto (RIO) round out the top 4 securities by volume with an average price improvement of 3bps. Both average trade size by number of shares and dollar value decreased by 10.84% and 11.41% respectively to A$2,450 (US$2,519)

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and 568 shares. 242 names traded on average in the last week of September, 371 on Centre Point and 1,962 domestic names on the ASX. On the primary, ASXs market share drifted lower to a Q3 average of 97.35% from 97.64% in Q2. Total value traded was also lower by 5.65% to nearly A$73.5 billion (US$75.6 billion). Conversely, Chi-X executed volume increased 4.81% to a Q3 average of A$1.95 billion (US$2 billion). Despite the lower volumes overall Chi-X is making headway. ASX also saw the average number of shares per trade drop by 11.61% to 2,374 but average by value was down just 3.13% to nearly A$5,700 (US$5,862). Centre Point achieved another record with over 1 million trades valued at A$2.7 billion (US$2.77 billion) though it should be noted they do double count trades while Chi-X does not. This is an average trade size of A$2,679 (US$2,755). Telstra (TLS) was the largest name traded in CP executing 13% of its monthly total or A$914.3 million (US$940 million) earning a price improvement of 13.1bps over 53,330 trades.

India We expand our coverage of fragmentation to India. While there are market structure issues such as clearing and foreign access, this market has one of the more advanced electronic trading markets in Asia. Also, with the arrival of the Delhi

EQuItIEs

â&#x20AC;&#x153;the arrival of the Delhi Exchange and the MCX-SX exchange, [India] should be quite a battlefield of competition.â&#x20AC;?

Exchange and the recent Sebi approval of the MCX-SX exchange to begin offering equities trading this market should be quite a battlefield of competition with each venue trying to attract liquidity. For some time now the leader National Stock Exchange of India (NSE) has been eroding the market share from the BSE which hit a low of just 16.05% in September. We believe that the cost of developing smart order routing for local brokers and the double ticketing necessary for the exchange clearing houses are seeing flow drift to the NSE. We shall see how the addition of a third and fourth exchange shall impact fragmentation but we suspect the investment banks will not jump on-board until there is some reasonable volume. The Delhi Exchange as a High Frequency Trading venue will find it difficult to survive if their only customers comprise that segment on the buy-side. As for some statistics, the NSE has both larger trades by shares and value (427 shares and US$1,314) than the BSE (259 shares and US$479) In other news, the Hong Kong exchange (HKEx) reduced the reporting window from 15 minutes to 1 minute for alternative trading systems (ATSs). We expect that the exchange or the regulator will begin to publish off exchange trades in ATSs very soon though we do not expect any increase in this kind of flow which is around 2-3% on the primary. Asia Etrader z Q4 2012 z www.asiaetrading.com

Market fragmentation in Japan: A tale of two PTSs Japan provides a particularly interesting chapter in the global fragmentation story. Whilst it was one of the first countries to allow alternative trading venues, way back in 1998, levels of fragmentation in the Japanese equity markets have remained relatively low compared to other regions that have adopted a multi-market structure much later. Until recently, alternative trading venues in Japan (known as PTSs) have been able to make only a modest impact on market fragmentation. Clearing restrictions, a short-selling ban and the lack of a formal best execution framework (as enshrined by the trade through rule in the US and MiFID's principles-based approach in Europe) presented PTSs with some serious challenges in their efforts to gain market share.

Fidessa Fragmentation Index

The closing of kabu.com in October 2011 left the two remaining PTSs in Japan in direct competition in their efforts to attract liquidity. This led to some interesting shifts in market share between SBI Japannext and Chi-X Japan over the past two years. In that time we have seen an increase in market fragmentation in the country's main index, albeit at a relatively slow rate. (Diagram 1)

1.2 1.14 1.1 1.05 1.0 2010-10-01

2011-06-03

2012-01-27

Diagram 1

2012-09-21

Nikkei 225

SBI Japannext was in business for almost three years before it started to gain any significant market share, whereas Chi-X achieved a 2.5% market share by the end of its first year of operation in Japan. However, it seems that the tables have turned and SBI Japannext is now consistently outperforming its rival. In May 2012 SBI Japannext achieved a substantial market share of 5% in the Nikkei 225. Chi-X, on the other hand, has been incredibly successful in Europe and Canada, and has made a good start in Australia too, and it would be foolish to underestimate that venue.

Lit value %, Nikkei 225 Chi-X Japan

SBI Japannext

7% 6% 5% 4% 3% 2% 1% 0% g

1 r1

1 t1

1 c1

Even though we're witnessing an interesting game being played our between the two, it's important to note that the Chi-X and SBI Japannext combined market share in the Nikkei 225 has increased significantly over time and is now at around 6%. This is due in large part to their ability to attract liquidity (including HFT volume) and the momentum they have been able to gain by offering smaller tick sizes (one tenth that of the primary exchange), hence providing narrower spreads. (Diagram 2)

Diagram 2

MAZDA MOTOR ORD Monday, 2012 September 03 to Friday, 2012 September 07

Market share

Lit venues

Dark venues

87.72%

12.28%

DARK (12.28%)

Chi-X Japan(3.63%)

Japan Crossing(.16%)

SBI Japannext(10.82%)

Instinet Japan(.79%)

Tokyo(73.27%)

ToSTNet-1(11.33%) 0M

Diagram 3

5000M

10000M

1000M

2000M

LIT (87.72%)

Interestingly, it appears that the two venues are also competing over the same universe of stocks. In some, Mazda for example, their combined market share averages over 10% in any given week, thus making a clear statement of their ambitions for further growth. (Diagram 3) Given the impending relaxation of the TOB 5% rule and the challenges that the TSE/OSE merger might bring, it will be interesting to see what the future holds for alternative venues in Japan and the effect on overall market fragmentation in this region. Source: Fidessa Fragulator

226,762,245,869

368,501,872

256,117,067,029

Hong Kong Exchanges

Indonesia Stock Exchange

Korea Exchange

29,711,389,199

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

5,767

5,927

54,337,193,000

40,826,264,971

35,767,195,096 57,813,822,500

33,468,690,142

30,425,186,052

39,322,278,915

36,822,508,988

2,499,769,927

89,760,070,447

123,181,579,688

-33,421,509,241 5,229,504

246,628,835,010

123,341,264,400 220,232,428,030

109,923,984,900

26,396,406,980

13,417,279,500

26,509

20,889

4,184

2,367

275

2,654

Average Trade Size Shares Q2 2012 (USD)

Shenzen Stock Exchange

Taiwan Stock Exchage

Stock Exchange of Thailand

Tokyo Stock Exchange

Sinagpore Exchange

Shanghai Stock Exchange

6,486

10,945

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16,156

4,937

15,050

6,839

104,415

6,760

16,478

5,146

14,589

7,400

2,918

9,920

7,525

4,558

17,164 87,235 11,800

-323 2,120

-209 21,464

461

-561 4,831

101,498

1,025

-525 93,599

-274 785

-11 416

958

3,778

2,139

22,348

10,723

4,825

2,127

23,209

109,642

761

400

-18

-885

1,077

85,108

-6,045

-16,044

780

-1,175

2,173

-604

-13

-275

Change

10,570

-172 25,335

-111 23,062

-500 3,580

-190 2,376

-61 262

-160 2,378

Average Trade Size Shares Q3 2012 (USD)

National Stock Exchange of India

7,000

5,307,405 -77,901

1,351,664 -147,652

10,250,833 9,854,602

10,452,231 11,490,546

1,635,944

201,398

83,300,071 83,299,703 368

-293,551,753,857 2,425,321,162,827 2,545,106,894,695 -119,785,731,868 784,618,209 809,056,759 -24,438,550

New Zealand Exchange

Osaka Securities Exchange

2,506,399

-95,342,265,319 99,200,347,957 110,462,739,011 -11,262,391,054 46,784,799 51,654,083 -4,869,284

6,017,759,680

7,756,708,194

-46,704,571,065 402,452,974,083 401,902,310,712 550,663,371

Philippine Stock Exchange

91,963,608

-179,515,084,704 456,195,658,589 528,859,407,984 -72,663,749,395 202,896,192 248,670,982 -243,441,478

4,587,891,253

-1,743,093,785 112,693,793,422 148,199,551,759 -35,505,758,337 1,204,012

94,470,007

-7,414,616,112 3,737,619,484 4,313,111,496 -575,492,012 4,764,295 5,667,820 -903,525

2,063,597,406

331

100,996,813 18,016,510

2,296,190

81,912,074

119,013,323

7,584,577 -949,699

84,208,264

-3,476,629,500 4,505,735 4,385,721 120,014

7,357,574,829

5,342,009,044

6,594 6,397 197 12,060 13,182 -1,123 1,236

1,035,435 -415,363

-96,074,875 845,861,529 808,718,126 37,143,403 185,571 214,053 -28,482

1,654,570,556

22,100,600,495

19,450,244,512

-4,264,807,859 168,091,603,726 201,062,200,514 -32,970,596,788 6,634,878

962 914 47 343 9,612

Net

-10,408,854,353 442,395,878,127 413,554,820,523 28,841,057,604 19,183,073 19,797,753 -614,680

KOSDAQ

1,225

Number Trades Q2 2012

49,969,885 44,511,363 5,458,522

-1,545,465,488 2,220,166,920 4,332,314,680 -2,112,147,760 620,072

Bursa Malysia

3,291

3,119

Number Trades Q3 2012

-477,953,320 917,239,400 1,750,833,200 -833,593,800 386,091 739,611 -353,520

-196,058,995 13,070,777,606 12,227,153,638 843,623,968

371

13,462

13,351

2,974

1,144

526

Share Volume Q2 2012 Net

3,340 3,196 144 425

Indonesia Stock Exchange

Korea Exchange

Hong Kong Exchanges

2,474

954

Hanoi Stock Exchange

Hochiminh Stock Exchange

465

BSE

Australian Securities Exchange

Average Trade Size Q3 2012 (USD)

Exchange

Share Volume Q3 2012

-9,474,280,078 93,516,140,145 105,765,532,752 -12,249,392,607 39,319,660 39,858,659 -538,999

Average Trade Size Q2 2012 (USD) Change

3,254,035,183,907 3,547,586,937,764

851,178,802,402

50,713,416,256

149,544,648,883

616,389,541,669

725,555,261,275

52,647,721,858

10,171,242,480

38,313,715,497

113,686,173,867

2,057,498,109

28,056,818,643

92,356,646,383

261,830,086,347

24,961,867,961

266,525,921,382

3,079,762,631

846,455,192

23,434,830,982

236,236,525,947

Value Share Trading Q2 2012 (USD) Net

Total

755,836,537,083

56,731,175,936

157,301,357,077

569,684,970,604

546,040,176,571

57,235,613,111

8,428,148,695

30,899,099,385

115,749,771,273

1,961,423,234

114,457,246,878

KOSDAQ

281,280,330,859

20,697,060,102

1,534,297,143

Hochiminh

Hanoi Stock Exchange

23,238,771,987

BSE

Australian Securities Exchange

Value Share Trading Q3 2012 (USD)

Exchange

44 equities

Equity Trading Recap

Source: Thomson Reuters Equity Market Share Reporter

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equitiess

In pursuit of liquidity – minimize impact, maximize opportunity By Josephine Kim, Director – Asia Pacific Execution Sales, Bank of America Merrill Lynch

iquidity continues to be the key issue for investors in the current market. As the market shrinks, many institutional investors are looking at alternative trading venues and liquidity-seeking algorithms in order to source liquidity and minimize market impact. At the same time, the number of dark pools in the developed Asia Pacific markets is growing. The last couple of years have seen the launch of alternative trading venues Chi-East and Chi-X Australia – although Chi-East closed after only 18 months. Meanwhile, more brokers have begun to offer liquidity seeking algorithms and smart order routing (SOR), which provide opportunities for price improvements. With more choices on the menu, it is increasingly important that buy-side clients pay close attention to the quality of venues – rather than focusing on those with the highest crossing rates – in order to achieve their trading objectives.

Case study: Japan Japan was one of the pioneers in introducing alternative venues, or proprietary trading

systems (PTS) as they are known locally Japan currently has three major PTSs: Chi-X, Japannext and brokers’ dark pools, such as MLXN. These offer smaller tick sizes than the primary market, as well as longer trading hours and, in some instances, faster exchange access. We have discovered that although large cap stocks generally have higher crossing rates – in other words, a higher percentage of trades going through alternative venues – the actual cost saving is more significant in smaller market cap stocks, due to their wider spreads. Crossing rates are also higher for smaller orders, which are easier to fill. Our study (see figures 1 and 2) confirmed that trade frequency determines the crossing ratio, while spread determines the actual basis point savings. Long queue names, such as Mizuho, could save as much as 20bps, for example, whereas Gree or Dena could save around 3bps. Another important consideration is the quality of the execution price. A trader who makes a buy and later sees the stock trading lower may feel that she has been ‘adversely selected’ because she could have achieved a

Growth of dark pools versus efficiency of the exchanges Region-wide, the buy-side continues to drive brokers to pursue liquidity and best execution, while market fragmentation is prompting more exchanges to focus on their own efficiency levels. It remains to be seen whether exchanges will continue to lose their liquidity to dark pool providers, or whether they will focus their efforts on winning liquidity back. Certainly a number of the region’s exchanges are working to improve their trading systems. Whatever the outcome, the one thing we all agree on is that only the strong will survive. BofA Merrill Lynch will continue to work as a thought leader in this space in partnership with institutional investors to help maximize investment opportunities.

“Our study confirmed

Figure 1

Avg Trade Cross Rate

Saved (BPS)

Typical Stocks

Frequency 320

21%

10.8

Miraca (4544), DIC Corp (4631)

675

26%

10.6

NS solutions (2327), Mitsubishi Materials (5711)

1,120

27%

10.2

Kyocera (6971), Seiko Epson (6724)

1,792

28%

6.9

Orix (8591), Fanuc (6954)

28%

6.6

Gree (3632), Sony (6758)

Saved (BPS)

Typical Stocks

3,941

better (lower) price for her purchase if she had waited. Such concerns have become common since bulge bracket brokers started offering their own dark pools. BofA Merrill Lynch’s quant desk and execution consulting team continuously looks at the price path around the fill to ensure there is no adverse selection in the pools.

that trade frequency determines the crossing ratio, while spread

Figure 2

Avg Trade Cross Rate

determines the actual

Frequency

7.7

3.5

25%

Gree (3632), Dena (2432)

12.1

5.6

26%

Sony(6758), Advantest (6857)

15.9

7.4

28%

Toyota(7203), Honda (7267)

23.1

10.6

30%

Nomura (8604), MUFJ (8306)

53.5

20.5

30%

Mizuho (8411), Tepco (9501)

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basis point savings.”

sHoRt sELLInG

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GreTai pushes for Mandarin link to rival ASEAN Taiwan’s GreTai Securities Market has set its sights on China and Hong Kong for growth.

he new chairman at the GreTai Securities Market, former finance minister Sushder Lee, faces considerable challenges in his new role. Having taken over on 20 August 2012, he will be responsible for enhancing the exchange’s technology, which includes designing and implementing a continuous trading system tailored to Taiwan’s unique market-participant profile, and fostering closer links with China. While some exchanges burnish their technological credentials, GreTai emphasises the stability of its electronic trading system, despite its moderate efficiency. The primary concern vis a vis improving performance and reducing latency is the needs of the market. “Foreign institutional investors want greater efficiency, and more technological support, and our individual investors want more open information before they make orders,” says Benjamin Chang, manager in GreTai’s Trading Department. “Taiwan must be the only market that uses the auction system, but that’s because our investor structure is the most important problem for us.” The Taiwan Securities Association, Taiwan Stock Exchange, GreTai and regulatory

Source: GreTai Securities Market website

authorities are discussing what form a continuous trading system would take, but the hurdles are many. “Along with Taiwan Stock Exchange we plan to upgrade our trading system to find a good solution for our market,” says Benjamin Chang. “But we haven’t found a solution that’s suitable for everybody because our market is special compared with other markets, especially in terms of investor structure. More than 80% of investors are individuals, over 60% for TWSE. When we change any system, any matching method, many different opinions must be taken into consideration.”

Fairness a priority Some investors are concerned they will lose out under a new system. “Our retail investors think institutional investors and dealers could use technology to get a better price, and that that wouldn’t be fair. Also, our regulator worries about that. To some degree that wouldn’t be fair, with some market participants enjoying the use of advanced technology, and other participants left with inferior technology,” says Eric Chang, manager in GreTai’s Planning Department.

So far, a solution isn’t forthcoming. “Every time we look at the issue, there are more and more questions. I can’t tell you a firm timetable, but we can say we are very eager to settle on a continuous trading system that makes everyone happy,” says Benjamin Chang. Still, continuous trading is just one part of GreTai’s development strategy. On 2 April, GreTai’s trade matching and confirmation mechanism was embedded in a new trade repository. As of end-August, 57,774 deals had been matched and confirmed. An OTC derivatives trade repository is being rolled out in three stages, and is scheduled for completion in June next year. Currently, interest rate swaps, foreign exchange swaps, non-deliverable forwards and Taiex-related derivatives must be reported. In December, foreign exchange options and forward exchange contracts will be added to that list. “We have several trading systems, for listed stock, emerging stock, bonds and derivatives negotiation. All of them have implemented the FIX Protocol. We trade US treasury bonds using ICAP’s API to connect with BrokerTec GeniumINET, and use the FIX Protocol to connect with our clients. That system is operational for 22

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heading

hours a day. Next year, we plan to introduce middleware into our trading system,” says Charles Twu, manager in GreTai’s Information Department. “We are surveying products. And we are going to migrate the trading system from a Unix-based platform to Linux to reduce costs. We aim to finish the migration by the end of the year for testing, and will fully migrate next year.”

Opportunity knocks While GreTai may be behind its peers in adopting cutting-edge technology, it aims to parlay Taiwan’s unique relationship with China into competitive advantage. “We have been keeping an eye on developments, such as the ASEAN trading link. We realise this kind of connection could harmonise their operations, or even cross-border trading, and increase competition, so we are holding conversations with mainland China, and Hong Kong exchange, to try to organise a kind of Mandarin-speaking, or Chinese-based exchange connection,” says Eric Chang. Trade ties across the Taiwan Strait are burgeoning, facilitated in part by the warming of relations under President Ma Ying-jeou and the signing of agreements such as the Economic Cooperation Framework Agreement trade pact in June 2010. “If companies based in China list on GTSM, we will be more competitive,” says Wei-ming Lee, associate in GreTai’s Trading Department. China and Taiwan inked a memorandum of understanding late August on setting up a

currency clearing mechanism for direct new Taiwan dollar and renminbi trade. Their central banks are working out the details, including designating clearing banks. Currently, only offshore banking units of domestic banks are permitted to conduct renminbi business. “A lot of Taiwan-listed and non-listed companies do business in China, so renminbi business is important to them,” says George Wu, vice president of Underwriting for China at SinoPac Securities, the first Taiwanese firm to offer same-day reminbi remittance. “The bank interest rate in China is pretty high. So they could fund-raise through renminbi bonds instead of through a bank loan. We can exchange renminbi to new Taiwan dollars; before we had to change to US dollars, then renminbi. The exchange rate might be better for these companies. I think eventually those companies want to have a cross-country capital market platform.”

A world of difference Though there may be a need and some impetus for closer ties between capital markets across the Taiwan Strait, the regulatory environment could prove to be an effective barrier. “I think it’s a long way off – first of all because of regulation,” says Joseph Chou, leader of Assurance Services, PricewaterhouseCoopers Taiwan. “Even between Hong Kong and China, and they are already considered one country, the systems and regulations are different. Look at the European experience. The euro proved to be not so successful. If you are not the

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same country, how can you make regulation that fits everybody? And if you have different regulations, how can you expect to use the same currency, or use the same exchange? Right now there is a mechanism for you to be dual-, or triple-listed. So there is already a mechanism for you to enjoy the benefit of the capital markets in different territories. I don’t think there is an urgent need to consolidate capital markets.” And then there is the political minefield to navigate. “This is to some degree a political issue. So we must follow policy. But aside from that, we still have many opportunities to interact with mainland China, or Hong Kong. We are preparing for regulators on both sides of the Taiwan Strait to make the relationship more open,” says Eric Chang. The speed and extent of deepening ties largely depends on Taiwan’s ruling party, currently the Kuomintang, which favors a closer relationship with China. “It depends on the government’s appetite. The current government has an appetite for this. More interaction with China is seen as good, but if there is a change of government, that could change,” says Chou. “The overall direction is towards opening up. Right now we need foreign companies to list in Taiwan because the capital market seems to be slow, very slow. Last year, there were 100 IPOs; this year, up to August, we have had 30. Even though there are more IPOs in the fourth quarter, historically, I don’t think there will be 100 this year.”

post-trade

Backstage passes by Dan Barnes

Smaller markets need to strengthen post-trade processing to build up investor confidence and drive liquidity

rading is not all about what is done up front. Developing strong post-trade capabilities is increasingly important for national market operators seeking to attract liquidity and trading volume. Emerging and frontier markets in Asia are maturing in their development of legal and technical infrastructure, providing reassurance for investment firms and brokers seeking to trade into their markets. “I think there has always been appetite for these markets, they can offer larger returns than comparable developed markets, but the biggest challenge has always been how does one get access to them, easily, and turn an idea into a real trade,” says Mike Corcoran head of sales and trading, Asia Pacific at broker ITG. “As access to them opens up, they become more relevant to portfolio managers globally.” The ten ASEAN countries are all at significantly different levels of maturity; Singapore is a developed market with ambitions stretching far from its own borders. Indonesia, Malaysia, the Philippines and Thailand have made great strides in establishing themselves as accessible and reliable. “Processes like broker confirmation are relatively OK in these markets,” says Nick Wright, head of global services, South Asia at global custodian State Street. “The sort of matching engine technology that you might see in the West, like Omgeo and other utilities, are still evolving out here. Faxes are more prevalent than they have been for some time in the West but that’s more of an evolution.” He notes that local regulation can vary in complexity; the correct account opening process is critical to ensure successful trade settlement and safekeeping, and in some markets such as Thailand, Philippines this process is relatively straightforward but in others such as Malaysia, Indonesia, Vietnam it is more time consuming and bureaucratic. By comparison the other ASEAN markets – Brunei, Cambodia, Laos, Myanmar and Vietnam – are uncharted territory for most investment managers.

Feet on the ground In central and northern Asia, the mineral wealth and mining operations are drawing interest from investors but infrastructure is again limited. Custody, clearing and settlement are back office activities but they cannot be overlooked by the front office if a firm is attempting to trade into a developing market. Kazakhstan’s clearing and settlement model is similar that of Russia, with a heavy use of registrars and a T+0 settlement cycle which requires cash and securities to be deposited up front. A consequence of this is that a majority of stocks are traded over-the-counter, as regulations then allow a bilateral agreement on settlement date. Custody and clearing are provided by a number of banks including large international firms such as HSBC. Mongolia has an established stock market but it does not have any legal framework for custody, nor any link to SWIFT for interbank payments, making settlement of trades somewhat fraught. Without

“If you take Mongolia as an example we have set up a way to invest in a country through a trustee structure” – Bruno Campenon

any delivery versus payment (DvP) mechanism trades cash can be deposited with a broker without any receipt of stock; in a global environment marked by defaults Mongolia is too risky a market for many. “At the moment we see appetite from clients, wealth managers and hedge funds, to invest in those frontier markets because they see opportunities for growth and the richness of the country; in the case of Mongolia through its mineral wealth,” says Bruno Campenon, CEO for Hong Kong at custodian BNP Paribas Securities Services. “We see the first pioneers moving into those markets. It still takes a bit of time to go ahead but as an agent bank we can help people to do it. If you take Mongolia as an example we have set up a way to invest in a country through a trustee structure and we are very happy with it.” To allow its client Harvest Global Investments to move into the country, BNP Paribas set up an account with the exchange in the name of its client, but which it had access to, so that it was able to see when a counterpart had made a payment and complete its side of the deal in return, a makeshift DvP model.

Hard to crack Still, such arrangements are rare. Corcoran says that typically markets like Cambodia and Laos will see direct investment rather than firms feeding through the fragile secondary equity market. By contrast he notes electronic trading is well established in Malaysia, and says that his firm has been supplying an increasing number of trading algorithms to markets such as Thailand and Indonesia, where ITG has just launched its over-the-counter (OTC) mid-point crossing network, POSIT. “The spreads in Indonesia for large caps average over 50 basis points,” says Clare Rowsell, head of client relationship management and marketing, Asia Pacific at ITG. “When you move down to mid- and small-caps the spreads are down to 150 basis points; compare that to a market like Australia where spreads are around 24 basis points across Asia Etrader z Q4 2012 z www.asiaetrading.com

Post-trade

Bruno Campenon, Hong Kong CEO BNP Paribas Securities Services

the board. For the institutional investor trying to get into these markets getting a mid-point cross can save you 40-50 basis points on a trade.” For the primary exchanges, reducing the costs of trading will prevent firms from trading OTC, increasing their own trading volumes and therefore revenues, but it takes investment. The Stock Exchange of Thailand (SET) has long campaigned to attract increased overseas order flow and claims to have some low post-trade fees in comparison with similar markets. The country’s capital markets were upgraded from Secondary Emerging Market to the Advanced Emerging Market status by index provider FTSE in September 2011, a categorisation based in part on the country’s efficient market infrastructure. The inclusion of Thailand in FTSE’s Advanced Emerging Market Index started in March 2012. This year it has announced a series of initiatives intended to improve the trading and post-trade experience for exchange members. On 3 September it went live with its new Cinnober-based trading system SET Connect, and it has commissioned the Korea Exchange to design a new clearing engine to be launched in Q4 2013. It also plans to offer third-party clearing (TPC) and global custodian services as part of its 2012 strategic plan. “We don’t have exact number of post-trade services cost to investor because our charge is directly to our participants as intermediary in the market such as brokers and custodians,” said Bordin Anakul, executive vice president at SET. “Our participants will add up their margin for their service on top of our fee. However, our post-trade services fees are much lower than those of SGX and Bursa Malaysia.” “Building post-trade infrastructure facilities enables us to expand and centralise services effectively, boosting SET’s competitiveness and www.asiaetrading.com z Q4 2012 z Asia Etrader

Nick Wright, head of global services, South Asia State Street

paving the way to become the centre of post-trade services in Southeast Asia,” he continued. Exchange participants, brokers and commercial banks, currently need to apply to be clearing house participants to clear and settle their own trades. However, the extension of third party clearing services will allow exchange participants to outsource the clearing function to third party clearers, lowering their operational costs. The global custodian project will allow clearing, settlement and safekeeping to be performed by a global custodian under Thailand Securities Depository (TSD) account. “There is no need for participants to open their own account or relationship with a global custodian to do operational work when investing,” explains Anakul. “This initiative could help our participants lower their operational costs by using our workflow and system interface to link up with a local transaction.” Campenon says that improvements on the operational side of posttrade processes are welcome but that the crucial part for traders is to know that their assets are not going to get lost in transit. “There is still a problem of asset safety,” he says. “There is a lot of discussion in this area currently because there are more risks around companies going bankrupt, and it could be that infrastructure could also become bankrupt. People are concerned about their assets and the way that those assets are held. There is a big rush from clients wanting to understand the way that assets are held in custody. In that what we see is that frontier markets are keen on progressing. If those markets want to expand they need to put their framework in place and they need to show that there is full protection of assets.”

oPInIon PoLL

How do you select algos before trading?

he equity trading business has been a tough environment since 2008 whether you are on the buyside allocating assets or on the sell-side generating commission. Using the right algorithm can mean the difference between boosting a fund’s performance ranking and whether or not a broker retains its customers for the next trade. We put this opinion poll to the industry in order to gauge how firms are selecting algorithms before trading under the current tough market conditions. The high number of “DMA order” responses, at 40.63%, was perhaps not surprising. There are a number of possible explanations for this. Firstly, many securities in Asia are quite illiquid and placing small limit orders is an ideal way of getting a reasonable price without moving the market too much, particularly in a low volatility environment. Additionally, not all buy-side firms are tapped into broker algorithms as Tier 2 / 3 firms are still putting together this offering for their clients.

The second highest response at 31% said that the algo chosen “Depended on the name being traded”, indicating a sophisticated buyside base that are using several algorithms on any given day to minimise trading costs and maximise their fund’s returns. At Asia ETrader we had expected a higher number of respondents to be supporting VWAP (only 15.6%) as this algo type tends to be favoured in Asia as both an easy way to place a trade and to realise the benchmark among their peers. We hope in the future that this response continues to trend lower. For 9% of respondent to go with “Whatever my broker recommends” was interesting to see. Buy-sides who are reducing heads at the execution layer are now depending on their brokers to help them in the investment process. Advising clients on which algorithms is a service that appears to be on the rise as the level of support continues to improve in this very competitive business. Just over 3% chose the “High-touch service” response. In markets with

low volatility, and during the summer doldrums, the use of high-touch and more expensive execution would seem to be waning. We do not see these types of trades disappearing forever as different markets and clients will always have the need for services that algorithms just cannot cover. A question we ask in our piece on algo advisory desks (see page xx) is that if brokers are telling their clients which algos are better suited to their trading needs, why do their clients need to go to the high touch desk anyway? They could save 80% on commission.

Asia Etrader z Q4 2012 z www.asiaetrading.com

oPInIon PoLL

Which exchange technology will the merged OSE/TSE select?

ith the Tokyo Stock Exchange’s takeover of its national rival the Osaka Securities Exchange all but complete, there are still a few unanswered questions. Chief among them is which exchange technology vendor will prevail under the merged entity? One of the selling points for the deal was the reduced costs to both the exchange and the members by having one single technology to match Japanese trades. The exchange could consolidate hardware and the industry would need only support one matching engine application programming interface (API). The TSE Arrowhead technology is a homegrown effort with Fujitsu behind the development. Their derivatives platform Tdex+ is based on

LIFFE expertise under NYSE Technologies. The Osaka exchange’s derivatives platform was built by NASDAQ OMX and its equity technology by Hitachi. Each exchange has made large investments in its respective matching engines, but which one will prevail? Just over half the respondents believe that NASDAQ OMX would be the last matching engine standing when the merger comes to a close. This is a much larger share of the votes than we had expected. If this does come to pass then NASDAQ will have effectively pushed NYSE Technologies out of Japan as SBI Japannext has also moved across the aisle (as of September 24) from NYSE to NASDAQ. We were surprised to see that NYSE garnered so few votes and came in at 19.23%, the same

as Fujitsu. Hitachi along with “Other” rounded out the bottom decile of the poll. We did have some feedback from one participant who said they couldn’t vote as they thought there were two answers, one for cash and the other derivatives. The technology vendor who wins out here could push out its rivals for a very long time in one of the larger global trading markets. We will be watching what happens in Japan very closely.

Visit: http://www.AsiaEtrading.com/opinion-polls/ Vote on the latest Opinion Poll

www.asiaetrading.com z Q4 2012 z Asia Etrader

word on the street

WORD

on the street Ralp van Put, CEO, True Partner Fund

strongly believe that the takeover is a very smart move of HKEX. Although still restricted for mainland investors, I believe that a large part of HKEX volume is done by mainland investors. Besides trading HKEX and TAIFEX, mainland investors trade commodity futures. The move of HKEX proves that they understand that HKEX needs to provide commodity trading to their growing mainland customers. Also the trend of mainland financial institutions obtaining foreign memberships shows that the need to trade outside China is growing rapidly!

Steve Grob, Director, Group Strategy Fidessa

he change of control in the LME is significant in a number of ways. Firstly it is the final nail in the coffin of mutualised ownership of exchanges and the last call for the romantic idealism of floor based trading. More importantly, it demonstrates that the centre of power in global commodities trading is moving ever eastward. The fact that exchanges with substantial brand and financial firepower in the US were hopelessly outgunned by HKEx is testimony to the new world order that we live in today. HKEx should be congratulated for seizing this opportunity and demonstrating its relevance on the global stage.

Simmy Grewal, Senior Analyst, Aite Group

think this is a great move for HKEx, they are diversifying their revenue away from Chinese equities and gaining a business that will allow them to compete with some of the largest global exchange players. As the LME has been run as a limited-profit company there is scope the expand its coverage and business with this new ownership structure. HKEx have said they will expand the product offering to other metal contracts, RMB denominated contracts, and non-metal commodities which not only opens a door to China but also the other commodities heavy BRICS markets.

Tom Voute, CEO, Algorithmic Trading Group

like HKEx taking over LME because itâ&#x20AC;&#x2122;s another East takes over West.

Frederic Ponzo, Managing Partner, GreySpark Partners

his deal starts the Asian leg of the exchange globalisation process that saw European and North American exchanges merge and coalesce over the past 10 years.Having the HKEx acquiring a European market operator demonstrates a relaxed approach of London which may lead, as a quid pro quo, to the opening of the protected Asian market places to foreign competition through either acquisitions or the setup of local branches from the likes of CME, NYSE-Euronext or Deutsche Borse. This deal is not just about trading metals, but also about clearing these trades as HKEx is buying not only a market share in commodities trading but also a slice of the associated clearing business. Asia Etrader z Q4 2012 z www.asiaetrading.com

word on the street

What do you think of the HKEX takeover of the LME? Arjen Gaasbeek, Managing Director, Ingensoma FG HK Ltd

he take-over should be good news for Chinese firms dealing in physical commodities. They will have an easier access to the LME through HKEx. However, for algorithmic trading this take-over will not have much impact as LME-contracts are still being traded via the open outcry system, and this system will remain in place for the coming 3 years. So at the moment I just hope that the capital expenditure for this take-over will not impact any of the existing investment plans that HKEx has lined up for its current platform.

David West, Managing Director, ABN AMRO Clearing HK Ltd

e believe that the HKEx’s planned takeover of LME is a great strategic move which gives them access to expertise and a client base that they do not currently have, and which provides diversification away from their current IPO/ cash based market. The takeover gives participants in HK, like ABN Amro Clearing Hong Kong, the opportunity to provide clearing services to a potentially very large Chinese client base.

Gen Utsumi, Head of Sales and Business Development APAC smartTrade Technologies

o me, this is clearly the direction the market is moving – more multi-asset and cross-asset. Regardless of exchange, brokers, vendors etc – if you look around the world it is generally becoming more and more difficult to expect big positive growth in revenue projection within single asset class. New opportunities can be found when you start crossing the asset classes and have access to the people and firms you previously do not have any business with. I think this is what HKEx is doing and it is definitely the move in the right direction.

Nick Wright, Head of South Asia, State Street Global Services and Global Market

his particular tie up will help LME access large consumers of commodities such as China, Japan and Korea, while HKEx could also benefit from a reduction in its reliance on cash trading, which weighs on its earnings.

Rob Hodgkinson, Director of APAC Operations, First Derivatives

KEx and the LME shows China is interested in expanding its reach; where the attempted merger between SGX and ASX offered cross listing opportunities, HKEx is into new territory with metals on the LME.

www.asiaetrading.com z Q4 2012 z Asia Etrader

tEcHnoLoGy

Algo development challenged in tough market by Frederic Stephan

here is a shift currently happening in the world of financial technology: the traditional support functions such as back-office have become saturated with matured systems and skilled engineers while demand is increasing for those with quantitative and front-office experience. The high competition and low return environment is pushing investors to invest in optimising their strategies and beat the market. But selecting the right algorithm and tailoring it for purpose are difficult tasks when recruiters struggle to find candidates with a degree in finance, IT experience and mathematical ability. Algorithmic trading was developed as a method of automating simple strategies that had little risk of going wrong e.g. executing small volume trades for highly liquid stocks. Electronic trading has evolved over the past ten years to encompass such sophisticated algorithmic strategies as finding liquidity in fragmented markets direct market access (DMA) a trading model in which brokers allow clients access to their order routing infrastructure. A variant is sponsored DMA where clients connect directly to the market using the broker’s trading identifier without having to go through their entire infrastructure. The boundaries between these methods are blurring. Both DMA and algorithms trading are well suited for the trading styles of institutional investors (block, principal, and agency) and hedge funds (quantitative, high-frequency, arbitrage, portfolio, and systematic). The variation of use across markets is huge; according to research firm Celent, algorithmic trading accounted for just 0.6% of trading in China last year but in 2013 this is expected to grow to 2.5%. By contrast it estimates a

minimum of 30-40% equity trading on the Tokyo Stock Exchange is effected by algorithms, based on the use of colocation facilities by trading firms. Customisation and adaptability are becoming key focuses for algorithms, allowing brokers to more easily offer client-centric trading algorithms. This is particularly true for large sizes orders. To work such large block orders, brokers traditionally find counterparties who require the asset (crossing) or split the order into smaller quantities on the market (slicing). Small size orders may be aggregated to benefit from volume trading. In markets like Japan these kinds of orders may be traded on proprietary or alternative trading systems (PTS/ATS) also called dark pools due to the fact that trades are anonymous and order size is not disclosed pre-trade. In order for the execution to meet the client’s objectives, it is vital that parameters such as limit prices, benchmarks are specified. So the richness of these options differentiates the trading algorithms and is a sign of quality when appropriately set up.

Making the best of it Increasingly there is a demand from the buyside to determine that brokers are delivering best execution, supported in some jurisdictions by regulation, such as Europe’s MIFID. Having initially been used in equities, the appetite has increased to reach other asset classes such as X and bonds. Electronic trading has enabled this task, providing relatively detailed, if frequently non-standard, data on execution which can be used. There are no hard and fast rules for how to achieve best execution. The judgment

depends on the investor, his risk aversion and his objectives. Others key factors are the asset class, target benchmark and the specific goals whether it is minimising the expected cost, achieving price improvement or balancing the trade-off between these two. The trading decision starts by gauging the difficulty of the order based on the order size, the price, the volatility, the trading horizon and the liquidity. Based on this difficulty, the trader must select the most appropriate method, either manual, DMA, crossing, algorithm, or a mixture of them. The order is then placed on the efficient frontier which allows traders to see the potential costs and risks of a wide range of trading strategies. While urgency, risk aversion and volatility tend toward a more aggressive trading, large orders and favourable price encourage a more passive style. The availability of market data and market facilities may restrict the choice of strategy. Once the order is sent to the trading venue, the order type goes through a process of price formation and discovery. Exchange matching typically prioritises orders based on their price, time and size, with a range of others variants. So the traders’ decision of which order type to choose, how aggressive the price and size are where to place the order are crucial. A wide range of trading mechanisms may be adopted, like slicing orders up to lower the impact, hiding to take advantage of hidden order types, layering to place order throughout the book to maximise execution probability, pegging to adjust price and size, seeking actively for hidden liquidity, sniping to takes available liquidity, or routing to determine the best destination of an order. Trading algorithms may use several tactics in parallel.

Asia Etrader z Q4 2012 z www.asiaetrading.com

technology

The building blocks Most of the algorithmic strategies are implemented using modern programming languages such as Java or .Net. Increasingly, the algorithms used by large brokerages and asset managers are written to the FIX Protocol’s Algorithmic Trading Definition Language (FIXatdl), which allows firms receiving orders to specify exactly how their electronic orders should be expressed. Orders built using FIXatdl can then be transmitted from traders’ systems via the FIX Protocol. Basic models can rely on as little as a linear regression, while more complex game-theoretic and pattern recognition or predictive models can also be used to initiate trading. Neural networks and genetic programming have been used to create these models. Some algorithms trade on simple news stories while others are more sophisticated to interpret and understand news. Some firms are also attempting to automatically assign sentiment (deciding if the news is good or bad) to news stories so that automated trading can work directly on the news story. Adapting strategy to news and events can give traders a significant edge. Complex artificial

“Recruiters struggle to find candidates with a degree in finance, IT experience and mathematical ability.”

intelligence and natural language processing techniques are being employed to analyse text. Implementing algorithmic strategies involves a considerable amount of infrastructure. An order management system fulfils the role of portfolio management, risk management, analytics, execution and operations through the

www.asiaetrading.com z Q4 2012 z Asia Etrader

service of order entry, routing and transmission. Infrastructure provides the latency (delay in transmitting and process data), capacity and reliability required. Most algorithmic trading platforms are event-driven, built using an object-oriented language such as Java or C++. Artificial intelligence and data mining offer the potential to give traders an edge by predicting trends. Data mining is used to identify common features in the data, forecasting or spotting trends. Data mining analyses data relationships intra and inter markets, either top-down or bottom-up. Predictions are effective when using neural networks, vector machines and statistical analysis. Back-testing is an important means of verifying the potential performance and profitability of any trading strategy. Algorithmic and DMA trading are constantly evolving in parallel with innovations in financial and technological products.Experts will be in demand if they keep their skills updated, and courses that offer certificates in quantitative finance like at the Chinese University of Hong Kong or the National Taiwan University continue to develop, helping recruiters find resources.

back page

Dates Date

Event

Where Type

October 16

Australia FIX Conference

Sydney

Conference

October 25

Asia Etrading Forum – Asia Liquidity

Hong Kong

Forum

Oct 29 - Nov 1

Sibos

Osaka Conference

November 1

FISD Australia Local Meeting

Sydney

Forum

November 5-7

Asia Pacific Financial Information Conference

Hong Kong

Conference

November 7-8

TradeTech Asia

Singapore

Conference

November 14

Asia Etrading Forum – OSE TSE Merger

Tokyo

Forum

November 27-29

FIA Asia

Singapore

Conference

Date Country Holiday

Oct 1

Hong Kong

National Day

Nov 15

Malaysia

Oct 1

Korea

Mid-Autumn Festival – Day 3

Nov 15

Indonesia Muharram

Oct 1-5

China

National Day

Nov 16

Indonesia

Joint Holiday

Oct 2

Hong Kong

Day after National Day

Nov 23

Japan

Labour Thanksgiving Day

Oct 2

India

Mahatma Gandhi Jayanthi

Nov 25

India Muharram

Oct 3

Korea

National Foundation Day

Nov 28

India

Guru Nanak Jayanthi

Oct 8

Japan

Health and Sports Day

Nov 30

Philippines

Bonifacio Day

Oct 10

Taiwan

National Day

Dec 5

Thailand

The King’s Birthday

Oct 14

Hong Kong

Day following Chung Yeung Festival

Dec 10

Thailand

Constitution Day

Oct 23

Hong Kong

Chung Yeung Festival

Dec 23

Japan

The Emperor’s Birthday

Oct 23

China

Chung Yeung Festival

Dec 24

Japan

Bridge Public Holiday

Oct 23

Taiwan

Double Ninth Day

Dec 24

Indonesia

Joint Holiday

Oct 23

Thailand

Chulalongkorn Day

Dec 25

Hong Kong

Christmas Day

Oct 24

India

Vijaya Dashami

Dec 25

Korea

Christmas Day

Oct 26

Malaysia

Hari Raya Haji- Hari raya Qurban

Dec 25

India Christmas

Oct 26

Philippines

Eidul Adha

Dec 25

Malaysia Christmas

Oct 26

Indonesia

Eid al-Adha

Dec 25

Vietnam

Christmas Day

Oct 26

Singapore

Hari Raya Haji

Dec 25

Philippines

Christmas Day

Oct 27

India

Bakri Id (Idul Zuha)

Dec 25

Indonesia

Christmas Day

Nov 1

Philippines

All Saints Day

Dec 25

Singapore

Christmas

Nov 2

Philippines

Special Non-working Holiday

Dec 26

Hong Kong

First weekday after Christmas Day

Nov 3

Japan

Culture Day

Dec 30

Philippines

Rizal Day

Nov 13

Singapore

Deepavali

Dec 31

Philippines

New Year’s Eve

Nov 13

India Diwali

Dec 31

Thailand

New Year’s Eve

Nov 13

Malaysia

Awal Muharram (Maal Hijrah)

Deepavali or Diwali

Asia Etrader z Q4 2012 z www.asiaetrading.com

DIRECTORY AlphaFlash is the low latency algo news feed developed by Deutsche Bˆrse and its subsidiary Need to Know News. The feed provides machine-readable macroeconomic indicators, treasury auction results, corporate news and Fitch ratings for integration into trading algorithms. Direct connectivity is available in data centers across the globe. AlphaFlash also feeds into the new and revolutionary trading application AlphaFlash Trader that allows users of popular execution platforms to automate trading based on economic news. By employing AlphaFlash Trader, orders can be entered into the market automatically at the release of an economic event. Both AlphaFlash and AlphaFlash Trader are available for a 30-day free trial. www.alphaflash.com www.alphaflashtrader.com E-mail: alphaflash@ntkn.com

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 financail centers on the planet. Please visit http://asiaeheads.com/support@asiaeheads @asiaeheads or scan the QR code BofA Merrill Lynch, recently voted Asia’s Best Brokerage and Asiaís Best Sales in the 2012 Institutional Investor All-Asia surveys, offers a full suite of premier multi-asset execution services globally backed by the bankís global resources and expertise. The Global Execution Services (GES) team is made up of experienced market experts who partner with clients to ensure all aspects of best execution. Key services include comprehensive execution consulting, state of art algorithmic trading technologies, quantitative analytics and research. GES a key business partner to BofAML’s institutional clients. AsiaPacAlgo@baml.com Bloomberg: MSG MLAPDSA<GO> Hong Kong +852 2161 7550 Mumbai +91 22 6632 8718 Singapore +65 6678 0205 Sydney +61 2 9226 5108 Tokyo +81 3 6225 8398 Corvil is the market leader and trusted brand to monitor trading systems in global financial markets. The company was founded in 2000 and operates from New York, London, Singapore, Tokyo and Dublin. The world’s leading banks, exchanges, data providers and network service providers use Corvil products to: - Verify and demonstrate performance and correct operation of trading systems and services - Identify and eliminate performance or operational problems occurring in either application processing or network transport - Quickly resolve client experience issues with proactive alerting supported by full transaction record - Manage and optimise on-going investment in trading infrastructure - Reduce costs and improve outcomes by consolidating on a single trade monitoring solution for all asset classes and departments

BAcK PAGE

Equinix, Inc. (Nasdaq: EQIX) connects businesses with partners and customers around the world through a global platform of high performance data centers, containing dynamic ecosystems and the broadest choice of networks. We provide a neutral meeting place for the world’s leading financial market participants, including trading venues, buy- and sell-side firms, market data providers, technology providers and financial networks. These customers locate servers and infrastructure within Equinix data centers to support mission-critical financial services applications with highly reliable, low-latency connectivity covering multiple asset classes including foreign exchange, cash equities and derivatives. Learn more at: www.equinix.com/industries/financial-exchange/ http://blog.equinix.com @equinix 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 leadingedge, integrated solutions ensures Fidessa remains the industry’s number one choice. Tel: +852 2500 9500 Email: ap.info@fidessa.com www.Fidessa.com @fidessa Founded in 1996, FlexTrade Systems Inc. is the industry pioneer in broker-neutral algorithmic trading platforms for equities, foreign exchange, options and futures. FlexTRADER, our flagship platform, is widely viewed as unique in the industry for its high performance and multi-asset capability. We also offer Mottai, a web-based front-end trading solution combining market data and leading edge risk management and trading tools for brokers. With offices in Asia, North America and Europe, FlexTrade has a worldwide client base spanning more than 150 buy- and sell-side firms, including many of the largest investment banks, hedge funds, asset managers, commodity trading advisors and institutional brokers. www.flextrade.com T: +65 6829 2569 sales_asia@flextrade.com @flextrade OneMarketData provides market data management and analytical solutions that enable financial institutions to outmaneuver the competition by executing new trading strategies faster. Through its flagship product OneTick, the only solution that combines complex event processing (CEP) and tick data management spanning both historical and real-time, quants, analysts and traders can enhance alpha and increase performance through superior data management. Through its intuitive, performance-driven design, OneTick users benefit from an enterprise system that was built by Wall Street experts to address the sophisticated data analysis needs of the most discerning financial institutions. More information: www.onetick.com. +852 2987 7798

www.corvil.com Asia queries email peter.oconnor@corvil.com

Would you like to be included the Asia Etrader Directory? Contact support@asiaetrading.com for details. www.asiaetrading.com z Q4 2012 z Asia Etrader

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Social Media Join the Online Community

ocial media measurement tracks various social media content; blogs, wikis, news sites, micro-blogs (like Twitter), social networking sites, video/photo sharing websites, forums, message boards, blogs and user-generated content in general are monitored as a way to determine the volume and sentiment of online conversation about a brand. Various strategies and technologies are employed to help firms interact more effectively with social media: analytics are intended to allow marketers to identify sentiment and identify trends in order to accommodate the customer better; Perhaps no industry has changed as much in recent years as the financial industry. The mortgage crises, the debt crisis, the fall of big institutions have all negatively impacted the confidence in our industry. A number of financial institutions have adopted social media channels in an effort to reconnect and engage with consumers. Usually financial marketers lack a solid understanding of the online conversations occurring around financial products. They need to know what consumers are thinking and saying to understand where they stand in sentiment range and passion intensity. This is becoming a matter of survival to master the business drivers of social media in order to enhance branding, protect reputation, extend public relations, build community around the brand, extend customer service, facilitate research & development, and drive sales. There are few interesting facts to know about on-line success: - Companies that made a big impact in advertising scored big with consumers talking positively about them online. For example, HSBC’s ad campaigns are famous for being either humorous or innovative. - Free online community has big impact if this is without prime financial interest. Wells Fargo has launched a free online community for students, parents and financial advisors to foster an open dialogue about college planning topics, such as selecting a major,

@asiaetrading Tweet cloud Top 25 Tweets Q3 2012 Who we are following on Twitter @DerivSource

@SabrinaBelkadi

@Equninx

@Solutionsheaven

@Fidessa

@SunGardCM

@MFDVbrokers

@symphonyfintech

@mobis_philipose

@TradingJeremy

financing, education and housing. Wells Fargo has its own representatives active in the forum and does not promote its own services within the forum. - Charity is well perceived. Scotiabank has launched a social media experiment aiming at raising money for 18 different charities in exchange for submissions from users willing to explain what they think about a specific topic. For every person who shares their opinion, photo or video, one dollar is donated to one of the charities. - Sport and art sponsorship is definitely a positive image a company gives, particularly when caring for local community and the environment.

- Building new services or products with the participation of the web community is an innovation that brings the community a sense of involvement. Acceptance is facilitated by a ‘web friendly’ certification. - Over 90% of the conversations took place on forums and message boards and most of the opinion expressed are located in non-financial related forums. Like it or not, the social media community is gaining power in making or destroying a brand in a short time. Financial companies must plan an on-line marketing strategy and develop positive events to be considered a web community member.

Follow Asia Etrading on Twitter @asiaetrading Asia Etrading Fan Page is now on Facebook – www.facebook.com/AsiaEtrading Asia Etrader z Q4 2012 z www.asiaetrading.com

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