Asia Etrader Issue 7 by Asia Etrading

AsiaEtrader Issue 7 | Volume 1

heading

I 2013 Q3

The Electronic Trading Resource for Asia

Chinese A-Shares MSCI Index Standards, Shariah and Sukuk HKMEx provides a lesson T+1 in India

Will Abenomics transform Japan? Korea algo rules to curb instability

leader

AsiaEtrader Issue 7 | Volume 1

HEADING

I 2013 Q3

Abe the deflation slayer

The Electronic Trading Resource for Asia

Chinese A-Shares MSCI Index Standards, Shariah and Sukuk HKMEx provides a lesson T+1 in India

Shōki the demon queller, protector against evil spirits, rose to popularity during Japan’s Edo era. As a man he studied to become a doctor who in the afterlife vowed to protect the emperor Will Abenomics transform Japan? Korea algo rules to curb instability

for showing him great kindness. Shinzō

CREDITS

Abe, Japan’s prime minister is certainly

Editor-in-Chief Stephen Edge steve@asiaetrading.com

the queller of passive Japanese markets and protector of inflation.

Managing Editor Dan Barnes dan@icorp.co.uk Contributing Writers Roger Aitken roleoa@aol.com

Our summer issue of the Asia Etrader comes right in the middle of an exciting and volatile Japan market spurred on by Abenomics, much to

Stephen Price steveprice@ymail.com

the relief of the electronic trading industry. Volumes have doubled and so

Lynn Strongindodds strongindodds@aol.com

have commissions and that can only mean further reinvestment into the

Cover Design Nadia P. nad3e9@gmail.com

Japan market.

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

Of course, there is much more going on in the region: Korea regulating algorithmic trading, China A-share ETFs, derivatives growth in Singapore, T+1 in India and Shariah and Sukuk in Malaysia. In this, our seventh issue, we present our most diverse coverage to date. Before you go off to your favourite vacation spot this summer don’t forget your copy of the Asia Etrader.

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Stephen J. Edge Editor

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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 化生: Abenomics floods the market with orders – Japan’s equity trading volumes have doubled; brokers and exchanges deluged with orders, while the traditional buyside is under pressure to keep up. Page 6

Korea algo rules to curb market instability – Plans to tighten the rules on algorithmic trading in Korea have been given a cautious welcome by market participants.

Page 11

DERIVATIVES China equity derivatives ready for take-off – Noteworthy innovations and developments are taking place in its China derivatives market. Page 14

HKMEx provides a lesson – The Hong Kong Mercantile Exchange has suffered an abrupt demise and the subsequent criminal investigation raises some thorny issues. Page 16

Asia Futures Trading Q2 2013 Recap – See how Asia’s derivatives exchanges faired this past quarter. Page 18

BUY SIDE Standards, Shariah and Sukuk: Trading Islamic products in Asia – Shariah compliant financial products are a route to a wealthy tranche of investors, but trading them can be challenging. Page 20

REGULATION Choppy waters of regulatory change shake up static data – A roundtable discussion on the profound regulatory changes taking place affecting market data. Page 22

WHO’S WHO Asia Etrader spoke with Philip York of quant trading group Alt 224 and director of the professional advocacy body the Etrading Association. Page 26

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contents

opinion What does best execution mean in a dark pool? – The proliferation of dark pools and driven a desire for more granular definition around best execution in these types of venues. Page 30

HFT Concerns Are Overstated – David Stocken a broker with BGC Securities in Sydney weighs in on HFT. Page 32

WORD ON THE STEET

How should exchange circuit breakers be managed? – Four of your industry peers weighed in. Page 33

EQUITIES Rebalancing act – The inclusion of Chinese A-Shares in the MSCI Emerging Market Index will need firms to rebalance their portfolios. Page 34

Asia’s Fragmentation Footprint Q2 2013 – See the latest on venue competition in

Asia. Page 36

Asia Equity Trading Q2 2013 Recap. Our quarterly review of turnover, average trade sizes, spread and market impact costs on Asia’s exchanges. Page 39

post trade An expensive efficiency – India moves closer to T+1 but savings from efficiency will not be passed on to investors. Page 42

TECHNOLOGY The cable trade – Investment in physical connectivity is spurring on electronic trading in Asia. Page 44

BACK PAGE 47 Dates – Exchange holidays and important industry events. Directory – A listing of Asia’s electronic trading industry participants.

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In the zone

In the Zone... The first half of 2013 is already behind us and what an exciting time it has been. Asia market structure continues to evolve, LME is now Chinese, HKMEx failed to deliver and Japan has awoken from its sleep (we hope) among others. Besides Japan’s huge volume upturn we also saw the same in Thailand, Malaysia and Indonesia; ASEAN is really shaping up. Despite the challenges in China it still remains the largest commodity market in Asia. See what else happened this quarter in the zone. Australia

Hong Kong

The major theme in Australia over the past quarter was the effect of changes to the Market Integrity Rules (MIRs) made by the Australian Securities and Investment Commission (ASIC) relating to pre-trade transparency exceptions. The amendments, which took effect on 26 May, include the introduction of tiered thresholds for block trading, while the meaningful price improvement exception to pre-trade transparency replaces the ‘at or within the spread’ exception. Another revised rule allows for a transaction to be executed without pretrade transparency where the consideration for the transaction is not less than A$1 million or more for Tier 1 products; A$500,000 or more for Tier 2 products; and A$200,000 or more for Tier 3 products. After a consultation process, ASIC has refined its proposed rules on dark liquidity and high-frequency trading. Notable developments include the dropping of proposed changes that would have required small orders to rest on the market for a set time and for dark orders to meet a minimum size. Instead, ASIC will monitor the impact of the new meaningful price improvement rules. In response to changes to the MIRs, Chi-X altered its NBBOX validation and Hidden Orders protocols. Chi-X now requires hidden orders to provide meaningful price improvement, and for the validation of NBBOX trade reports to be changed. In related news, government officials announced that new MIRs for the Asia Pacific Stock Exchange (APX) were approved, and that variations to the APX Australian Market Operator Licence and new APX Business Rules had been passed. Meanwhile, Chi-X welcomed two new trading participants to the fold, with Phillip Capital Limited joining on 20 March, and Canaccord Genuity (Australia) Limited joining on 10 April. And in a staff shuffle, John Fildes took over from Peter Fowler as the alternative trading

Perhaps the most headline-grabbing event in the Special Administrative Region over the quarter was Hong Kong Mercantile Exchange’s (HKMEx) demise. On 18 May it announced that it had voluntarily surrendered authorization to provide automated trading services granted by the Securities and Futures Commission (SFC). Closure of the bourse was followed by an SFC probe, criminal investigation and several arrests. Meanwhile, the SFC doled out several punishments for wrongdoing. Sun Hung Kai Investment Services Limited (SHKIS) was fined HK$1.5 million for internal control failures; Credit Suisse Securities was reprimanded and fined HK$1.6 million for regulatory breaches

John Fildes Appointed Chi-X Australia CEO May 1

venue’s CEO, effective 1 May. Over at ASX, the exchange welcomed IMC Pacific as an ASX 24 Principal Trading Participant, effective 27 May. ASX announced on 30 April that it plans to extend by end-2013 its new OTC Derivatives Clearing Service, which would provide new risk management controls for investors and asset managers. And on 21 May, Australian Government Bonds (AGBs) began trading on the exchange. The exchange-traded AGBs are quoted and transacted in a similar way to shares, with each bond quoted as a gross price (capital plus accrued interest) with a face value of A$100. Global custodian BNP Paribas Securities Services announced 26 May the expansion of its global Dealing Services solution to asset managers and asset owners in Australia.

China Moving to China, the country’s first cross-border exchange-traded fund (ETF) began trading on the Shanghai Stock Exchange. Based on the NASDAQ-100 Index, the Guotai NASDAQ-100 ETF is the first exchange-traded fund in China to provide access to the US market. Previously, investors in China could only access the US market through ordinary Qualified Domestic Institutional Investor funds.

Chuck Chon JNX Cross launched on SBI Japannext

and internal control failings relating to position limit failures; and UBS Securities was fined HK$1.6 million for regulatory breaches and internal control failings also related to position limit failures. After an SFC investigation, Lee Lam Chong was convicted of manipulating a Callable Bull Bear Contract and was handed a suspended prison sentence and HK$67,000 fine. In related news, the Securities and Futures Appeals Tribunal is reviewing the SFC’s public reprimand of former Deutsche Securities Asia

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in the zone

trader Christian Denk over the trading of HSBC shares during the Closing Auction Session. Turning to global regulatory matters, the Hong Kong Monetary Authority and SFC announced 28 March their commitment to comply with the new international regulatory standards on financial market infrastructures (FMIs) as detailed in the “Principles for financial market infrastructures” report issued jointly by the Committee on Payment and Settlement Systems of the Bank for International Settlements and the International Organization of Securities Commissions in April 2012. The report contains 24 principles for FMIs and five responsibilities of regulatory authorities to provide for the effective regulation, supervision and oversight of FMIs. In other developments, CLSA became the first Asian broker to go live on SWIFT’s Global Electronic Trade Confirmation solution for the automation of allocation and confirmation processes, and Martin Abbott stepped down as HKEx co-head of global markets and LME’s chief executive. He will remain in the posts until end-2013.

India Multi Commodity Exchange of India (MCX) and MCX Stock Exchange (MCX-SX) dominated the news in India the past quarter. The former commenced futures trading in guar seed and guar gum contracts on 14 May. The commodity markets regulator approved trading of June 2013, July 2013, October 2013 and November 2013 contracts in order to facilitate price discovery and price risk management in the guar complex. Meanwhile, on 15 May MCX-SX introduced futures and options on its flagship SX40 index, a free float-based index of 40 large cap and liquid stocks, representing diverse sectors of the country’s economy, and on 10 June the exchange’s dedicated debt-trading platform went live.

Japan Over in Japan, the country’s Financial Services Agency (FSA) proposed revisions to short-selling regulations and measures to relax the restrictions on share buybacks. The changes are expected to be implemented by November 2013, with current temporary measures prohibiting naked short selling, and requiring public disclosure of short positions having been extended. Meanwhile, OSE plans to increase the contract months for futures and options, and strike prices for options on the Nikkei 225 at the same time as Clearing Houses in Japan Exchange Group are integrated, which is scheduled for July. In other news, SBI Japannext launched its new crossing platform, JNX Cross, on 27 May. The service provides a platform for participants to cross their orders prior to primary exchange market open

Bong-soo Kim proposals to restrict HFT in Korea

and execute at the VWAP price after market close. The Securities and Exchange Surveillance Commission ruled that RBS Securities had violated the Financial Instruments and Exchange Act through inappropriate conduct related to the Yen LIBOR, and recommended administrative action. In June, Japan Exchange (JPX) announced it will re-launch Super-LongTerm (20-year) JGB futures (SL-JGB futures) in April 2014, following the integration of the derivatives markets. SL-JGB futures were listed on Tokyo Stock Exchange from 8 July, 1988, but were suspended due to little demand. And last but not least, Jupiter Asset Management appointed Peter Swarbreck as head of its Asia business.

1 August, and Jenny Chiam joined its team as head of securities. New SGX members this past quarter comprise DMG & Partners Securities, which joined as a derivatives clearing member, and Maybank, which was added as an OTC financial derivatives member. In May, SGX revealed that the Philippine Stock Exchange wished to enter discussions with it on the sale of its 20% stake in Philippine Dealing System Holdings Corp, and that a memorandum of understanding had been signed. The following month, SGX issued a consultation paper outlining its plans to institute securities market circuit breakers to address sharp price movements. Also in June, the Monetary Authority of Singapore (MAS) announced after a yearlong review a proposed regulatory framework for financial benchmarks. The new framework

Michael Syn SGX AsiaClear iron ore futures began trading

South Korea BGC Partners announced in May that it had been granted a license by the Financial Services Commission to offer principal bond trading to financial institutions in Korea. Korea Exchange announced proposals to restrict high-frequency trading (see page 11).

Malaysia At the 18th ASEAN Exchanges CEOs meeting held in Vietnam in early April, the seven participating ASEAN exchange heads announced the next phase of the Invest ASEAN roadshows, which this year took place at Bursa Malaysia on 2 March, the Stock Exchange of Thailand on 12 January, and Singapore Exchange on 2 February.

Singapore On 9 April Singapore Exchange (SGX) delayed opening of the derivatives market because a system monitoring process malfunctioned. Later the same month, SGX AsiaClear Iron Ore Futures trading began. The first two trades totalled 200 lots (20,000 mt) and involved Barclays Bank, Deustche Bank and Trafigura. Meanwhile, SGX appointed Nico Torchetti as its new head of post-trade services effective

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is intended to enhance the integrity of the processes for setting the financial benchmarks. Later the same month, MAS issued the Technology Risk Management (TRM) Notice and Guidelines, which replace the existing MAS Internet Banking and Technology Guidelines as well as past circulars on IT risk management, and apply to all financial institutions.

Taiwan NYSE Liffe, the Europe-based global derivatives division of NYSE Euronext, announced early May that KGI Futures had joined as a member of the exchange’s London and Paris markets. The division said it has doubled its Asian membership within the past six months.

Thailand Having commenced operations on 21 June, 1999, the Stock Exchange of Thailand’s Market for Alternative Investment entered its 15th year with a record market capitalization of THB200 billion (approx. US$6.67 billion) and an average daily trading value of THB3 billion (approx. US$100 million) per day, while market liquidity continues to increase.

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化生: Abenomics floods the market with orders Japan’s equity trading volumes have doubled in four months; brokers and exchanges deluged with orders, while the traditional buy-side is under pressure to keep up, writes Dan Barnes.

Yasuo Mogi

Lee Bray

chairman Nissan Century Securities

head of APAC Equity Trading JP Morgan Asset Management

rder flow in Japan is skyrocketing. This is a big turnaround; since 2008 global capital markets including Japan have been suffering from low trading volumes. Prime Minister Shinzo Abe’s economic reforms, dubbed ‘Abenomics’ appear to have liberated the country from this trend. The policies of his government and the Bank of Japan started pushing down the value of the yen to the dollar in November 2012, strengthening export-led industries. Long-term investors have been buying into these stocks, while short-term investors are trading on the high level of market activity and have been sustaining it since stocks began to fall in May. For trading firms that thrive on order flow, Abenomics appears to be a blessing. The Tokyo Stock Exchange (TSE) monthly trading turnover reached US$872 billion in May, more than double the US$330 billion seen in December 2012, according to Thomson Reuters’ data. Japan’s turnover now makes up just under 40% of trading in Asia Pacific, having maintained a fairly steady 25% previously.

“For the last ten years the trading volumes in the Japanese stock markets have been at a lower level,” says Kazuhiko Yoshimatsu, head of media relations at the TSE. “Last March we published our target for daily trading volumes, which was ¥1.7 trillion (US$16.5 billion). However, recent daily trading volumes have been around ¥3.4-3.5 trillion (US$34 billion). We hope this situation will continue, but we have to be conservative in our outlook.” “Liquidity has tripled compared to the daily average last year,” says Christina Makiguchi, director for equities at Goldman Sachs Electronic Trading, Japan. “The exchange has benefited from this the most; brokers have seen our client order flow double or triple. The alternative liquidity pools have not gained as much momentum as they had hoped, because in a fast-moving market people will just trade on the primary exchange.”

New orders A sense of optimism in the country’s economy has gripped its citizens; the volume of retail investment in the equity markets had increased by around 7-10% of its three-year average,

according to trading venue SBI Japannext, a proprietary trading system (PTS). Shin Shinozuka, representative director for Newedge Japan, a major clearing broker for the Nikkei 225 index derivatives says, “The six-month uptrend was sudden and steep but still I have a feeling that it will keep going, because the actual economy has not yet caught up. I see things positively.” The Nikkei 225 index, Japan’s key equity benchmark, had increased in value by 70.65% in the year up to 17 May 2013, according to Thomson Reuters’ data. Although the market has been falling since 23 May, the trigger of retail activity has drawn other traders into the market. “There’s a bit of ‘flow begets flow’ in Japan this year,” says Kent Rossiter, head of Asia Pacific Trading, at Allianz Global Investors. “Many HFT strategies do better in more liquid stocks, and the market volumes in the first few months of the year have been strong, much of this coming from renewed interest by retail investors who have made up a third of the markets activity – up from 20%.” Allianz Global Investors has also observed strong capital flows into Japanese equities, with about US$80 billion year-to-date coming from overseas investors as of 19 May against US$11.3 billion during the same period last year. Yasuo Mogi, chairman of financial and commodity market broker Nissan Century Securities, says his firm has seen the upside of this interest. “It is the case that Nissan Century Securities has received a large number of enquiries from overseas proprietary trading houses and hedge funds since January this year, asking how they can effectively participate with the Japanese market,” he says. “So I would say there is definitely a growing foreign investor interest, based on our day-to-day experience.” Mogi-san observes a significant change in the way they are approaching the country compared to previous forays. “Today their approach to the Japanese markets is rather conservative,” he says. “They want the

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Cover story 1

best information and the best technology they can get to mitigate the risk of investing into the market. We see research teams coming over and talking to the clearing house, to the exchange and to the brokers to really limit any risks that might exist.” Lee Bray, head of APAC Equity Trading at JP Morgan Asset Management, says his Japan desk is currently using all options in the trading space from traditional sales traders to algorithms, in order to manage the increased pace of trading. “As markets become faster and more complex the key is to be able to decipher what is actually helping you and what is taking away from the execution quality, we have recently created a new role within the APAC region with a remit of looking at all styles of trading and feeding this information back to the desk. This feedback loop is invaluable when the trader chooses which tools they wish to execute a trade with.” As their clients deal with a changing environment, the sell-side firms have to adapt too, observes Hidenori Hirabayashi, vice president at Bank of America Merrill Lynch Japan. “There is more liquidity and more notional volume on the PTSs and on other exchanges, so we should be getting more order flow. That

proprietary trading

means we need to invest more in our technology; internal platforms, exchange connectivity and market data,” he says. “Buy-side clients are becoming more technically aware. Longonly buy-side traders have started to ask me where our server centre is so they can understand the effect that has on the speed at which we can execute their trades. These are technical questions that they weren’t asking a couple of years ago.”

houses and hedge

A more sophisticated market

“[We have] received a large number of enquiries from overseas

funds since January this year” - Yasuo Mogi, chairman Nissan Century Securities

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Volatility increased in May and onwards stocks began to make big moves intraday, with traders noting that it is not unusual to see a stock up and down over 5% in the same day. This is provided a better trading environment for hedge funds and high-frequency traders. “We’ve seen implied volatility which was low in November, trend much higher in late May,” says Rossiter. “It feels like a lot more of the market activity is short-term focused, trying to get in for a trade instead of an investment. The liquidity picture of who the participants are has tilted to shorter timeframe investors over the last year. Reports of increased co-location activity also point to greater HFT strategies being employed as they make up most co-lo usage. Combined

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Cover story 1

with retail activity these day-trading type of investors may make up over half the market.” While the level of market activity may be attributed to Abenomics, the use of sophisticated strategies by local and international traders has been enabled by investment in the market infrastructure, which allows more complex trading strategies and systems to be used. The Fujitsu-built ‘arrowhead’ trading platform, launched by the TSE in 2010, heralded a growth in electronic trading as it facilitated much faster matching of orders than was previously possible. This allowed algorithmic trading to flourish, which at a basic level helped asset managers to break down large orders more effectively, limiting their trading costs, and at a more sophisticated level allowed proprietary trading houses to operate high speed strategies that relied upon lowlatency trading. High-frequency trading (HFT), here defined as trading using colocation to maximise speed of orders, increased as a proportion of overall trading from 12% at the start of 2010 to over 50% at the end of 2012 according to Ko Nakayama, director of financial markets at the Bank of Japan, in a presentation he made to the Organisation for Economic Cooperation and Development (OECD) on 5 April 2013. It also led to an increase, albeit small, in the use of PTSs and in the Osaka Securities Exchange (OSE), the alternative markets to the TSE, no doubt in part because higher speed trading facilitates arbitrage strategies. Chi-X Global, then owned by a subsidiary of Japanese broker Nomura, launched Chi-X Japan in July 2010 to capitalise on the market’s evolution. In 2013 the market is evolving once again. Firstly, at the end of 2012 market regulator the Financial Services Agency (FSA), waived the takeover-bid (TOB) rule for PTSs. This had required any investor who acquired 5% of a company off-exchange to mount a takeover bid; understandably this had limited the use of PTSs by investors who feared they may accidentally trigger the rule by trading on alternative markets. The removal of the rule may increase interest in the PTS trading, although it has yet to show any sustained effect. Secondly the ongoing merger of the OSE and the TSE into Japan Exchange Group not only pools 95% of the equity market trading by volume, it also unites the cash market with the much stronger derivatives offering of the OSE, which provides the only trading for Japan’s key Nikkei 225 stock index. As part of the merger, the firms plan to deliver a new trading platform, ‘arrowhead 2’, which will deliver further

technical improvements to the market allowing increasingly sophisticated trading strategies to be used. “All of these things will involve more investment in technology in the sell-side; I think this will have a very positive impact into the market” says Hirabayashi. “The time and resources that brokers have to spend will be quite massive, but it is their responsibility and this is for everyone’s benefit.” In addition to technology investment, the JPX Group exchanges are planning to reduce the tick sizes they offer, in line with the PTSs, which will make it harder for the smaller alternative venues to differentiate themselves. Makiguchi asserts that ongoing modernisation by Japan’s regulatory and exchange authorities is continuing to improve the market for trading participants over the longer term. “Specifically, these include the Japan FSA’s plan to change the short-selling uptick rule in November to adapt to the US style Circuit Breaker rule, the Japan Exchange Group’s margin rule change conducted in January which encouraged retail trading and its plans to reduce tick sizes/decimalisation of Tokyo Stock Exchange listed stocks from 2014 onwards,” she notes. Reform of the, at present, separately regulated commodity and financial markets is also on the cards says Mogi-san, which would allow firms to trade across markets from the same account and under the same rules, cutting cost and complexity. “These are a consequence of having a separate exchange, a separate clearing house and a separate regulator,” he says. “A big issue on the agenda, because when we think about what will provide easier access to the Japanese market, we are missing this reform.”

Full steam ahead There are reasons to be cautious about the sustainability of market growth under Abenomics. The shock to the market on Thursday 23 May 2013 when the Nikkei fell from 15,942.6 points to 14,500 points tested some investors’ faith in the government’s model. Analysts at Goldman Sachs issued a Portfolio Strategy Research note on 24 May which played down the sell-off. The three triggers observed across the market were the potential reduction in the next round of US quantitative easing, a spike in Japanese Government Bond yields, an unexpectedly poor downturn in Chinese manufacturing. The GS analysis argued that concerns about such catalysts are “misplaced”, and although it

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“As markets become faster and more complex the key is to be able to decipher what is actually helping you and what is taking away from the execution quality” - Lee Bray, head of APAC Equity Trading at JP Morgan Asset Management

cover story 1

- Hidenori Hirabayashi,

expected the market to remain muted for up to three months it was positive about the economy in the medium to long term. Shinozuka also voices optimism about the market conditions. “I believe this trend will keep going; it might take a hit if Abe and the current government were to lose the general election in the summer but I don’t think they are going to lose,” he says. “I am still positive in a longer term market trend even though we may encounter some market adjustments time to time.” For traders rather than investors, it is liquidity and speed of market movement that are the most pressing issues. Trading volumes are high at the time of going to press, even as markets globally are falling and the Nikkei has proven wobbly. Whichever direction the market moves in, flow-driven businesses must capitalise on the new found momentum while longterm investors swim hard in the flood of order flow. Abenomics appears to be a powerful force for liquidity.

vice president

Arrowhead 2

“Long-only buy-side traders have started to ask me where our server centre is so they can understand the effect that has on the speed at which we can execute their trades.”

Bank of America Merrill Lynch Japan

The sequential trade quote system may be reviewed, which currently provides parameters for increases and decreases in prices quoted in sequential trades, and smaller tick sizes are expected to be introduced, which will directly compete with the PTSs, who currently use their smaller tick sizes as a unique selling point. For the sake of market security the exchange will introduce a cancel function on disconnection, and a kill switch. The speed of the matching engine will also be improved, with a target latency of about half level the current level (five milliseconds), with an expansion made to the level of processing capacity.

Although the TSE is cautious when talking about arrowhead 2, Asia Etrader has established that the trading system for JPX is expected to be upgraded in 2015, with plans to improve along three lines: credibility, usability and capacity. A hard limit function is expected to be introduced, which users will be able to set by themselves, and a virtual trading environment for testing will also be brought in to support the responsible development of electronic trading strategies such as HFT and algorithmic trading. Asia Etrader z Q3 2013 z www.asiaetrading.com

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Korea algo rules to curb market instability Plans to tighten the rules on algorithmic trading in Korea have been given a cautious welcome by market participants, who believe any short-term pain will be offset by the longer-term structural stability, writes Dan Barnes.

n 29 April 2013 the Korea Exchange (KRX) released a consultation of its plans to regulate electronic trading. Although they are not yet public, Asia Etrader has seen the proposal, which seeks to increase the level of risk management imposed on algorithmic trading, limit the posting of excessive numbers of orders, and improve risk management of the ex-post customer margin account. “The long term view of these reforms is pretty positive but in the short term it is less so, just because firms to have adapt,” says Seunghyun Cho, managing director, One Asia Investment Partners. “That is especially true for those running market-making strategies, who are primarily foreign investors. I’m sure they will adapt but I know that some guys are thinking about moving out of the market due to the changes in leverage that will affect them.” The motivation for KRX is clear. In Korea, there have been several cases of large-scale algorithmic trading system errors. On 7 January 2013, Eclipse, a Hong Kong-based hedge fund appears to have suffered a software glitch that resulted in it submitting the same limit order repeatedly, so that buy orders for 120,000 contracts were accumulated. As a result, 34,000 contracts executed and caused a loss, reported by sources to be of KRW 19 billion (US$17 million). This was not the first event; on 5 October 2010, an order program error at a local securities company generated 9,900 buy orders for 20,000 contracts and 13,000 contracts executed within 5 minutes in the KOSPI200 futures market. Fortunately, the company made some profits unwinding their trades. Globally, these types of events are common. The US suffered the notorious ‘flash crash’ on 9 May 2010 which led the whole Dow Jones Industrial Average index to fall 1000 points in 20 minutes before rebounding. That was attributed to a large sell-order being placed on the e-mini futures market without a time constraint, by long-only asset manager Waddell & Reed. On

1 August 2012, US broker Knight Capital lost US$440 million in 45 minutes when a marketmaking algorithm went wrong trading equities. There is no doubt that such events are disruptive, and regulators in highly electronic markets such as the US and Europe have been keen to rein in fast moving trading that can become out of control.

Half of derivatives volume is HFT in Korea Korea has fewer firms engaged in algorithmic trading than the US and European markets, however the number is set to grow and establishing rules now could prevent problems further down the line. There is no easy way to determine the exact number of algorithmic traders as they do not have to register or report algorithmic trading, and sell-side firms do not disclose information about their clients’ trading. Joon-Seok Kim, research fellow in the Capital Markets Department at the Korea Capital Market Institute, provides analysis that can estimate the scale of certain types of trading. Using trade and quote data from the KRX, he defines high-frequency traders as those who submit 1000+ / 5000+ orders per day for a single stock or derivative. As a subset of algorithm trading, this accounts for over 50% / 15% of trading volume in the KOSPI200 futures, over 50% / 30% in the KOSPI200 ATM options, and less than 0.5% / 0.1% in the cash market. He notes that HFT is inactive in the cash market because there is a transaction tax of 0.3% in cash market trading while there is no transaction tax in the derivatives market. “High-frequency traders are mostly foreign institutional investors and individual investors known as ‘boutiques’”, he says. “Practitioners note that algorithmic trading is not widely used among domestic institutional investors because they are not sensitive to price impact costs, not familiar with algorithmic trading, and reluctant to invest in algorithmic trading systems. But considering that in recent years the number of trades has increased and trade size has decreased significantly in the cash

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Joon-Seok Kim research fellow Korea Capital Market Institute

“The long term view of these reforms is pretty positive but in the short term it is less so, just because firms to have adapt.”

market, algorithmic trading seems to have emerged and will proliferate among domestic institutional investors.” The scale of HFT trading is also expected to increase following the planned upgrade of the KRX Exture trading platform. Called Exture+, the upgrade is scheduled for launch

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Seunghyun Cho Managing Director One Asia Investment Partners

in September 2013, becoming fully operational by February 2014. It will deliver a throughput capacity of 20,000 trades per second (tps) up from 250 tps, reduce roundtrip latency to 70 microseconds from 20 milliseconds (20,000 microseconds) and increase capacity to 2 billion trades up from 400 million.

The big change The new rules would significantly change trading for algorithmic and high-frequency traders. The KRX says that at present it cannot shield the market against the sort of negative events that it has seen previously, such as technical glitches triggering abnormal numbers of orders. It is nearly impossible for it to perform real-time monitoring on every automated transaction or to detect traces of abnormal transactions in absence of the information, members’ account information in algorithmic trading. To overcome this issue, it plans to make use of member-submitted account information regarding algorithmic trading. Currently, it is mandatory to register only the market making accounts of members and the ex-post customer margin accounts to KRX; under new rules firms would have to register all derivatives accounts in use for algorithmic trading, both exchange members’ and their customers’. The account number and order process IDs must be registered so that the KRX can allocate a kill switch to the account – which will enable members to cancel a batch of orders by one-click and to shut down additional orders afterwards – and a ‘cancel on disconnect’

expected as part of the Exture+ upgrade and which will be allocated to the registered order process ID. KRX wants to introduce a “safety net” that will cap accumulated orders for a trading firm that are caused by irregular duplication of individual orders, but which nevertheless comply with the existing quantity limit per contract, for example, the current limit of 1000 contracts for KOSPI 200 futures. Members will be asked to set their own cumulative order quantity limit for themselves and their clients’ ex-post margin accounts to curb orders beyond the limit. Upfront initial customer margin accounts are exempted from adopting the cumulative order quantity limit, as they already have a margin in place. The cumulative order quantity limit is 7,500 Delta to the long/short for the ex-post customer margin accounts for algorithmic trading, or 15,000 Delta to the long/short for the ex-post customer margin accounts which are not for algorithmic trading. Exchange members will be mandated to use the automated order cancellation system, which serves to cancel each unmatched order automatically. Under the proposal, KRX would be able to refuse to accept ‘excessive’ numbers of orders and will also charge firms that post excessive numbers of orders fixed cost, KRW 1,000,000 per month. The ratio of orders to trades set at 20-1 for if the number of orders is between 20,000 and 100,000 and 10-1 if the number of orders exceeds 100,000. Finally, to prevent “very same accident caused by the algorithmic trading errors on 7 January 2013” management for the risk exposure amount of the ex-post customer margin accounts has to be tightened up, and the margin calculation applied to the ex-post margin will be simplified.

Consequences As the proposals are currently in a draft format and have not been made public it is difficult to gauge market sentiment. One hedge fund told Asia Etrader that it had put plans to launch HFT ventures on ice, until the full impact of the rules was clear; another said that its prime broker was prepared to increase its margin to compensate for the effect of the rules. “I’m not really an HFT guy so it won’t affect me, but it will probably impact volumes,” says Cho. Kim reports that practitioners have submitted positive opinions for the registration of

algorithmic systems and the adaptation of the ‘Kill Switch’, while negative opinions have been directed at the restriction of order submissions. Implementing change in Korea’s capital markets can be challenging. The Financial Investment Services and Capital Markets Act (FSCMA), which introduces a central counterparty (CCP) for over-the-counter (OTC) derivatives and will allow alternative trading systems to launch in the country, was passed on 30 April after seven month delay triggered by a general election. The Ministry of Strategy and Finance has proposed a levy of 0.001% futures trades and 0.01% on options trades, however this has been opposed by market regulator the Financial Services Commission and is currently in limbo. Kim does not expect the same fate to befall the proposed algorithmic trading rules. “Currently, only a few market participants are actively involved in algorithmic trading in Korea although it represents a large share of total futures and options trading volume,” he says. “Therefore, algorithmic trading regulation is not as recognised or controversial as the derivatives transaction tax, changes in options trading unit, or the introduction of hedge funds. Amendments of regulations depend on the willingness of financial authorities. Recently the financial authorities have tendencies for increasing regulation of the derivatives market.” KyongSun Kong, analyst at research firm Celent, notes, “The regulators have positive sentiment about KRX proposal but the market participants don’t. The market participants are concerned if the proposals will drive the decrease of volatility. We expect [delays in implementation]. There are a number of conflicts between regulators and market participants. It is expected to take time to resolve the discrepancies.” However Cho says that the timeframe for implementation, with rules expected to come into play from September 2013 to February 2014, mixed with the limited impact for the majority of market participants, could make the implementation relatively smooth. “These rules will take some time to come in and they are changing the whole system early next year so we should have enough time to adapt to the new environment,” he says. “I think the regulator is being quite reasonable compared to other markets although there aren’t really easy comparisons to make with between other markets and the Kospi. In the short term this might be negative but gradually the markets will attract more HFT again.”

Asia Etrader z Q3 2013 z www.asiaetrading.com

884,448

165,731

154,514

51,397

534,355 23,132,283 636,467

122,512 5,171,223 150,044 6,668,669

1,267,669 6,986,905

117,913,980 275,332,778

32,625,829 177,460,476

116,109 897,218

202,221,558 615,301,456

Investment & Trust

Private Funds

Bank

Other Finance

Funds

Government

Other Institutional

Individual

Foreigners

Other Foreigners

Total

www.asiaetrading.com z Q3 2013 z Asia Etrader

71,125

25,167

7,468

0.1

13.63

15.54

10.64

5.8

0.78

10.55

0.02

5.78

0.21

0.1

Insurance

Investment & Trust

Private Funds

Bank

Other Finance

Funds

Government 15.81

0.45

Finance Invest

Other Institutional

Individual

Foreigners

Other Foreigners

Total

Trading Vol (1000)

8.18

11.81

8.87

0.31

2.39

12.43

6.34

1.65

48,168

488

2.65

1.4

1,960,709 20.14

30,890

718

11,658 4.96

23,801

173,923

74,303

2.65

Amount (Rate %)

Cash (Sell)

2,809,178

10,377,379

0.18

Trading Vol (Rate%)

13.41

12.87

1.85

0.02

0.51

0.27 2,858,035 0.18

25,121

70,711,999 5.96

1,730,406

309,014

26.03

Rate %

1,346,464 0.16

15,863,111 1.93

3,210,138 1,470,855 0.18

169,402

462,598

0.8

2,293,298

14,328,636 1.74

1,360,495

11,445,701

321,126,370 38.98

16.17

18.2

20.42

9.17

Amount (Rate%)

0.29

3.79

31.75

15.99

4.1

80,932

618

9.17

1.93

2,104,791 40.42

29,496

7,626

39,457

99,803

714

11,375 7.08

27,311

157,980

89,348

80,932

Trading Vol(1000)

Cash(Buy)

5,079,635

27,330

74,810,397

1,457,702

317,494

2,323,893

4,919,288

46,521

356,735

1,262,805

7,978,615

4,554,937

5,079,635

Amount(Won Mil)

54,737,888 252,382,963 54,737,888 252,382,963 823,878,878 100

1,471,181 20.73 313,165

6,553,556

851,984

4,138,436

114,070 525,542 116,515 515,652

1,323,287

3,211,689 12.03

37,665

214,459,901

Trading Vol

1,628,381 1,379,607 0.17

2,467,327

Amount(Won Mil)

Derivatives

52,088,591 225,608,059 52,097,815 224,549,806 247,350,378 30.02

378,652

453,152 6.55

1,145,090

9,420,761

11,438

33,268

49,211

236,670

2,758,883 193,031

333,307

513,169

986,191

3,903,833

3,452,583 14.29

2,858,035

202,234

1,598,919 87,915

2,427,115

Trading Vol(1000)

Cash KOSDAQ (Buy)

36,694 541,384 40,277 650,234

140,018

40,943

46,508

57,986

234,406

85,829

190,899

Amount(Won Mil)

Cash KOSDAQ(Sell) Trading Vol(1000)

Amount(Won Mil)

202,221,558 615,301,456

Trading Vol (Rate %)

48,168

173,655,586

114,145 899,261

33,925,297

Classification

6,092,598

27,557,471

964,727

4,578,604

6,956,151

39,699,716

119,770,779 274,608,842

1,182,876

27,232

140,388

154,424

990,603

Reference : Classification of Investors During latest 6 Months(Dec. 07, 2012 – Jun. 07, 2013)

1,319,283

4,565,554

7,047,045

40,095,703

20,681,339

52,938,487

459,271 18,227,971 537,340

44,591,958

Insurance

55,065,013

47,925,737

Amount(Won Mil)

Finance Invest

Trading Vol(1000)

Cash(Buy)

Trading Vol(1000)

Amount(Won Mil)

Cash (Sell)

Classification

Algorithm Trading of Cash market During latest 6 Months(Dec. 07, 2012 – Jun. 07, 2013)

cover story 2

Source: Jim Choi Blashnet

derivatives

China equity derivatives ready for take-off Despite recent wobble, China derivatives poised for growth. By Stephen Price

s China marches, albeit with dainty footsteps, further along the path to liberalisation of its financial markets, noteworthy innovations and developments are taking place in its China derivatives market, with exchanges releasing new A-share products, and interest in existing contracts likely to grow. Two contracts, in particular, highlight the forces at work: Singapore Exchange’s China A50 Index Futures and Hong Kong Exchanges and Clearing’s Renminbi Futures.

China A50 index futures Inflows to ETFs that track China A-shares more than doubled from 2010 to 2012, reaching over US$20 billion at the end of last year. And in the same period, open interest in Singapore Exchange’s A50 Index Futures, touted as “the most liquid offshore A-share product,” grew three-fold. Monthly open-end interest reached 307,491 in January, 2013. That’s impressive growth for a contract that after being looked

like it was nose-diving into obscurity when it was traded only once in 2009, three years after its launch. “Four key factors explain the growth of the futures product,” said Janice Kan, Senior Vice President, Derivatives/Head, Product Development & Management at SGX “Firstly, the utility of the contract. China is the world’s second largest economy, and its growth rate is relatively high compared with mature markets, or similarly sized economies. However, China is a restricted market, with Qualified Foreign Institutional Investor (QFII) and Renminbi Qualified Foreign Institutional Investor (RQFII) licensing. So market demand for offshore investment in China is driving the need for access products, such as this.” That ease of access provides investors with a convenient risk-hedging vehicle. “It’s very difficult, but not impossible, to invest directly in China itself,” said Singapore-based Bill Herder, executive director of trade body the

Janice Kan Senior Vice President, Derivatives/ Head, Product Development & Management

SGX

“It’s a classic example of liquidity begets liquidity”

Asia Etrader z Q2 Q3 2013 z www.asiaetrading.com

derivatives

Futures Industry Association (FIA) Asia. “So the index future gives people a simple way to take advantage of any changes in the Chinese markets; that’s why it’s been pretty popular.” “The second factor is distribution,” said Ms. Kan. “Operating from a global financial centre, SGX is a natural destination for offshore investors. We already have a wide range of international participants that are currently trading our various contracts, so they can easily trade this contract and help build liquidity. And we have regulatory approval from the US, as well as from Taiwan, which expands the user base.” In January 2012, US regulator the Commodity Futures Trading Commission gave SGX the green light to trade the contract directly in the US, and on 1 March 2012, the exchange extended the close of the A50 futures’ T trading session to 4pm from 3pm, for 16.5 total trading hours per day. “The third factor is a fairly recent development: new ETFs, including RQFII ETFs, based on the A-share market,” Kan explained. “It’s a classic example of liquidity begets liquidity. You get a distribution pool, you have regulatory approval coming in, adding more interest, and then the ETFs.” Besides hedging convenience, arbitrage opportunities are fuelling interest, especially with regards volatility. “More and more prop traders and hedge funds are exploring the arbitrage opportunities between A50 futures and CSI 300 futures because both closely track the performance of A-shares,” said Wang Zilong, Greater China strategist at Phillips Futures. “For professional traders and hedge funds, arbitrage between CSI300 and A50 futures contracts, or arbitrage between ETFs and A50 futures, is a reasonable and profitable choice. Orders from Hong Kong brokers – most Chinese A50 futures trading is through them – show that many of them are currently arbitraging.” “The most popular underlying in the Singapore warrant market is the Hang Seng Index,” said Barnaby Matthews, head of derivatives, Singapore at Macquarie Group. “One of the reasons that investors favour this index is because it is more volatile than the local Straits Times Index, with a 100-day volatility of 14 vs. 9 for Singapore. However, the China A50 is significantly more volatile than both the STI and HSI. Currently, 100-day volatility is 25.” Another reason for increasing interest in the contract is the product’s design. “The value of the A50 Futures contract is quite small, only around US$8,000,” said Wang. “And there is a very strict requirement to open a futures trading account via local FCMs in China. However, opening an account is quite easy with overseas brokers.”

After growing strongly from November, 2012, to January, 2013, interest in the contract has declined year-to-date. Average daily volume expanded from 55,433 contracts traded in November 2012, through December and January, and peaked at 115,827 in February 2013, before declining through March and April to hit 73,661 in May, while month-end open interest peaked in January at 307,491, before declining through February, March and April to 186,710, though it picked up to 198,821 in May. “Macroeconomic factors are the primary reason for that slowdown, or dip in volume. That’s consistent with what we see with ETFs as well as other markets,” stated Kan. “If you look at Hong Kong and US ETFs benchmarked to China, they also suffered outflows, and volume decline. Our contract is still a very nascent contract. It’s not like there’s a million contracts a day, it is 100,000 contracts; so we are only at the tip of the iceberg.” “The Shanghai Composite is around 2,100 points, almost the same as 10 years ago,” said Wang. “All of those individual traders, mutual funds and hedge funds in China are losing money presently. That is why the volume is thin both in the A-share market and for its derivatives.” Despite waning interest, the future looks rosy for SGX’s contract. China’s regulators are increasing foreign investor quotas, speeding up the QFII and RQFII application process and relaxing other rules, which will likely lead to inclusion of the A-share market in global indices (see story on Page 34), and increased fund flows into the market. Hedging demand, therefore, looks set to expand, not only for SGX’s futures contract, but HKEx’s Renminbi Futures, though as with the former contract, it has not been quick out of the blocks.

Renminbi futures “As the offshore Renminbi market is a market of a currency that is not yet fully convertible, and the links with onshore financial markets are still subject to limitations, we experienced a relatively slow start,” said HKEx in a written statement. “However, we are confident that this growth will continue as even more channels for two-way flows open up.” After debuting in September 2012, HKEx’s Renminbi Futures saw monthly open interest increase steadily from 1,956 in October 2012, to 6,685 in March 2013, before declining through March and April to 4,791 in May, while monthly volume peaked at 12,089 in January, before dipping to 5,979 in February, though in March it hit 6,986, and in April it reached 7,451. “The Renminbi contract has huge potential, but it’s a little slow because no one’s really afraid of having China risk right now,” said Herder. “They’re not hedging as much as nobody minds

www.asiaetrading.com z Q2 Q3 2013 z Asia Etrader

Barnaby Matthews Head of Derivatives

Singapore Macquarie Group

“The most popular underlying in the Singapore warrant market is the Hang Seng Index...”

taking on the risk of the Chinese currency. But as it picks up, as China opens its market a little more, people will be able to invest more in China and they will be able to use the Renminbi contract to hedge through Hong Kong entities.”

New kids on the block HKEx introduced stock futures on the CSOP FTSE China A50 ETF, iShares FTSE A50 China Index ETF and China AMC CSI 300 index ETF on 10 June 2013, and the exchange plans to launch CES China 120 Index (CES 120) futures on 8 July 2013. “The CES China 120 Index (CES 120) futures contract is designed to provide convenient, cost-efficient exposure to leading China stocks from the Mainland and Hong Kong markets,” said HKEx. “We think the contract will be a very effective risk management tool for market participants with China-related equity portfolios, including ETF market makers that are looking to hedge their positions in China-related ETFs.”

derivatives

HKMEx founder and CEO Barry Cheung Chun-yuen

HKMEx provides a lesson The Hong Kong Mercantile Exchange has suffered an abrupt demise and the subsequent criminal investigation raises some thorny issues, writes Roger Aitken.

s exchange demises go Hong Kong Mercantile Exchange’s (HKMEx) announcement of 18 May 2013 to voluntarily surrender authorisation to provide automated trading services (ATS) granted by the Securities and Futures Commission (SFC), the Hong Kong financial regulator, was swift. Virtually two years to the day after commencing for business the fledgling exchange, which had expressed high hopes at the outset, was shut down pending a potential “refinancing”. However, the subsequent investigation by police into suspected “irregularities” at the exchange, which has led Barry Cheung Chunyuen, chairman at HKMEx, to resign all of his official and board positions, makes refinancing look increasingly unlikely. All the signs had appeared so promising back in May 2011 when a press communiqué touted it as being the “world’s fastest commodity exchange” that was fully operational to trade its first product, a 32-troy-ounce gold futures

contract offered in US dollars with physical delivery in Hong Kong. The plan had initially been to offer trading in crude oil, but it ended up offering in the main trading in gold and silver futures contracts. Beginning with 18 members including some of the world’s largest financial institutions, trading firms and several well-established brokerages in Hong Kong, the exchange attracted shareholders from around the globe, including China’s ICBC and COSCO Group as well as Russia’s En+ Group amongst others. Cheung proclaimed that the exchange’s debut represented an “historical milestone” creating a “liquid and vibrant international commodity exchange linking China with the rest of Asia and the world.” The bourse had adopted an advanced architecture and deployed some cutting-edge functionality with its Pearl Trading system from Swedish platform technology vendor Cinnober AB.

It operated trading hours between 0800 and 2300 Hong Kong time, thus overlapping European and US commodity markets, a requirement to compete with similar contracts trading on Chicago Mercantile Exchange’s metals market. In the pipeline were standardised products that would either be physically or financially settled, spanning base and precious metals, energy and agricultural products, and commodity indices. Subsequently on 22 July 2011 the exchange launched a second product with a US Dollar silver futures contract.

Lacking urgency Patrick Young, executive director at DV Advisors, which advises investors in exchanges and exchanges themselves, says “The final outcome for HKMEx was a shame but fundamentally the problem for the whole exchange centred on the fact that it saddled itself with a high cost structure, a management hierarchy

Asia Etrader z Q2 2013 z www.asiaetrading.com

derivatives

that resembled the old fashioned legacy clubs and it lacked the urgency to succeed as a for profit business.” The author of ‘The Exchange Manifesto’, Young adds, “Ultimately low trading volumes in the final period before shuttering compounded matters. The secret to success nowadays in terms of new exchange launches is to have a long burn to reach profitability. Fundamentally HKMEX was a very expensive show where the content failed to shine before the cash ran out.” Fredrik Backlund, a Senior VP at Cinnober in Stockholm, says, “The closure of the HKMEx is of course regrettable. We knew for some time that the exchange was experiencing financial issues in their operations, mainly related to low volumes.” According to HKMEx the surrender decision to shut was made to enable it “re-align its strategy with the new industry environment” as trading revenues had not been sufficient to support operating expenses. In consequence it was unable to meet the required regulatory financial conditions. As of 21 May the Hong Kong SFC stated that it would “not make further comment while investigation continues.” The exchange nevertheless maintained that it would continue to operate with its existing staff and focus on developing new products including renminbi-denominated precious and base metals contracts to “better serve customer needs”. It also hoped to offer stronger and more effective market maker programs. How exactly this all comes to pass remains unclear. Aubrey Ho, HKMEx’s head of corporate communications, said in early June, “We do not have anything to add at this stage. We will have more to offer when our funding is in place.”

Rebound in doubt However, market sources are sceptical, noting that problems surrounding HKMEx’s business viability have not happened overnight. As far back as mid2012 the bourse had started looking at a joint initiative with a mainland [China] precious metals exchange. The deal as envisaged would allow the mainland exchange to become more international and let HKMEx tap into the liquidity of the mainland China market. One source close to the deal reveals that the HKMEx had not been doing well and in consequence it needed to consider looking at expanding its business, particularly in the face of increasing competition.

“The story about the London Metal Exchange (LME) and the Hong Kong Exchanges and Clearing Limited (HKEx) merger surfaced between May and June [2012]. And, it was at around that time that the precious metals exchange [in question] and HKMEx were talking,” the source says. The go-ahead had reportedly been granted in principle by the Hong Kong administrative government. However, a Directive from the central government in late 2011 had established new rules to clamp down on exchanges. This included the requirement that they be authorised by the central government rather than by regional authorities. As a result in mid-2012 the ownership of the precious metals exchange changed hands leaving it “effectively nationalised”, according to one source. Had the deal come off it would have represented the first Hong Kong/ mainland exchange. On 6 December 2012 HKEx and LME Holdings Limited, the parent company of the LME, announced that the acquisition of the LME by HKEx had been completed, moving control of the world’s leading nonferrous base metals exchange to Asia. At the time it was touted by the exchanges as providing a “platform for significant long term growth through the expansion of the LME’s business and operations in Asia and the Chinese market by leveraging HKEx’s resources, infrastructure and network in the region.” Undoubtedly the expansion of into commodities by otherwise the finance-focused HKEx was seen as potential competition for HKMex. Cheung asserted in May that global commodity demand was continuing to shift towards Asia as the region undergoes sustained growth, suggesting that the “favourable conditions” under which HKMEx may not have changed much. China will eventually open up. On this point some like Young believe it will be “more for inbound as opposed to outbound flows.” He thinks too that: “Singapore will always be sniffing around the edges for products to launch and it is highly likely that one can expect to see far greater developments in Thailand and Malaysia.” In relation to the value of good commodity exchange open-access architecture in the region, there still remains a lack of good market access and product listing to serve the Asian hedging and investment community. As such there is an opportunity and a niche that HKEx with LME as well as others will no doubt attempt to address.

www.asiaetrading.com z Q2 2013 z Asia Etrader

HKMEx Timeline Jun 2008 Barry Cheung announces launch of HKMEx

Dec 2009 ICBC invests in HKMEx

Jun 2010 En+ Group Announces 10% Stake in HKMEx

Apr 2011 Receives trading authorisation from SFC

May 2011 HKMEx goes live

May 2011 Deploys Patsystems front-end

Jul 2011 Silver contract begins trading

Aug 2011 Stephane Lannoy joins as Executive Director

Oct 2011 Appoints Spencer Campbell as MD SEA

Nov 2011 Appoints William Barkshire as COO

Feb 2012 Surpasses 1 million contracts

Mar 2012 Barry Cheung elected chairman of Rusal

Jun 2012 10,000 gold contracts trade on one day

Aug 2012 Jane Wang and William Barkshire appointed co-Presidents

Mar 2013 FFastFill provides for middle & back office

May 2013 HKMEx surrenders its ATS authorization

May 2013 HK SFC suspect criminal irregularities

May 2013 Barry Cheung quits public posts

May 2013 Barry Cheung under investigation

derivatives

TOP 50 Futures Contracts by Volume in Asia for Q2 2013 Q2 2013

Q2 2012

Product

Vol

Difference Type

Zhengzhou Commodity Exchange

Flat Glass

235,981,221

Commodity

Shanghai Futures Exchange

Steel Rebar

206,958,586

38,603,280

168,355,306

Commodity

National Stock Exchange of India

US Dollar/Indian Rupee

195,333,767

149,060,527

46,273,240

Currency

MCX-SX

US Dollar/ Indian Rupee

150,699,508

138,299,625

12,399,883

Currency

Dalian Commodity Exchange

Soy Meal

143,492,166

141,405,400

2,086,766

Agriculture

Zhengzhou Commodity Exchange

Pure Terephthalic Acid (PTA)

123,510,452

44,188,344

79,322,108

Commodity

Zhengzhou Commodity Exchange

White Sugar

103,876,460

71,162,772

32,713,688

Commodity

Dalian Commodity Exchange

Coke

87,008,690

Commodity

Dalian Commodity Exchange

Soy Oil

51,847,592

32,517,342

19,330,250

Agriculture

Zhengzhou Commodity Exchange

Rapeseed Meal

50,080,361

Agriculture

Shanghai Futures Exchange

Copper

49,754,594

34,741,296

15,013,298

Metal

Dalian Commodity Exchange

Palm Oil

41,043,788

14,819,420

26,224,368

Agriculture

Shanghai Futures Exchange

Rubber

39,702,908

26,383,670

13,319,238

Commodity

Dalian Commodity Exchange

Linear Low Density Polyethylene (LLDPE) 38,546,002

33,427,790

5,118,212

Commodity

Shanghai Futures Exchange

Silver

25,225,782

12,443,308

12,782,474

Metal

Dalian Commodity Exchange

Hard Coking Coal

17,945,844

Commodity

Multi Commodity Exchange

Crude Oil

14,951,488

13,258,858

1,692,630

Energy

Australian Securities Exchange

3 Year Treasury Bond

13,551,478

11,761,826

1,789,652

Interest Rate

Korea Exchange

US Dollar

14,860,515

15,074,724

-214,209

Currency

Multi Commodity Exchange

Silver Micro

11,627,232

13,816,331

-2,189,099 Metal

Zhengzhou Commodity Exchange

Cotton No. 1

10,342,407

17,355,272

-7,012,865 Commodity

Dalian Commodity Exchange

Corn

9,043,346

24,692,472

-15,649,126 Commodity

Multi Commodity Exchange

Natural Gas

8,487,408

6,473,757

2,013,651

Energy

Australian Securities Exchange

90 Day Bank Bills

8,446,789

6,178,550

2,268,239

Interest Rate

Multi Commodity Exchange

Copper

7,982,156

9,767,287

-1,785,131 Metal

Tokyo Financial Exchange

US Dollar/ Japanese Yen

7,639,693

2,208,607

5,431,086

Shanghai Futures Exchange

Zinc Futures

7,621,274

10,108,028

-2,486,754 Metal

Multi Commodity Exchange

Silver Mini

7,296,448

9,640,576

-2,344,128 Metal

Australian Securities Exchange

10 Year Bond

6,631,276

4,878,661

1,752,615

Multi Commodity Exchange

Gold Petal

5,892,129

10,146,158

-4,254,029 Metal

Multi Commodity Exchange

Gold Mini

5,810,255

5,913,675

-103,420 Metal

Shanghai Futures Exchange

Gold

5,440,058

3,144,420

2,295,638

Zhengzhou Commodity Exchange

Rapeseed Oil

4,885,701

5,687,122

-801,421 Agriculture

Dalian Commodity Exchange

No. 1 Soybeans

4,758,698

12,093,468

-7,334,770 Agriculture

Multi Commodity Exchange

Silver

4,464,008

4,536,372

-72,364 Metal

Multi Commodity Exchange

Copper Mini

4,443,761

5,196,578

-752,817 Metal

Tokyo Commodity Exchange

Gold

3,930,093

2,729,826

1,200,267

Tokyo Financial Exchange

Australian Dollar/ Japanese Yen

3,529,890

5,085,512

-1,555,622 Currency

Multi Commodity Exchange

Gold

3,436,595

2,624,932

811,663

Metal

Tokyo Financial Exchange

Euro/ Japanese Yen

3,096,002

4,352,112

Currency

Multi Commodity Exchange

Nickel

2,840,850

3,608,958

-768,108 Metal

Tokyo Stock Exchange

10 Year JGB

2,656,332

2,422,461

233,871

Multi Commodity Exchange

Nickel Mini

1,898,224

2,109,690

-211,466 Metal

Shanghai Futures Exchange

Aluminum

1,874,308

2,367,616

-493,308 Metal

Bursa Malaysia

Crude Plam Oil

1,822,853

1,896,549

-73,696 Agriculture

Zhengzhou Commodity Exchange

Strong Gluten Wheat

1,745,892

16,617,090

-14,871,198 Agriculture

Tokyo Financial Exchange

Three-month Euroyen

1,525,714

1,151,016

374,698

Zhengzhou Commodity Exchange

Methanol

1,277,391

1,821,116

-543,725 Energy

National Commodity & Derivatives Exchange Ref Soya Oil

1,076,633

1,839,497

-762,864 Agriculture

National Commodity & Derivatives Exchange Cotton Seed Oil Cake

1,075,644

1,422,729

-347,085 Commodity

Total

1,756,970,262

Source: Exchange Websites

Exchange

Currency

Interest Rate

Metal

Interest Rate

Asia Etrader z Q2 2013 z www.asiaetrading.com

derivatives

Stock Index Futures

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

Nikkei 225 mini 83,914,741 33,856,526 50,058,215 CSI300 45,056,683 19,732,840 25,323,843 S&P Nifty 18,001,836 22,065,287 -4,063,451 KOSPI 200 14,123,498 16,897,408 -2,773,910 TAIEX 12,244,854 14,930,176 Nikkei 225 10,373,289 5,206,854 5,166,435 Nikkei 225 8,495,835 TOPIX 7 207 955 4,008,210 3,199,745 mini-TAIEX 6,624,868 HSI 5,468,244 5,405,556 62,688 HHI 5,259,192 3,973,006 1,286,186 FTSE China A50 3,252,836 MSCI Taiwan 3,203,430 SGX CNX Nifty 2,769,171 SPI 200 2,700,631 2,777,048 -76,417 Mini HSI 2,169,689 2,278,107 -108,418 SET 50 1,728,092 1,333,515 394,577 Mini TOPIX 1,281,317 KLCI 787,337 630 434 156,903

Index

Total region

Q2 2013 Vol

Q2 2012 Vol Net

234,070,514

Top 5 Gainers Top 5 Decliners Product Net Exchange Exchange

Product Net

Corn Strong Gluten Wheat No. 1 Soybeans Cotton No. 1 Gold Petal

Shanghai Futures Exchange Zhengzhou Commodity Exchange National Stock Exchange of India Zhengzhou Commodity Exchange Dalian Commodity Exchange

Steel Rebar Pure Terephthalic Acid (PTA) US Dollar/Indian Rupee White Sugar Palm Oil

168,355,306 79,322,108 46,273,240 32,713,688 26,224,368

Dalian Commodity Exchange Zhengzhou Commodity Exchange Dalian Commodity Exchange Zhengzhou Commodity Exchange Multi Commodity Exchange

-15,649,126 -14,871,198 -7,334,770 -7,012,865 -4,254,029

Exchange

Product Volume

Soy Meal Soy Oil Rapeseed Meal Palm Oil Rapeseed Oil

Dalian Commodity Exchange Dalian Commodity Exchange Zhengzhou Commodity Exchange Dalian Commodity Exchange Zhengzhou Commodity Exchange

Top 5 Agriculture Futures

Total

143,492,166 51,847,592 50,080,361 41,043,788 4,885,701 291,349,608

Exchange

Product Volume

Flat Glass Steel Rebar Pure Terephthalic Acid (PTA) White Sugar Coke

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

Top 5 Commodity Futures

Total

235,981,221 206,958,586 123,510,452 103,876,460 87,008,690 757,335,409

Exchange

Product Volume

Top 5 Currency Futures

National Stock Exchange of India MCX-SX Korea Exchange Tokyo Financial Exchange Tokyo Financial Exchange

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

Total

195,333,767 150,699,508 14,860,515 7,639,693 3,529,890 372,063,373

Exchange

Product Volume

Copper Silver Silver Micro Copper Zinc Futures

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

Top 5 Metal Futures

Total

www.asiaetrading.com z Q2 2013 z Asia Etrader

49,754,594 25,225,782 11,627,232 7,982,156 7,621,274 102,211,038

Source: Exchange Websites

Exchange

buyside

Standards, Shariah and Sukuk: Trading Islamic products in Asia For asset managers in Asia, Shariah compliant financial products are a route to a wealthy tranche of investors, but trading them can be challenging. By Dan Barnes

ew Shariah compliant funds are launching in Asia, but their traders are challenged in their ability to snap up assets. Illiquidity in the secondary bond market and the lack of a standardised approach in the equity market are both concerns for the dealing desk. “There is strong growth in Islamic investment products especially in Islamic bonds (Sukuks),” says Sandeep Singh, country head for Malaysia at Franklin Templeton Investments. “The global Sukuk market is expected to see double-digit growth this year. We see increase issuances from corporates besides government issuances, and there is an increase in the trading

activity of Islamic fixed income by institutional investors in Asia.” The primary market for sukuk reached BHD52 billion in 2012, up from BHD35 billion in 2011, according to the 3rd Sukuk report of the International Islamic Financial Market (IIFM), released on 28 May 2013. Nevertheless on 3 June 2013 at the IIFM conference in Singapore, Ng Nam Sin, assistant managing director at regulator the Monetary Authority of Singapore, said more needed to be done to facilitate trading. “The increased volume of issuance is still insufficient to meet the huge demand for Islamic assets for investment and by Islamic financial

institutions to manage their liabilities,” he said. “Within the Islamic capital markets there is also a need to broaden the range of Islamic capital market products available to address various investment and financing needs.” Jesse Liew, portfolio manager, at buy-side firm BNP Paribas Investment Partners, based in Malaysia, said, “Growth in issuance size and quantity is one of the several factors in improving liquidity. However, the technical position of the Sukuk market in Malaysia, as well as the global Sukuk market, is clearly showing greater thirst from investors for a smaller supply of Sukuk. We believe that this phenomenon would remain in the near future given the continuous growth in

Asia Etrader z Q3 2013 z www.asiaetrading.com

buyside

the Sukuk asset in general, but should subside as the market develops further.” Sukuk provides Islamic investors with an investment vehicle that avoids making money from interest on loans (Riba). Under Shariah money should be viewed as a measure of value and profit should only be made from the trade of actual goods or services. Sukuk provides a structured cash flow which replaces the interest payments with payments to be made as profits from the underlying business, with a commitment from the issuer to buy back the certificate to provide return on capital. “Liquidity [in the secondary market] is a lot lower for sukuk than many other types of bond because people tend to buy and hold and so it is not easy to build positions or set up a sukuk portfolio,” says Gerald Ambrose managing director at Aberdeen Asset Management Malaysia. Liew observes that market is evolving to deal with liquidity issues, which should help mitigate problems for traders. “Although there is a demand and supply imbalance, generally there is no material liquidity risk in the Sukuk market given the growing number of participants in the market,” she says. “As an example, the bid/offer spread for Global Sukuk products has been on a narrow trend given the growing number of financial institutions participating as market-makers.” On 6 April 2013 the Malaysia-based International Islamic Liquidity Management Corporation (IILM), which has support from both Middle Eastern as well as Asian firms, announced it would try to develop short-term Sukuk debt instruments. At present the plan is to develop products that are deliberately liquid to enable banks to support short-term funding via sukuk. Several market-makers are reported to be on board to provide secondary market liquidity, however there is no public timeframe for the project to deliver at present.

Getting a fair share Trading Shariah-compliant equities can also be equally challenging but for different reasons. There is no central authority in the Islamic world to can determine an investment’s acceptability under Shariah. Imams who are suitably qualified can offer authoritative guidance on what should be allowed for investment purposes. For an equity investor this may mean discounting investments that generate revenue based on alcohol, arms, gambling, interest-based financial activity and tobacco. The ethical nature of Shariah requires investors to go beyond the face business of a company, for example its involvement in

Sandeep Singh country head for Malaysia Franklin Templeton Investments

agriculture, and to know how much of that business might comprise tobacco or ingredients of alcoholic drinks, such as hops or sugar. “There is no self-assessment in Shariah investment so interpretations vary from Muslim country to country,” says Peter Sherriff, principal architect, Asia-Pacific at order management system (OMS) supplier Charles River. “For example, in Malaysia there is a 5% allowance for including retail companies. This means that a supermarket can still be deemed halal, as long as total haram sales do not exceed 5%. However, in the Middle East, even the slightest trace of haram activities is deemed unacceptable. This makes harmonisation a big problem.” This level of complexity can present challenges for the portfolio manager or trader. To provide guidance fund managers have two primary resources. Firstly they are able to offer funds that track indexes such as the FTSE SGX Shariah Index Series, which tracks the performance of Shariah-compliant companies from the Japanese, Singaporean, Taiwanese, Korean and Hong Kong markets, or the MSCI All-Country Islamic Index which tracks a more global base.

The right trade Aberdeen Asset Management launched two equity funds in January, with the MSCI AllCountry Islamic Index as its benchmark for one, and the Shariah compliant investments as listed every six months by the Shariah Advisory Council of the Malaysia Securities Commission

www.asiaetrading.com z Q2 2013 z Asia Etrader

for the other, Malaysian equity unit trust. It also uses a third party for advice. “Sometimes we might come up with a stock that is not a component of the MSCI AC Islamic Index but we don’t see anything in it that looks un-Islamic so we might submit the annual reports to the Islamic Banking and Finance Institute of Malaysia (IBFIM) and they can come back with a decision within five working days as to whether that stock is Shariah compliant in their view,” says Ambrose. Transferring this to the trader requires an order management system that incorporates takes information from pretrade compliance ‘checking’ during the portfolio construction phase to ensure that non-compliant securities, taking into account complex ownership structures and related entities are not included inadvertently. “We have a software system provided by Charles River that interlocks between the front office and our portfolio manager’s systems so that the trader cannot trade in non-Shariah compliant companies,” says Ambrose. Sherriff goes on to explain, “[Our system] provides clients with pre-trade, post-execution, in-trade, and end-of-day compliance monitoring. In Malaysia, many systems are legacy or proprietary requiring significant input from investment managers to create a rule for each restriction list specific to each account – a manual process that can be time consuming and subject to error – Charles River IMS can automate this compliance process.” For the moment he acknowledges that it would be, “Difficult, if not impossible, to create a fund that could be considered compliant across all the Shari’ah Boards or Islamic countries.” However he asserts that Islamic fund managers can use technology to incorporate compliance rules that mirror religious decrees within their trading systems, rather than using the box-ticking model approach of ‘permitted securities’ lists. “They can monitor the metrics of various stocks and issuers across portfolios and ensure compliance,” he says. The IILM project offers hope for increased liquidity in the secondary Sukuk market, however harmonisation of Shariah standards is really needed to circumvent the different schools of thought that are hindering cross border transactions. “A success in this would reduce the fragmentation of the entire Islamic industry, where some Shariah standards are defined differently from country to country which rises questions of prohibition, and promote greater international transaction,” says Liew.

regulations

Choppy waters of regulatory change shake up static data This article is based on a roundtable discussion hosted by HKEx and supported by the Software and Information Industry Association’s Financial Information Services Division, held in Hong Kong on 9 May 2013.

gainst the backdrop of the profound regulatory changes taking place, the panel discussed the response of Hong Kong regulator the Security and Futures Commission (SFC) to electronic trading, the impact of new Hong Kong Monetary Authority regulations on data consumers. It also considered elements of America’s Foreign Account Tax Compliance Act (FATCA) and Dodd-Frank Act, Basel III, the European Markets and Infrastructure Regulation (EMIR) and Solvency II, with regard to how they affect market data consumption. Chris Johnson, head of product management for Market Data Services at HSBC Securities Services, began by noting that new data fields required for new regulations, such as Unique Counterparty Identifiers (UCI), and Unique Product Identifiers (UPI), have been created slowly, and their rollout has been far from uniform so far. As a result interim data fields are being used (e.g. pre-LEIs) while global standards are still being created, and that in turn results in uncertainties. He identifies ten new regulatory data fields that have been created under new rules such as Dodd-Frank, EMIR, FATCA and Solvency II, but no single consultation paper succinctly details them. What will impact derivatives transactions in respect of central counterparties, he said, was what is required specifically for each CCP regulation as that will directly impact how trades are reported. Homing in on Hong Kong and Singapore, Barnaby Nelson, head of client development, Asia BNP Paribas Securities Services, said there are three keys areas to the regulatory agenda: liquidity, counterparty risk, and OTC derivatives. With regards to liquidity, the International Organization of Securities Commissions (IOSCO) has significantly increased the amount of collateral that must be posted as margin in order to trade, and has prompted restructuring within firms, because of changes to the amount of capital participants must keep in their localities. For some houses, the cost of trading in 2013 has increased in Hong Kong and

Singapore by a multiple of 10 in collateral terms compared with 2012. The panel heard that regulatory change is fueling entity arbitrage, with EMIR and Dodd-Frank making it far more effective to trade through certain entities than others. “The fundamental point is that from an overall infrastructure perspective, trading infrastructure now needs to be far more joined up than ever before,” Nelson said. “Organisations need to be sufficiently equipped to be much more agile because they’re being called for much more collateral, they probably have less of it, and they need to be far better at managing collateral in every entity around the world. The linkages between trading, market data, and treasury have to be much more sophisticated then before.” Magnus Cattan, director of business development (Asia) at Interactive Data, cited a recent KPMG report that identified the three largest issues in Asia as capital, liquidity, and tax. “When I speak with banks in Hong Kong, certainly liquidity and capital within Basel III are real headaches,” he said. “Everyone’s talking about risk-weighted assets (RWA), and that has a real data issue with regard to how they are calculated. The devil is in the detail because a lot of instruments no longer qualify under Basel III as capital, and there is a sharp increase in what you must allocate for trading activities.” Johnson pointed to the impact of FATCA and changes in the derivatives space as having the biggest impact to the market data space. With regard to the former, he stressed the importance of complying with entity data requirements, which includes assigning the FATCA status for each entity along with codes from the Internal Revenue Service (e.g. TIN and GIIN) in order to apply any FATCA tax amounts and produce a list of entity names for US authorities. Another facet of FATCA compliance, he said, is the identification of assets. In terms of the derivatives space, reference data for reporting and clearing is a significant challenge. “With the new regulatory data, it’s difficult to see where the industry leadership comes from,” said Johnson. “As far as firms joining up, and coming up

Magnus Cattan Director – Business Development

Interactive Data

“It’s therefore a shame you’ve got local entities looking to do their own version and creating disparities…”

Asia Etrader z Q3 2013 z www.asiaetrading.com

regulations

with a consensus, it’s something that’s very hard to do but we have fortunately enjoyed a great deal of support from some Trade Associations .” “Firms need flexible systems to handle all the different scenarios,” continued Johnson “For the CCPs, under Dodd-Frank the UPI (Unique Product Identifier) uses a concatenation of the ISDA taxonomy, as an interim code, which can be up to 70 characters long. In Europe, for EMIR, the interim UPI will comprise a combination of various ISO standard codes (e.g. ISIN, CFI, Aii and LEI). EMIR reporting also includes futures and options unlike Dodd-Frank. EMIR reporting is scheduled to commence in September 2013.” “For Australia, I’ve seen references to three domestic entity codes, the Australian Company Number (ACN), the Australian Registered Scheme Number (ARSN) and the Australian Registered Body Number (ARBN) with the Global LEI as fourth choice,” he explained. I’ve read that the Monetary Authority of Singapore supports the international adoption of the LEI and the HKMA lists LEI as first choice.”

Broad support for Legal Entity Identifiers The next topic up for discussion was Legal Entity Identifiers (LEI), specifically the extent to which they make sense, what kind of burden they entail in terms of compliance, and whether that burden outweighs the benefits. Panelists were largely in favor of the move towards using LEIs. Johnson said that it will enable derivative counterparty exposure to be quickly ascertained, which is a key regulatory driver, although he sees implementation as a challenge. While he said there won’t be a return on investment in the short to medium term the LEI will enable some operational efficiencies in the long run. He thinks implementation is the right course of action. Nelson said “There are a lot of soft benefits to LEI, which will be felt at the working level. I think we significantly underestimate the value of being able to understand each other.” The ability to report to regulators using a single set of codes on credit risk, and therefore counterparty exposure, would cut down the regulatory burden, he said. Holistic risk management is the big buzzword phrase, said Cattan, and that requires looking across the entire enterprise, which without LEI would be impossible. The process of formulating and implementing LEI, said Cattan, is one of the few times that regulators, most industry sectors, and data vendors have all embraced an issue. “It’s therefore a shame you’ve got local entities looking to do their own version and creating disparities,” he said.

“Regulators are crystal clear, they know exactly what they want to achieve” added Johnson. “The two specific things they are looking for from the new reference data are certainty of the counterparty with UCI (LEI), and the certainty of understanding the type of instrument the risk is for with UPI. It will not be straightforward to deliver, but it I think will work and it will be right.”

Getting what they want Turning to Unique Counterparty Identifiers (UCI), Unique Product Identifiers (UPI), the panelists observed that regulators were becoming more assertive in their approaches to compliance. “I think it is unlikely that the regulators will want to allow delays to the CCPs for derivatives” said Johnson. “Regulators are likely to treat derivatives reporting and clearing as a high priority. The derivatives CCP implementation tends to come in two phases: reporting first, then clearing.” Several banks have reported that regulators have become very active in checking reporting of exposure, said Nelson. “You’re sitting here on a Tuesday morning and suddenly your regulator calls you up, and says by this afternoon they want a report on your positions related to a certain counterparty,” he said. “That’s an enormous amount of work, and that means extra costs. Organisations are trying to stay lean; obviously they’re not earning much in terms of brokerage, but you have to add headcount solely to deal with questions arising from regulators.” “[Regulators] have issued consultation papers, and have kept the industry briefed on their intentions and offered opportunities for feedback through the process,” said Cattan. “The firm, at board level, may be waiting to be told what to do, but actually they’ve already been given that guidance. It’s out there already. You just have to manage it.” “Regulation is discredited in terms of deadlines, too few of which are meaningful,” said Nelson. “There are a lot of deadlines, but there’s a either a partial lack of clarity about what needs to happen on the deadline, or a total lack of clarity. A lot of people are therefore skeptical of any new regulation.” The responsibility for compiling and maintaining records for reporting and auditing was raised as an issue, with the cost of that process, who would pay for it, and whether it should be centralised noted as potential problems. Johnson, meanwhile, observed that responsibility is being pushed upstream, “The regulations tend to treat the asset owners as accountable for complying with new regulations, such as derivative counterparties (CCPs), funds (AIFMD)

www.asiaetrading.com z Q3 2013 z Asia Etrader

Chris Johnson Head of Product Management, Market Data Services

HSBC Securities Services

“With the new regulatory data, it’s difficult to see where the industry leadership comes from.”

regulations

and insurers (Solvency II) and so service providers, such as asset managers and fund administrators need to ensure these regulations can be supported.” “It’s going to be the responsibility of whoever is doing a particular transaction,” said Cattan. “But at the heart of that, you need a centralised utility managing that complication.”

Balance sheets under BASEL III For many Asian markets, particularly the smaller ones, liquidity is a major issue. With that in mind the panelists turned to the challenges Asian banks face in complying with BASEL III. “A lot of the banks around the world and in Asia are reducing their balance sheet activities,” said Nelson. “There’s a massive move, from an investment perspective, into wealth management and asset management; basically anything that can be done without lending out balance sheet. “Long term, that’s probably positive as it breeds a more institutional industry in Asia,” he continued. “For those on the other side, most organisations in Asia finance through credit. Because banks are deleveraging, credit scarcity is already a problem, and it is going to become a much bigger problem, which I think will drive bond issuance and listings in Asia. Asian banks are not big risk-takers compared with European and US banks, therefore risk of failure for them is much lower. It’s not such a pressing issue here because they’re not running massive proprietary operations.” “A lot of local banks in Asia are in the relatively fortunate position that they have the capital to be able to adhere to most of Basel III,” said Cattan. “The challenge is that as the growth engine of the world, Asia is being predominantly funded by balance sheet. With more growth comes more stress on balance sheets, and the greater the need for high-quality assets, which will be problematic when you’ve got a very small debt capital market like many markets in Asia Pacific.”

Collateral transformation Discussion moved on to the lessons Asia could learn from Europe and the US about the collateral requirements that new regulations require. The US and Europe encountered these issues earlier, said Nelson. And while there is much Asia could teach the US and Europe, the latter

two are ahead in terms of the sophistication of collateral management. Another difference is the assumption of counterparty risk. “While in Asia it’s assumed that if you’re trading you take the counterparty risk for that trade, in Europe the outsourcing of that risk is much more widespread. That’s an area that will grow in Asia in the next couple of years,” said Nelson. “In terms of reference data, there is quite a lot of press in Europe about collateral transformation because some funds might have to transform their collateral. Entities, organisations, and businesses that hold assets could have an opportunity as a result of this transformation activity.” “In the area of collateral management, Australia and Hong Kong are this year launching their CCPs, and we might see a development in the derivatives market,” said Cattan. “Hopefully, the range of derivatives might expand, which would also entail more collateral.” The penultimate topic for discussion was compliance with the Foreign Account Tax Compliance Act (FATCA), which was enacted in 2010 by the U.S. Congress to target noncompliance by U.S. taxpayers using foreign accounts. Under the act, foreign financial institutions (FFIs) are to report to the IRS details of financial accounts held by these U.S. taxpayers, or by foreign entities in which U.S. taxpayers hold a substantial ownership interest. Johnson pointed out that the scope of FATCA reference data requirements will reach across the entirety of Financial Services. “FATCA compliance will extend from account holders right down to the transfer agents,” he said. “It’s a mega activity and it has to be in place by the end of this year, for income and dividends, and it the scope will be incrementally extended increased through to 2017.” As a consequence of the legislation, a lot of Asian financial institutions are choosing to avoid American customers, said Nelson, as the cost of compliance is too high. The session closed with an audience question: With compliance coming to the fore through the rest of 2013, can we expect increased volatility, the winding up of positions, or a rise in the borrowing of collateral? “We don’t really know what we are going into this year in terms of regulation,” said Barnaby Nelson. “We’re running into a massive gray area, and nobody knows what’s going to happen.”

Barnaby Nelson Head of Client Development, Asia

BNP Paribas Securities Services

“…trading infrastructure now needs to be far more joined up than ever before…”

Asia Etrader z Q3 2013 z www.asiaetrading.com

Opinion Who’s Who & Analysis

Philip York Asia Etrader spoke with Philip York director of Alt 224 Group and the Etrading Association. As a long time algo developer and trader he lends us insight into the evolution of algorithmic trading, high frequency trading, short selling and liquidity. He also speaks about FATCA, the challenges a fund manager faces in Asia, what he looks for in a clearer and what the future holds for electronic trading in APAC.

AE: How did you get started algorithmic trading? Philip York: I started trading in 1984, and always wanted to systematize things because I came from the software side. I started out using a program called Computrac, which hails back to the original Technical Analysis Group (TAG). It was just a group of analysts who put together some money to pay programmers to write a platform to analyse and test trading methods, but it was woefully basic in terms of system testing. In 1988, I settled on a suite of programs. For chart analysis I used Relevance III from Maynard Holt and for testing, SystemWriter-Plus. System-Writer was written by Sam Tennis who was hired by Bill Cruz when he formed Omega Research. System-Writer was quite powerful and its Pascal like language EasyLanguage, is still used in TradeStation today. I used that for a lot of prototyping, for testing individual algos in individual markets, however portfolio testing had to be done externally in spreadsheets. In 1992, I started trading managed accounts. I had an actuary to help. He programmed in Fortran and did a lot of the portfolio work for me. At that time, my greatest frustration was, what happens when your algos wane, or when an algo is performing better, or if you have a new algo, should you replace an old one or proportionally allocate between them. Also, Ralph Vince’s book “Portfolio Management Formulas” really hit a nerve, but it posed more questions than it answered. By 1995, I had the answers and had a model for completely automated dynamic position sizing, so you could plug in new algos, pull out algos, and it would make the allocation decisions for

you. I see this issue as the downfall of a lot of algo shops in that they use a lot of discretion when it comes to portfolio allocation. In 1996 we went into production with the Dynamic Asset Allocation Model. AE: What are the challenges for a hedge fund to establish itself in Asia? PY: Many of the challenges are the same no matter where you are in the world. You have the challenge of finding investors, and if you are setting up a hedge fund you start with the high-net worth individual, and or friends and family, because they’re the most entrepreneurial. The SFC has recently put out a consultation paper, looking at potentially modifying the high net worth individual exemption to get involved in private placements. They’re happy for institutions to invest in private placements, but not necessarily high net worth individuals. This could potentially kill capital raising for new enterprises. I think as these people have earned a significant amount of money, then they’ve earned the freedom to make those riskier entrepreneurial choices. Finding a clearer has become more of a challenge post-2008, but you can always start with someone like Interactive Brokers. They might be a retail broker, but they offer reasonable execution, and if you are not too latency sensitive, they’re fine. As for looking for institutional brokers such as Newedge, it’s a tough call. They typically want hundreds of thousands of US dollars in brokerage per annum and won’t help you raise capital until you have at least US$20M under management, so that’s not commercial for someone starting out.

“The other challenge as a new manager starting in Asia, is the jurisdiction you are in.” The other challenge as a new manager starting in Asia, is regulation. If I’m residing in Australia and I’m managing an offshore fund, I don’t actually need to be licensed as long as I’m not marketing to Australians. In Singapore there is an Exempt Manager regime, but it was tightened significantly last August. The Singapore Exempt Manager Status is still a far easier regime than the Hong Kong regime though. The way to work in with that (in HK) is to partner with a local asset manager, which can be done for a fee, and they take responsibility. AE: What kind of services do you look for in a broker? PY: As an algo trader the service I look for is an automated interface, an Application Programming Interface (API). The API need to provide a real time interface to the middle office so we can get fills and check our reconciliation against their reconciliation, and check the open positions standing. The big issue when running live is synchronisation. Because the connection can drop out, between you and the market or the

Asia Etrader z Q2 2013 z www.asiaetrading.com

Opinionwho’s & Analysis who

“Finding a clearer has become more of a challenge post-2008” broker you need to be on top of what’s been done real time. This goes back to one of the advantages of being in Asia. Here we are open after the US closes, which is essentially the close of the 24-hour cycle. So the Friday close in New York is the end of the trade week. We can therefore be on top of the issues before they appear in a final clearing statement, which comes out during our daytime, whereas if we were in the US that clearing statement would be coming through during the night. Getting that clearing statement correct is critical. Let’s say I didn’t catch a US$100,000 error loss before it lands on the clearing statement, that could dramatically impact reported performance and hence performance and management fees coming through for the next month. After all, a fund manager’s greatest asset is his track record.

administrators aren’t up to date, the software they use isn’t up to date. It’s nothing short of a nightmare for non-US managers trading the US markets. AE: What are some of the challenges using algorithms in Asia’s markets? PY: I’ve always been a global trader; so I don’t really see any specific challenges in Asia. As mentioned previously I see a significant advantage being based in Asia because of the timeframe. Asia is a perfect place for a 24-hour global macro-type strategy manager. As for the challenges in the actual Asia markets, it generally just relates to liquidity and managing some of the regulatory issues, such as the recent kneejerk reactions in Korea of regulators who really don’t understand markets. There is also a challenge with latency. We’ve chosen to not get caught up in that kind of race. Even our day-trading models work fine with latencies of more than a minute. AE: Do you buy vs build and what ratio of each do you engage in? PY: I recognised back in the 90’s that there were two sides to the business, development and deployment. The SystemWriters and Trade Stations I used in the 1990s were great for development, but not

AE: How has FATCA affected where you can raise money? PY: FATCA has created quite an inconvenience. Previously, if I had a hedge fund in the Cayman Islands, and I was trading in the US, then the fund itself would sign a W8 form indicating it was non-resident in the US and therefore exempt from tax for its investment and speculation in the markets. Under US tax law, speculation and normal portfolio interests are exempt from tax, which has made it a great market to trade in. However, with the new FATCA lookthrough provisions, we have to go down to each individual investor and ask them to sign a W8 declaration, and the fund needs to sign an agreement with the US Treasury. Investors outside the US, especially Chinese investors, could feel uncomfortable with this. For example, if my Cayman Island fund was primarily investing in China, and had a mandate for Chinese businesses, some of which are listed in the US, then we wouldn’t do that anymore. This means that some potential investment and trading in the US is not going to occur. The problem for me is that most of the derivatives trading is in the US, so it is an unavoidable inconvenience for me. The FATCA deadlines keep getting pushed back because the www.asiaetrading.com z Q2 2013 z Asia Etrader

“There’s a significant advantage being based in Asia because of the timeframe” for deployment. I had to build proprietary software back then for deployment, and it’s much the same today. Your proprietary deployment environment though generally isn’t going to provide you all the facilities you want for an iterative development process unless you’re looking at the very highend tools like Deltix, QuantDeveloper, AlgoLab or SmartQuant. The dark horse is Smart Quant, a very flexible product, and a powerful suite at a price that fits for a start-up manager. As Windows environments though, these products are not suitable for true HFT. AE: Does HFT improve market liquidity? PY: Yes, but I like to see a diversity of traders trading different timeframes in the market. A

Who’s Who

“...we’ve been pretty much building everything ourselves, but you still need a prototyping platform.”

diverse market is a resilient market. I’m not a fan of exchange’s maker-taker strategies. Although they tighten the spread while the market is hovering, when the market moves, the spread goes very wide because HFTs don’t want to take. In the US there are other strategies used to jump between the national bid and ask, and then slide back to the front of the queue, which allows HFTs to game other traders. We don’t want that in Asia. We don’t want exchanges pandering to HFTs, but we do want HFTs because we want a diverse market. Having the bulk of volume going through a certain type of trader does not make for the most resilient market. We want a diversity of participants. One of the proposals the trading association is championing in Hong

Kong is a day trading exemption on stamp duty in the cash equities market. Currently, there is virtually no day trading in the cash equities as it isn’t viable. Spreads are wide because nobody is making the market, which when you add in the stamp duty on top of a wide spread means the transaction costs are huge. A day trading exemption would bring in a new group of participants to provide liquidity and tighten spreads. With tighter spreads, higher timeframe traders will be motivated to rebalance their portfolios more, resulting in more effective portfolio management, and better tracking of index-linked funds, etc, as well as increasing stamp duty revenue. AE: Should short selling be banned? PY: Quite the opposite. Anything that restricts the ability of someone to short over the ability for someone to go long actually disrupts valuation and a fair and orderly market. We have that in Hong Kong, and it means many equities are not being properly valued. Also, from a market-making point of view, if a market maker has just supported the market by buying, underneath it, he needs to be able to place a sell order above the market, to offset his risk. If he can’t do that, he’s must run a wider spread. A wide spread means high transaction costs, and that translates all the way down to lower returns for the man on the street. This is what a lot of regulators don’t realize.

There are now various academic reports clearly demonstrating that through 2008, where short-selling was restricted on various exchanges, volatility was worse in them, and spreads were worse. The reason people pursue these types of options is either because of a lack of understanding, or because they see disruptive practices, carried on in the US, for example, where people have shorted stock naked. Sometimes these stocks have been sold beyond the physical inventory of the stock issued by the company. That is just fraudulent. You don’t create a regulation to ban everyone from short selling simply because someone’s committed fraud, you effectively police the fraud.

“One of the issues I find with circuit breakers is that some of the exchanges over-simplify by using percentage circuit breakers.”

AE: How should exchanges manage circuit breakers? PY: Last year a few friends and I set up a non-profit called the eTrading Association. We’ve been active with the FSC and Hong Kong Exchange (HKEx) on regulation and risk management. For Hong Kong, we want multi-level risk controls in the matching engine. Some exchanges are leading the charge with risk controls directly in the matching engine to allow high-frequency traders (HFTs) to limit their risk without latency. What is missing is a level over that, with a clearer. These controls would enable a HFT with direct market access to control risk by instrument, by delta, by P&L, and set risk across his portfolio. The clearer then can oversee that with a disaster level in relation to P&L. If the HKEx chooses to implement that, we see it would be a world leading solution that could propagate change through the industry. One of the issues I find with circuit breakers is that some of the exchanges over-simplify by using percentage circuit breakers. The problem with percentages is you need a different amount Asia Etrader z Q2 Q3 2013 z www.asiaetrading.com

who’s who

for each instrument, and you need to monitor and adjust it on an ongoing basis. I never use percentages in any of my algos as it percentage is a very unstable metric. Alternatively, a multiple of an average of the 10-day and 90-day truerange, would automatically adjust to the volatility of each instrument far better. That way you could have a circuit breaker that works across a broad number of instruments and is a lot less of a headache for an exchange to manage. Also, circuit breakers shouldn’t be published to prevent them being gamed. AE: What are the opportunities in China and India and why? PY: In relation to exchange-traded instruments, the opportunities in China are somewhat restricted. If you’re going to trade actively in China, you need to form a joint venture, and then if you want to get involved with automated trading, relatively highfrequency trading, there are issues with the way they’ve set up their engines, but it can be done. As for India, it’s been very active in pursuing volume and memberships, so much so that it’s come out the other side. SEBI recently put out a consultation paper on issues they are facing with co-location (colo). They seem concerned that over 90% of executions, depending on the market, are through colo, and they seem to think this is a problem because they have many brokers in the outlying areas who are behind the market. If your broker is in an outlying area, it shouldn’t matter. He should have a colo execution server, or he should have access to one through another broker. It is an HFT world. SEBI is suggesting they’ll do some type of round-robin matching, where they’ll match a trade from a colo and a trade from an away broker, which is ridiculous. It’s like setting the speed limit for all road users because those with horse and carriage can’t compete with those driving trucks. SEBI needs to recognise it is now fiduciary responsibility for a broker to have a proximity hosted execution server at least. AE: What other markets in Asia represent an opportunity and why? PY: There are lots of markets; The Philippines, Thailand, Malaysia. The Malaysian equities market has had a brilliant run for years. Everyone’s been complaining about the lacklustre performance of the Hong Kong market. You could have just gone and played in Malaysia. More of the exchanges are opening up data centres. The biggest problem that we have in the less advanced markets is obviously wide spreads and lack of liquidity. A lot of them don’t have exchange-traded options so

“If your broker is in an outlying area, it shouldn’t matter. He should have a colo execution system...”

you have to go to the OTC markets, when really they should be on an exchange. With the advent of these co-located servers, hopefully we’ll get some market makers in there and we will see some tighter spreads. Those markets are high volatility, which has allowed you to compensate for the wider spread. If those spreads can come down a bit, the opportunities will be enormous. The biggest issue is liquidity; we’ve seen that in Vietnam, which has in some ways become a bit of a basket case. Because so many people have wanted to dive into Vietnam, you’ve ended up with some equities trading in ridiculous multiples. AE: How do you test your algorithms so they don’t adversely impact the market PY: Your algos are always going to impact the market, the key is monitoring and testing the impact. We call it the Heisenberg Principle of markets. If you know your quantity, you don’t know the fill price, if you know the fill price, you don’t know the quantity. On a different note, regulators want less volatility in the market, but anyone trading a trend is going to increase volatility. A higher timeframe trader, such as a mutual fund manager, is going to increase the volatility of the market and have a significant impact on the market. The traders that decrease the volatility of the market are high-frequency traders making the bids and asks, and most importantly the stat-arb traders. If a large trader comes in looking to move a position the statarb will create a correlation ripple through the market. For example, if a large fund manager comes in to buy US$20 million of Bank of China, then stat-arb traders will start buying correlated instruments and start spreading it round through the whole industry while they are also selling back some of the Bank of China to the fund manager. But stat arb traders aren’t that big here in Hong Kong because of the stamp duty and spread issue.

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AE: What will electronic trading in Asia look like in 5-10 years time? PY: The biggest change in electronic trading globally will be the movement to real time clearing and settlement. That will propagate the biggest change in the finance industry in general, including banking. Most of the exchanges around the world, when the brokers send in the orders, they have a Broker ID coming up on the data feed, and most of the exchanges are also receiving client IDs. The obvious benefit of that is in relation to surveillance, which is something ASIC is very much on top of in Australia with the new system they’re working on with First Derivatives AlgoLab. In Hong Kong, they don’t have Client IDs coming through. This is something the eTrading Association is pushing to the exchange. The benefit of Client IDs goes beyond surveillance; it goes to real time clearing and settlement. If trader A has sold to trader B, and the symbols for A and B are know at execution, those trades can be matched in real time. At the moment we’ve got a front office, middle office and back office. With the movement towards electronic trading there’s been an enormous cost saving in the front office, and that’s great, but we need to start making savings in the middle office and

“A lot of them don’t have exchange-traded options so you have to go to the OTC markets, when really they should be on an exchange...”

back office. By moving to real time clearing and settlement we can basically delete the middle office. That’s a big change. The move towards real time matching is the simple part, but settlement comes down to custodial issues, and because there are a lot of entrenched processes, that will take many years. The endgame is very exciting to contemplate though. Imaging holding an ATM card in your wallet with immediate deposit and withdrawal ability on your mutual funds. This will change the face of banking.

poll

What does best execution mean in a dark pool?

est execution is by no means a new concept. Licensed representatives of financial firms have a fiduciary responsibility to act in the best interest of the client as any prudent person would act on behalf of themselves. Dark pools or off exchange trading has been around for thousands of years since the advent of barter where a bilateral trade is conducted anonymously and at an agreed upon price. Modern technology and financial regulations have accelerated the proliferation of dark pools and driven a desire for more granular definition and expectation around best execution in these types of venues. From the results of our opinion poll it is clear that there are a few items one expects to encompass best execution in off exchange

trading. The most important item appears to be “No information leakage between desks (17.24%)”. Anonymity is the key here. You don’t want word going round that a big order to buy XYZ is going to hit the market. Scalpers will bid up the price ahead of you and sell it back at a higher price. Next was knowing why your broker sends orders to a pool (13.79%). Brokers may just try to cross orders internally to provide liquidity to its other desks or meet other commission requirements reasons that don’t necessarily have the client at heart. No one likes to be gamed in a dark pool. Not only will it hurt the reputation of the venue and see its large liquid long only clients trade elsewhere it will undermine participant use and be negatively viewed by the retail

community. Utilising sophisticated anti-gaming logic (10.34%) was on the list of the buy-side requirements for dark pools. Some buy-sides don’t like to trade against other algo driven buy-sides for fear that they are not getting the best price or they may be trying to gauge how much size they could potentially be putting into the market then get ahead of that order. That is why knowing where your broker will send your order (6.9%) came up on the list of best execution in a darkpool. Of course, all of the above (51.72%) was the clear cut response for the industry. If you are planning to offer a darkpool or improve your current offering it may help to examine if all four points mentioned above are covered and truly offer best execution.

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

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poll

Best execution in dark pools Dark pools can be vital sources of liquidity for buy-side firms, but to achieve best execution in broker dark pools, asset managers must ensure that they understand the pool’s characteristics and have the right feedback in place to monitor routing. With end investors demanding greater levels of transparency, best execution requires process and diligence. Jonathan Brunello and Kim Man Li of Bank of America Merrill Lynch’s Asia Pacific global execution services team answer the hard questions. Q: How do you talk to clients about dark pools in Asia? Kim: We try to educate clients as to which alternative liquidity venues they should interact with and how. Our experience with our pool, INSTINCT X, has been favourable in that there are more advantages than disadvantages when interacting with all of the different available liquidity. We advise clients to connect to as many of the venues as possible and use that as an opportunity to understand the depth/breadth of liquidity that is on offer at each venue, how it is made up and to quantify how it benefits them. Q: What are the advantages of trading in dark pools? Kim: It is easier to execute off-exchange without impacting the price. The anonymity and liquidity that can exist in a dark pool are the primary drivers. That said, Asia is slightly different to other regions. All trades on dark pools here still get printed in real time on the exchange. So while the matching process is handled offexchange it is not quite as invisible or dark as it could be in the US and Europe. Q: As a client, how will you be sure where your order was executed? Jonathan: Fix Protocol Limited (FPL) did everyone a huge favour by making the execution destination available via FIX tags. It is incumbent on the sell-side to push the FIX tags back to client vendor systems, and on the client base to demand them from their vendors. If clients do not demand it, brokers don’t provide it, and vendors do not support it, there is a risk that orders are being routed and onwards routed to venues of which the client is not aware. Q: How is transaction cost analysis (TCA) evolving with execution in dark pools? Jonathan: TCA is moving beyond the measurement of execution performance versus

Jonathan Brunello

Kim Man Li

benchmark or benchmarks. It is now at a point where clients are working with their execution partners to understand the factors that contribute to outperformance/underperformance versus a benchmark. More recently, we see a greater focus upon non-lit venue execution, and how this positively or negatively contributes to an execution outcome.

Q: What is best practice for achieving best execution in dark pools? Jonathan: It is really an extension of what the buy side and sell side already do. Firstly, both buy side and sell side should have real time transparency of where orders are being executed. Second, would be instilling a discipline of periodic post-trade execution analysis identifying multi period trends like excessive fill rates in dark pools, or sub optimal executions in dark pools based upon order momentum. Finally, ongoing collaboration between the buy side and the sell side on optimising execution performance is critical. We find that an increasing amount of our time is spent in this space – the client feedback loop is critical to ongoing development of our product.

Q: Where should clients expect technology to help, when it comes to dark pools? Jonathan: Everywhere really, be it their EMS providing real time data to the trader, their TCA partner helping shine the light on areas of focus, or their sell side partners continually investing in SOR technology. Technology cuts across everything we do that benefits our clients, especially in terms of access, execution and risk mitigation. Kim: Some technology work is embedded in the pool itself. Anti-gaming logic is important; a pool does not have to cross. If the logic in the pool believes that the price is a fair price then its anti-gaming logic should hold true. It should have the ability technology wise to limit executions of a certain size with minimum cross limits. The pool should understand what is or is not a fair price depending upon movements.

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When one thinks of best execution in dark pools, it is essential to look at factors beyond those offered within a standard post trade analytic report. Selecting an optimal execution strategy, understanding how each strategy interacts with the various execution venues, and what sources of liquidity make up the venues, are key to not only unlocking the value of dark pools, but also avoiding the potential hazards which exist.

opinion

HFT Concerns Are Overstated An ASIC investigation finds that commonly held negative perceptions about high-frequency trading are not supported by an analysis of Australian markets. But not everyone is convinced that HFT is benign. • The average holding period of securities traded by high-frequency traders was approximately 42 minutes. However, ASIC was concerned that excessive messaging noise and the bombardment of small orders was damaging investor confidence. Therefore, ASIC is proposing to introduce a minimum resting time of 500 milliseconds for orders below $500.

ASIC on dark liquidity in Australia

n March the Australian Securities and Investments Commission (ASIC) released the findings of its dark liquidity and high-frequency trading taskforces. The report, “Dark liquidity and high frequency trading,” was no doubt well received by high-frequency traders themselves and brokers. But the ASIC findings may raise some eyebrows from within the domestic Australian Funds Management community. Australian brokers spent a lot of their time in 2012 answering client surveys, with typical questions concerning: • How they routed their order flow? • Did they broker to HFT? • Did they run their own HFT models? • How did their dark pools work? • When did their Prop books become involved in their dark pools? Indeed, one local industry body, the Industry Super Network (ISN), has been very vocal in expressing its concerns about HFT. In its February 2013 Research Report, “Toward A Fairer and More Efficient Share Market,” ISN stated that the current Australian market structure facilitates “high frequency trading, and is resulting in wealth being redistributed from investors like superannuation funds to certain classes of traders.” ISN claims that a solution to this perceived problem is straightforward and suggests that the introduction of frequent call auctions during the trading day is required. However, the ASIC investigation finds that “some of the commonly held negative perceptions about high-frequency trading are not supported by our analysis of Australian markets.” ASIC reports that HFT is not a key driver of price formation and does not exacerbate market instability. Furthermore, ASIC finds that exchange co-location services are not inherently unfair.

Key ASIC findings on HFT in Australia • High-frequency traders accounted for 27% of total turnover in S&P/ASX 200 securities. • The 10 largest high-frequency traders were responsible for approximately 60% of all high-frequency trading turnover.

ASIC mentions “safety” as one of the reasons fundamental investors cite when explaining why they execute in the dark — e.g., so that these investors can avoid the perceived predatory and unfair trading activity of HFT on lit exchange markets. There are currently 20 crossing systems registered with ASIC (up from 5 in 2009). There is a high degree of principal trading in crossing systems (it can be as high as $1 in every $3 on some systems). But overall, ASIC finds that operations are generally fair. Nevertheless, ASIC is recommending that broker crossing systems should: • Have transparent procedures • Make disclosures about the user’s obligations • Monitor and report trading misconduct to ASIC • Not unfairly discriminate between users • Give clients an opt out clause These new ASIC requirements fall short of what the Australian Securities Exchange (ASX) is suggesting to the Australian Treasury. In its February 2013 submission, “Australia’s Financial Market Licensing Regime: Addressing Market Evolution,” the ASX urges Treasury that there “is no policy basis to have a different licensing model and set of regulatory controls for lit and dark venues offering broadly similar execution services.” The ASX makes specific reference to its Centre Point product, which it says is subjected to a significantly “different regulatory regime to other dark order books that are operated by brokers.” Centre Point is the ASX anonymous midpoint matching service and has been a runaway success for Australia’s incumbent exchange. In fact, ASIC references Centre Point as the “largest dark venue in the Australian market.” In recent weeks Centre Point has twice exceeded 5% of ASX traded volumes. However, some brokers bemoan the ASX Centre Point trading fee. ASX charges brokers a .15 bps trading fee for a normal trade but a .50 bps fee for a Centre Point trade.

New block trade thresholds Perhaps the most interesting structural change to the Australian equity market microstructure is the block trade thresholds that were revamped on May 26, 2013. In Australia (unlike some other jurisdictions) brokers can report “block” trades that can be outside of the existing NBBO. For more than 20 years, the threshold has been AUD$1 million. But the new tiered thresholds will be $1 million, $500k and only $200k for the majority of listed equity securities. This is an exciting development for brokers, but it may result in a spike in off-exchange blocks, to the detriment of the lit book. David Stocken is a broker with BGC Securities in Sydney. He specializes in Equity Derivatives strategy and Technical Analysis. Asia Etrader z Q3 2013 z www.asiaetrading.com

word on the street

WORD on the street How should exchange circuit breakers be managed? Gabriel Butler, Executive Director Morgan Stanley Electronic Trading

Brokers expend a lot of time, energy and resources ensuring that their order flow to exchanges is consistent with an orderly market. While the big brokers have converged to a robust methodology to do so, exchanges still handle their duty to maintain an orderly market in very different ways. It is heartening to see more exchanges like the SGX embrace methods to safeguard the markets along with existing approaches used by exchanges in Japan, Taiwan and Korea. Regulators have an important role in fostering and encouraging exchanges to protect markets from abnormal swings.

Mr Loh Hoon Sun, Managing Director, Phillip Securities Pte Ltd

xchange circuit breakers are good measures and have been practised by major stock and futures exchanges. During hectic trading sessions, incomplete or inaccurate news can result in high price volatility, and the circuit breaker would be useful for maintaining market orderliness and preventing loss of investor confidence, especially in todayís environment of rising algorithmic trading activities. Any cooling off period due to the trigger of the circuit breaker should be long enough to allow market participants to re-assess the situation, yet not too long to disrupt trading activities.

M. Benoit Deckmyn, Global Product Manager, Horizon Software

ith the recent issues in mind, the reduction of operational risks induced by systematic trading has become one of the top priorities for market participants and exchanges. Exchange implementation of industry wide circuit breakers provides part of the solution but that’s not enough. Lag monitoring triggers the market connectivity disconnection (and order removal by the exchange) when a certain number of checks with a negative feedback happens in a short period of time. Order pattern detection will prevent price drifts or abnormal order throughput by blocking all orders sent by the detected abnormal sources.”

Phil Joslin, Futures Industry Executive

xchange circuit breakers are going to increase in importance as investors will also choose exchanges according to their risk profiles. I believe all parts of the business need to be involved but that circuit breakers are the back bone to creating a safe trading environment. Probably the most important part is a break in trading and to open with an auction. This allows participants to re-evaluate their positions and indeed the current trading price. When I was a broker I realised this was a very effective way of ‘cooling’ a market. So members of the markets need to decide on what is a suitable level in percentage terms for the breaks and different for each product and market.

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equities

Rebalancing act The inclusion of Chinese A-Shares in the MSCI Emerging Market Index will need firms to rebalance their portfolios. By Stephen Price

hen equity index provider MSCI announced amendments to its indices on 11 June, most eyes were on countries that had been demoted or promoted. Also in the statement, however, was a pronouncement on formal consideration of China’s A-share market for inclusion in MSCI’s Emerging Markets Index. That foreshadows what could be the biggest change to the benchmark since its inception in 1989. While it is very unlikely to come in the form of a big bang, the process of inclusion, and the investment challenges and opportunities that an upgrade would create now look likely to happen more quickly than many observers had anticipated. “It’s going to alter the landscape of emerging market investors, the way they operate and invest, the way they function,” said Chin-Ping Chia, managing director and head of Asia Pacific Research, MSCI. “The level of market understanding and expertise investors need to accrue and start building up for that process is humungous.”

MSCI has been in talks with China’s regulators for the past 12 months, and it is not the only index compiler to set its sights on the massive A-share market. FTSE is currently engaging Chinese authorities, and at the end of May STOXX released the China A-50 Equal Weight Index, which represents the components of the recently launched STOXX China A-50 Index.

Stepping on the gas Though China already meets liquidity and market size criteria for a greater weighting in MSCI’s Emerging Market Index, capital mobility restrictions, strict regulation of foreign investors, and unclear taxation rules for offshore participants, not to mention limited renminbi convertibility, form formidable barriers, but barriers that the country’s regulators are relaxing at a quickening pace. Introduced in 2002, China’s Qualified Foreign Institutional Investor (QFII) program grants licenses and fund quotas to foreign investors who meet stringent criteria. In 2011,

RQFII (Renminbi Qualified Foreign Institutional Investors) permits were launched, which allow holders to use renminbi funds raised in Hong Kong to invest in the A-share market. In April 2012, the QFII quota was raised to US$80 billion from US$30 billion. As of end-May 2013, 225 QFII licenses had been granted, and 202 quotas totaling $42.5 billion allocated. In 2010, 13 QFII licenses were handed out, which increased to 29 in 2011 and 72 in 2012. By the end of 2012, foreign investment accounted for 1% of China’s A-share market, whose capitalisation at end-May was some US$3.7 trillion, according to the China Securities Regulatory Commission. Beijing has said it aims to increase foreign investment to 16% of market capitalisation.

Best-case scenario If restrictions on foreign investors were abolished, and opaque tax rules made clear, MSCI estimates that the A-share market could, in the most extreme hypothetical outcome, comprise 14% of its Emerging Markets Index,

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equities

which combined with the currently accessible MSCI China Index, mainly composed of H-shares listed in Hong Kong, would account for some 30% of the benchmark. And as China’s economy expands, that weighting would likely increase. MSCI says about US$1.4 trillion is benchmarked to its Emerging Market Index, and inclusion would lead to a large increase of foreign funds flowing into China. “After inclusion, many international institutions would have to add A-shares to their portfolios,” says Wang Zilong, Greater China strategist at Phillips Futures. “Naturally, the demand for hedging via futures would increase. And some of those without a QFII quota might use A50 Index futures to reproduce the performance of A-shares.” Such a huge shift in China’s weighting could present problems for market neutral investors, who would need to rebalance their portfolios, or risk becoming significantly underweight. And as the MSCI Emerging Markets Index is used by a wide range of investors and money managers, emerging market ETFs, index funds, and index-linked derivative contracts, the effects of China’s inclusion would be farreaching, not least for the markets that would see their weighting decrease.

On the home stretch? The three key challenges facing investors in China that are cited by MSCI are the disparity between the size of the quotas allocated to QFII and investors’ requirements, restrictions on fund flows, and QFII taxation. “If you think about an investor managing a global portfolio, even with a hypothetical 5-10% China A-share weighting, then the investor would need to be able to have sufficient quota to capture that weight in their portfolio,” said Chia. “If they are very big investors, and you give them a quota of US$100 million or US$150 million, they are not going to be able to gain the right amount of exposure.” Speaking at the Asian Financial Forum in January, then-China Securities Regulatory Commission Chairman Guo Shuqing raised eyebrows when he said that QFII and RQFII quotas could be increased ten fold in the near term. “Once you get your QFII quota, you need to remit your money into China within six months. Once you start investing, you will be subject to a lock-up period of about three months to a year,” said Chia. “If you are a long-term investor, that’s not a problem. But let’s say you are a mutual fund or an ETF provider, your investors need to redeem shares, and you need to deal with that liquidity. Because of all these capital

Chin-Ping Chia managing director head of Asia Pacific Research

MSCI

“The level of market understanding and expertise investors need to accrue and start building up for that process is humungous.”

mobility restrictions, you are not able to run those investment vehicles effectively.” Meanwhile, debate about taxation of QFII has dragged on for a decade, focusing on collection, whether tax rules should be applied retroactively, and the tax threshold, which has prompted some investors to stay on the sidelines. “The issue has not been clarified. Some investors are conservative, and from a risk management perspective, this lack of clarity is going to make them uncomfortable,” said Chia. “They will see this as a risk issue.” Though restrictions are being relaxed at a faster clip than before, Beijing could slam on the brakes with little notice.

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“I’m cautious,” said Singapore-based Bill Herder, executive director of industry association FIA Asia. “A lot depends on China’s internal issues, and that’s the speed they open up. If there’s any sort of impetus, or catalyst internally, to force them to open up, I think they’ll do it. They’re in a good position because they could open up very quickly if they want to, but they’re not going to open up for the benefit of the rest of the world, and nor should they. It’s not that long ago that they weren’t open at all.” And besides the question of how fast China’s ruling elite will continue to liberalize the country’s financial markets, concerns are being raised about the health and stability of the country’s financial system. In a report released mid June, Fitch Ratings warns of the danger of a Chinese banking crisis because of the country’s unprecedented level of credit, which it estimates at US$23 trillion. Among the issues Fitch raises is China’s shadow banking system, which it says now provides a third of the country’s loans, and escalating debt. “The one thing I hear, especially in Hong Kong, is that people don’t believe the news coming out of China,” said Herder. “They don’t believe the growth; they don’t believe the transparency. Is this a house of cards? Or is it smoke and mirrors? Those are the big questions.” But despite such caveats, investors appear eager to listen to China’s growth story. A good indication of interest in China’s A-share market is the popularity and proliferation of related offshore products, such as Singapore Exchange’s FTSE China A50 Index Futures, which are predominantly used to hedge exposure to Shenzhen- and Shanghai-listed companies, take advantage of arbitrage opportunities across indices, or conveniently gain exposure to the A-share market. Recently there’s been a spike in new China-focused derivatives, including Hong Kong Exchange’s A-share ETF futures, and CES China 120 Index futures (See story on Page 14), and from January through March, six new China A-share funds were brought to the market in key Asian countries. But when China’s A-share market opens further, foreign investors who haven’t prepared could find themselves disadvantaged. “You will not be able to wake up tomorrow and say, ‘now I want to invest in the A-share market’; you can’t go in like that,” said Chia. “If you want direct access, you need to start putting in applications, and apply for a QFII license, and then get your QFII quota, line up your custodian, select your brokers, and those processes take time.”

fragmentation

Fragmentation Footprint Q2 2013 Japan It has been an exciting and volatile ride in Japan for the last six months fueled by Abenomics. The market has been in need of a jolt, as it has been oversold for so long. In this environment, the primary market gains market share in volatile markets from the PTSs. Granted all venues in Japan saw notional increase but when trading Japan most prefer the JPX (TSE/OSE). This will be the last time that the OSE will be mentioned in the Fragmentation Footprint as the merger of the markets is expected to be finished July 2013 which will leave the JPX with around 95% of market share. The TSE held 88% averaging US$705.8 billion during Q2 and the OSE 7% averaging US$51.1 billion at the end of June according to Thomson Reuters Equity Market Share Reporter. Market share for the PTSs peaked last December with SBIJ at 4.5% and Chi-X at 2.73%. The OSE held just 4.4% though its low was 3.74% back in August. Evidently, the OSE has been the biggest beneficiary of market share under the current market volatility seeing a return of domestic trading participants who might not be otherwise tapped into PTS trading. Notional turnover in Japan’s display order books exceeded US$2.38 trillion averaging US$794 billion per month in Q2. May was the peak month for all four venues achieving in aggregate US$949.8 billion in turnover. May was also the lowest market share earned by both the PTSs with SBIJ trading just over US$26 billion yielding just 2.74% a level not seen since March 2012. Chi-X held just 1.72% on US$16.34 billion. The last month of the quarter, June, saw volatility and volume slide where the TSE saw its market share erode to its lowest level ever at 88.09% of display notional. Market share comparison does not include the TSE/ OSE opening auction data. Average trades size at the PTS continued lower indicating algo driven trading with Chi-X realizing trades worth US$5,276 each (down 11.34% YoY) and SBIJ slightly smaller at US$5,038 (down -16.83%). Conversely, both the TSE and OSE saw average trade size increase YoY by 7.83% to US 17,769 and a whopping 53.21% to US$10,357 on the OSE. QoQ however, saw average trade size decrease on the TSE (-3.2%) and SBIJ (-5.56%) but increase on the OSE (37.45%) and Chi-X (12.61%). This indicates that more buy algo-driven trading was taking place on the TSE and SBIJ and less on the OSE and Chi-X. For the week ending June 29 SBIJ reported that average price improvement was 6.93bps. PI has been steadily declining from just over 10bps in midNovember last year to its present level though it did tick up to nearly 8bps in May the month with the greatest notional turnover. On May 27th SBIJ launched JNX Cross where participants can cross orders before the primary exchange regular trading session. These orders will be filled at VWAP after market close. Worth mentioning, though not included in market share calculations is the SBIJ night session. Despite having only been live for less than a year and not really gaining much traction, trading soared to achieve a record in May of US$600 million. It remains to be seen if the night session can continue to attract liquidity. This data was provided by SBIJ June report. There was no indication of spreads or price improvement but we suspect that there was nothing positive to report. Chi-X reported for the month of June PI of 5.75bps. Like SBIJ, PI has been declining since October 2012 where it peaked just under 10bps. Its top 5 securities by market share are much different than SBIJ as has been the case since we start the watching the PTS flow. However, its largest securities by turnover do appear on the SBIJ ranks but the market share is much lower. These venues continue to attract different investors.

ChiJ Top 5 Securities By Market Share*

Code Name

Market Share

Avg PI (bps)

8227

SHIMAMURA

13.80%

2.2

4088

AIR WATER

12.30%

3.5

4041

NIPPON SODA

10.40%

3.9

7276

KOITO MFG

10.20%

5.1

4042

TOSOH

9.80%

8.8

SBIJ Top 5 Securities By Market Share*

Code Name

Market Share

Avg PI (bps)

7203

TOYOTA

6.62%

5.69

9984

SOFTBANK

5.91%

5.24

8306

MUFG

5.39%

5.71

8401

MIZUHO

6.42%

23.51

8316

SMFG

5.19%

3.39

* Week of 24 June, 2013

Australia Chi-X Australia continues to capture market share from the primary, achieving more than 8.5% on US$7.3 billion in May and a record 9.11% on just US$6.1 billion in June according to Thomson Reuters Equity Market Share Reporter. Price improvement on the venue, according to a Chi-X report, was 31.22bps with 31.69% of trades realising PI for the week ending June 28. The Chi-X report went on to say that Off-Market and On-Market trading resulted in average daily values of AUS$168.7 million and AUS$436.2 million, respectively. Q2 average trade size was just US$2,578 of 740 shares. BHP, ANZ and WBC are familiar names consistently appearing in the top five by market value though not market share. TOX saw 47.37% of market share, AJA 30.83% and RMD 27.83% rounding out the top three in terms of market share leaders. Turning to Centre Point, ASX’s non-display venue, it continued to grow in volume in May to another record. This data was provided by ASX which did not have the June info at the time of writing. AUS$4.3bn value traded that month representing 4.8% of on-market trading according to the exchange. It further went on to say that AUS$154 million of price improvement was generated to the industry. Taking a look at the average trade size for brokers on the venue we can see that values range from US$2,000 – US$4,000. Though not on the graph, Instinet continues to Chi-X Australia Top 5 Securities By Value

Market Share

Avg PI (bps)

BHP

Code Name 151.82

9.47%

2.94

TLS

119.71

14.57%

15.04

ANZ

112.55

10.30%

3.14

NAB

88.36

9.97%

3.19

WBC

82.60

8.68%

3.32

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fragmentation

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fragmentation

have the smallest at just US$674. Credit Suisse displays the most volatile average trade sizes, UBS remains the number one broker in terms of notional traded though Deutsche Securities had an impressive 38.7% growth from April to May on Centre Point to challenge a close second. During the quarter the regulator ASIC saw two updates on its Market Integrity Rules become effective 26 May 2013 regarding block trading (Rule 4.2.1) and trades that improve price (Rule 4.2.3) each bringing change to Australia’s developing market structure. Rule 4.2.1 introduces tier thresholds for blocks that replaced the traditional AUS$1 million block trade threshold introducing three thresholds based on type of name traded. The tiers allow for a trade to be executed without pre-trade transparency where the notional is not less than the following: • Tier 1 - AUS$1 million or more • Tier 2 - AUS$500,000 or more • Tier 3 - AUS$200,000 or more For Rule 4.2.3 Price Improvement replaces the ‘at or within the spread’ exception and occurs only where the order is sent with a price at the time of the trade where: • at a price step that is both above the best available bid and below the best available offer or • at the midpoint of the best available bid and best available offer where the midpoint is the average price of the spread.

Centre Point Top 5 By Value

Firm

Value AVG Trade (A$ Million) Size A$

UBS

1,245

3,470

Deutsche Securities

1,143

2,103

Morgan Stanley

673

2,507

Getco

661

2,715

Citigroup

544

3,616

Centre Point Top 5 By Trades

Firm Trades

AVG Trade Size A$

Instinet

608,543

674

Deutsche Securities

543,429

2,103

UBS

358,836

3,470

Morgan Stanley

268,466

2,507

Getco

243,466

2,715

*Centre Point data for May 2013

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413,573,947

2,598,861,379

347,289,355,232

37,806,652,741

263,680,633,297

119,437,710,725

45,201,084,601

3,035,917,604

115,266,930,280

155,433,389,199

15,548,357,081

73,937,088,699

770,305,220,383

832,251,554,759

156,059,704,268

173,114,453,224

2,222,958,920,519 851,178,802,402

5,597,587,369,496 3,547,586,937,764 2,050,000,431,732

Hanoi SE

Hochiminh

HKEx

IDX

KRX

KOSDAQ

BMB

NZX

NSE

OSE

PSE

SGX

SSE

SZSE

TWSE

SET

TSE

Total

4,563

596

1,185

ASX

BSE

Hanoi SE

Hochiminh

13,733

3,610

3,250

1,271

5,957

12,300

1,316

10,357

7,971

9,733

3,196

8,698

14,178

5,552

17,769

HKEx

IDX

KRX

KOSDAQ

BMB

NZX

NSE

OSE

PSE

SGX

SSE

SZSE

TWSE

SET

TSE

3,166

Q1 2013 (USD)

Average Trade Size

51.46%

30.30%

-15.61%

-51.14%

-4.81%

1.99%

1,371,780,118,117

122,401,036,968

6,515,055,385

215,862,013,090

44,749,959,108

21,289,366,841

5,377,114,601

117,119,673,702

1,580,756,413

978,419,495

17,144,265,958

27,081,064,342

16,478

5,146

14,589

7,400

2,918

9,920

7,525

6,760

1,236

9,612

6,397

914

3,196

3,291

13,462

2,974

1,144

526

5,927

Q1 2012 (USD)

1,290

406

-411

1,299

278

-186

446

3,597

2,688

-440

357

318

270

192

-1,364

Change

276,876,207,200

788,797,904,230

138,956,860,100

529,051,896,175

605,392,793,579

161,031,191,298

148,741,255,177

14,509,850,651

35,313,746,056

1,178,899,627

87,557,206,800

28,236,834,174

23,100,816,244

289,879,251,832

548,326,406,958

3,362,434,920

1,075,522,000

10,660,626,303

89,733,686,068

110,462,739,011

220,232,428,030

109,923,984,900

401,902,310,712

528,859,407,984

123,181,579,688

148,199,551,759

4,313,111,496

36,822,508,988

808,718,126

57,813,822,500

33,468,690,142

30,425,186,052

201,062,200,514

413,554,820,523

4,332,314,680

1,750,833,200

12,227,153,638

105,765,532,752

% Change

166,413,468,189 150.65%

568,565,476,200 258.17%

29,032,875,200 26.41%

127,149,585,463 31.64%

76,533,385,595 14.47%

37,849,611,610 30.73%

541,703,418 0.37%

10,196,739,155 236.41%

-1,508,762,932 -4.10%

370,181,501 45.77%

29,743,384,300 51.45%

-5,231,855,968 -15.63%

-7,324,369,808 -24.07%

88,817,051,318 44.17%

134,771,586,435 32.59%

-969,879,760 -22.39%

-675,311,200 -38.57%

-1,566,527,335 -12.81%

-16,031,846,684 -15.16%

Q2 2012 Net 39,858,659 44,511,363 739,611 1,035,435 19,797,753 7,584,577 81,912,074 100,996,813 4,385,721 214,053 91,963,608 5,667,820 1,351,664 5,307,405 248,670,982 83,299,703 10,250,833 9,854,602 51,654,083

52,804,575 37,415,758 348,967 820,837 25,288,895 10,474,077 81,132,790 93,957,011 7,587,695 246,830 87,599,233 15,008,290 1,950,711 7,596,390 241,004,928 95,678,005 11,007,293 31,182,139 125,104,328

32.48%

% Change

38.10%

27.74%

15.31%

73.01%

43.13%

44.32%

164.80%

73,450,245

21,327,537

756,460

12,378,302

142.20%

216.42%

7.38%

14.86%

-7,666,054 -3.08%

2,288,985

599,047

9,340,470

-4,364,375 -4.75%

32,777

3,201,974

-7,039,802 -6.97%

-779,284 -0.95%

2,889,500

5,491,142

-214,598 -20.73%

-390,644 -52.82%

-7,095,605 -15.94%

12,945,916

Q2 2012 Net

Q2 2013

Share Volume Number Trades Number Trades

Shares Q1 2013

7.83% 2,213

7.88% 25,296

-2.82% 12,624

17.55% 5,530

9.54% 2,512

-1.88% 21,198

5.92% 76,250

53.21% 967

6.44% 403

27.96% 4,776

-6.88% 11,539

39.01% 301

1.67% 285

9.67% 27,676

2.01% 21,682

6.45% 4,096

3.55% 3,082

13.24% 285

-23.01% 1,699

% Change

Average Trade Size

2,139

22,348

10,723

4,825

2,127

23,209

109,642

761

400

3,778

13,182

331

371

26,509

20,889

4,184

2,367

275

2,654

Shares Q1 2012

Average Trade Size % Change

75 3.49%

2,948 13.19%

1,901 17.72%

705 14.61%

385 18.11%

-2,011 -8.66%

-33,393 -30.46%

206 27.04%

3 0.68%

998 26.42%

-1,643 -12.46%

-31 -9.31%

-87 -23.34%

1,167 4.40%

794 3.80%

-88 -2.10%

715 30.19%

10 3.72%

-954 -35.96%

Change

57.79% 3,781,783,389,392 2,545,106,894,695 1,236,676,494,697 48.59% 926,208,752 809,056,759 117,151,993 14.48%

161.16%

241.36%

4.36%

35.02%

6.17%

40.44%

52.87%

305.69%

1.39%

47.55%

61.11%

29.32%

1,850,546,950 0.71%

12,844,784,780

80,763,433,850

-480,901,252

-432,881,245

-1,127,267,118

4,703,871,747

Average Trade Size

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

Exchange

22,307,563,864

BSE

240,940,397,694

ASX

Share Volume

% Change Q2 2013

Q2 2013 (USD)

Q2 2012 (USD) Net

Value Share Trading Value Share Trading

Exchange

equities

Equity Trading Recap

Source: Thomson Reuters Equity Market Share Reporter

equities

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equities

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post-trade

Sebi chairman Upendra Kumar Sinha

An expensive efficiency India moves closer to T+1 but savings from efficiency will not be passed on to investors. By Lynn Strongin Dodds

he move to T+1 settlement in India may cause shortterm pain but it will prove invaluable in the long term, say market participants. First mooted in 2002, the road to T+1 settlement has definitely been long and winding but the Securities and Exchange Board of India (Sebi) is hoping to turn the idea into a reality in the next two years. However, while many in the industry applaud the move some, especially those in the retail brokerage sector, are concerned about the operational and technical upheavals that will be incurred. The regulator, which issued a discussion paper in April, is currently canvassing industry opinion. The arguments are the same as in 2002 when then finance minister, Jaswant Singh, stated in Parliament, that”... market risk management becomes far more efficacious at shorter settlement cycle. There is need, therefore, to move to T+1 rolling settlement from the existing T+3.” The markets have been inching towards the goal although events of the past five years have moved the subject to centre stage. As Sebi noted in its discussion paper, “the financial crisis of 2008 has bought into focus the risks prevalent in the system, the magnitude of which also relates to the length of the settlement cycle. A shortened settlement cycle lessens the risks as well as frees up the capital required to collateralise that risk.” The general view is that the move to T+1 will also benefit investors who are not be able to arrange funds immediately to buy shares and who depend on their brokers to post margins for the purchase. Under the T+2 scenario, once the shares are credited to an investor’s account, he or she sells them for a higher price and repays the broker the margin along with interest, which normally ranges between an annualised 12% and 18%. The broker currently charges interest to such investors over a period of two days.

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post-trade

“While a shortened timeframe will improve efficiency and activity, there will be heavy cost burdens because processes will have to be completely re-engineered.” - Santanu Syam, Angel Broking

Modernisation will not save money In addition, the regulator said a shortened settlement cycle would reduce the number of outstanding unsettled trades at any given time, thereby decreasing the unsettled exposure to a clearing corporation by 50%. The window for counterparty’s insolvency to impact the settlement of a trade will also narrow. “The main drivers behind T+1 is to make the market as transparent as possible and to incorporate international best practice,” says Aditya Damani, director at Indian based K.M.Global Financial Services. “It should also modernise the process. At the moment, most of the payments to brokers are paid with cheques and a great deal of the transfer of shares is done manually. However, under the new system, everyone will have to become more sophisticated. “ The one thing that is unlikely to change is the cost of trading, according to Damani, “I do not expect to see it decrease because there will still be government taxes, stock exchanges fees and stamp duty. Changing the timing of settlement will not alter that.” Fellow broker, Yogesh Mehta at Motilal Oswal, concurs adding that the “the cost of trading will not come down because of the taxes as well as value added services that brokers provide. The main advantage of T+1 is that the processes will become more automated which should reduce the manual hours and the number of cheques

that are used to pay the brokers. This will add an extra layer of comfort in terms of safety and security. In time, it should also increase the number of customers to stock trading which in turn will improve the revenue stream of market participants and stock exchanges.” A deeper client base and liquidity pool would be a welcome boost for India’s brokerage community which has over the past few years been battered by a lacklustre market, changing technology and global competition. In fact, industry reports show that companies such as CLSA, Morgan Stanley, Merrill Lynch, JP Morgan and Credit Suisse have almost 70% of the market and have continued to extend their dominance despite the volatile conditions.

What price efficiency? Although there are many advantages, Santanu Syam of Indian based Angel Broking, believes that the operational challenges should not be underestimated. “While a shortened timeframe will improve efficiency and activity, there will be heavy cost burdens because processes will have to be completely re-engineered. It will also take time to implement these changes.”

“The main drivers behind T+1 is to make the market as transparent as possible and to incorporate international best practice.” - Aditya Damani, director, K.M.Global Financial Services

Syam is not alone in his views. Market participants on the retail side are also concerned about the cost of complying with a new settlement timeframe. For example, now the brokerage house has a one day cushion

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to stump up the cash for margin cover. If the new world settlement order is implemented than the firm will have to arrange for funds to be transferred overnight which could prove difficult. This might entail hiring additional staff to work the two shifts needed to ensure that the procedure runs smoothly and effectively. Institutional investors will also not escape unscathed. The custodians and banks catering to their requirements may have to upgrade their back office systems in order or them to be T+1 ready. Post trade processes that are still mainly conducted by paper, fax and phone calls will have to streamlined and manual processes automated. This could range from moving to real-time from batch overnight transmission of execution trade data to installing same day settlement affirmation mechanisms. Custodians will also have to manage and confirm trades with international investors who are scattered throughout different time zones. The UK may be only four and an half hours behind Mumbai, but the US is ten hours. Today an asset manager can perform all post-trade/ pre-settlement activities the day after trade date without difficulty. However a move to T+1 would mean that these functions may have to be performed outside of business hours and this could make it difficult for foreign investors to meet the new requirements. While there is no doubt that meeting the shortened settlement requirements will be costly and challenging. However, few believe the clock will be turned back and that another eleven years will pass before T+1 will be adopted. A deadline has not yet been set but most expect that the new regime will be embedded over the next one to two years.

technology

The cable trade Investment in physical connectivity is spurring on electronic trading in the region, says Lynn Strongin Dodds

t may have taken Asia longer to embrace electronic trading but the region’s major financial centres are quickly making up for lost time. A recent study by consultancy firm Celent, predicts that the adoption of computerdriven trading for all equities in Singapore, Hong Kong, Japan, Australia and India will jump to 58% in 2013, a sharp hike from 11% in 2008. This will surpass the European figure which stands at around 50% but is still far behind the US at 70%. Alternative trading platforms are mushrooming and low latency has become the buzzword. Not surprisingly, technology companies, particularly those with deep

pockets, are expanding their footprint, hoping to make their mark. To date the more developed markets have attracted the most attention although the pace of change has accelerated elsewhere over the past year, according to a ‘Electronic trading update: Attractive markets lie to the East’ a report from consultancy Aite. It shows progress is being made in the region’s more nascent markets where local regulators had been resisting the development of alternative venues. “The developed markets of the Asia-Pacific – Japan, Australia, Hong Kong, and Singapore – have developed their infrastructure to align with those of the US and Europe and are now

focused on developing their market structure via the introduction of alternative venues,” notes Simmy Grewal, senior analyst with Aite Group and author of the report. “Meanwhile, the emerging markets of Korea, Taiwan, and India are hot on the heels of their counterparts in terms of technology upgrades. With regulatory revisions, they will be primed to accept significant foreign investment.” The main drivers behind the adoption of electronic trading are not only individual and institutional clients looking to cut expenses but also banks, who need to offset the continual shrinking margins and spiralling technology expenses. The numbers speak for themselves.

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technology

A recent report by Greenwich Associates showed that an order in Hong Kong routed via low-touch electronic means costs investors on average 0.05% of the value of the trade, versus 0.19 % for high-touch handling from a broker. “Due to the economics, more and more people are opting to trade electronically,” says Daniel Burgin, head of Asia Pacific, NYSE Technologies. “In Asia, Japan is ahead of the game with the recent growth of proprietary trading systems (PTS). This has led the newly formed Japan Exchange (JPX) to announce they’ve reduced their tick size for 2014. Technically the rest of the region has to catch up although it will be interesting to see the developments in Korea which recently passed legislation to open the market to alternative trading systems (ATS) and fragmentation.” After more than 50 years of the Korea Exchange holding a monopoly, Korea’s financial watchdog, the Financial Supervisory Commission, has loosened the reins and at the end of August 2013, rivals will be able to compete with the stock exchange. Securities firm must have equity capital of more than Won20bn ($11m) to set up alternative trading platforms for stocks and depositary receipts. However, the door is not being opened all the way as trading volume on ATS cannot exceed over 5% of that of the Korea Exchange or more than 10% of an individual stock’s trading volume. Despite countries moving at their own pace, Burgin says, “The changes will create huge opportunities because it will require greater technology investment across all players. Many do not have the capital to do it themselves and are turning to reputed software vendors who provide comprehensive technology solutions and managed services.” NYSE Technologies itself has been busy over the past year extending its global trading network – Secure Financial Transaction Infrastructure (SFTI) – into Equinix’s International Business Exchange (IBX) data centres in Hong Kong and Tokyo. SFTI, which is specifically built for electronic trading and market data traffic, and provides over 1,300 financial market participants with a single point of connectivity to multiple exchanges, market centres and content service providers around the world. Already linked in Singapore, the two new connections will enable financial market participants to eliminate the overheads and costs associated by maintaining separate network connections in each location to numerous trading venues. Tanuja Randery, CEO of data provider MarketPrizm, is also optimistic about the region’s potential. “While Asia is still in the nascent stages

of electronic trading, it is becoming increasingly important to our clients,” she says. “We believe our services can greatly support the evolution of electronic trading in Asia. For example, we facilitate all trading infrastructure for our clients – connectivity, market data, exchange collocation, managed services, etc. This allows them to focus on their trading, rather than on their technology setup.” The firm has recently gone live with a new trading infrastructure service – PrizmNet Asia – in Japan, Australia and Singapore. It not only covers connections with the incumbent exchanges but also alternative platforms, Chi-X Japan and Chi-X Australia. The company’s local and cross-border networks and its co-location and hosting services at trading venues or proximity facilities enable onshore and offshore financial institutions to deploy their trading infrastructure as close to the market as possible. Initially users gained from exchange access, raw and normalised data, co-location and hosting at any exchange as well as being able to cross-connect to any broker. The second phase which is being rolled out covers additional venues in Japan – SBI Japan t and the Osaka Securities Exchange – followed by markets in Korea, Hong Kong and India. NTT Communications Corp is also taking advantage of a shifting landscape with the recent launch of its arrownet-Global network service in Hong Kong. Leveraging NTT’s Ethernet Leased Line service and ultra-low latency cable systems, including the Asia Submarine Cable Express (ASE), the connectivity offering will allow global financial service institutions in the special administrative region to directly access JPX Co-location, the new co-location service of JPX and TSE’s systems for the first time. NTT is a major investor in ASE, contributing about half of the total US$430m required to fund the project. According to Yoshinori Suzuki, senior managing director of TSE, the partnership allows global investors in Asia and across the world to access the JPX market from outside of Japan more easily and effectively by realising a seamless connection. “This highly reliable, ultra-low latency network will improve TSE’s competitive edge and push forward the bourse’s global expansion strategy,” says, Patrick Ng, executive vice president, global network business division at NTT Com Asia. “It not only help TSE expand its investor pool but also benefit the companies operating in the Hong Kong and Singapore financial markets, as it offers strategic advantage for financial service institutions which deal with trade and investments related to the TSE.”

www.asiaetrading.com z Q3 2013 z Asia Etrader

Daniel Burgin head of Asia Pacific

NYSE Technologies

“The changes will create huge opportunities because it will require greater technology investment across all players.”

back pages

Events Date

Event

Where

Type

12 September

FISD Southeast Asia

Singapore Forum

17 September

FISD Tokyo

Tokyo Forum

25 September

ETF Asia

Singapore Conference

10 October

Asia Etrading Forum

Hong Kong

Forum

4-6 November

Asia Pac Financial Information Conference (APFIC)

Hong Kong

Conference

7 November

Asia Etrading Forum

Tokyo Forum

Dates Date Country Holiday

Date Country Holiday

15-Jul

Japan

Marine Day

19-Sep

Korea

Mid-Autumn Festival Day 2

08-Aug

Indonesia

Eid al-Fitr

19-Sep

Taiwan

Mid-Autumn Festival

08-Aug

Malaysia

Hari Raya Puasa

20-Sep

Hong Kong

Chinese Mid-Autumn Festival

08-Aug Pakistan Eid-ul-Fitr

20-Sep

Korea

Mid-Autumn Festival Day 3

08-Aug

Hari Raya Puasa

23-Sep

Japan

Autumnal Equinox Day

09-Aug India

Id-Ul-Fitr

01-Oct

China

National Day

09-Aug

Hari Raya Puasa

01-Oct

Hong Kong

National Day

09-Aug Pakistan Eid-ul-Fitr

02-Oct

China

National Golden Week Holiday

09-Aug

Philippines

Eidul Fitr

02-Oct

India

Mahatma Ghandi Jayanthi

09-Aug

Singapore

National Day

03-Oct

China

National Golden Week Holiday

10-Aug Pakistan Eid-ul-Fitr

03-Oct

Korea

National Foundation Day

12-Aug

Thailand

The Queen’s Birthday

07-Oct

Australia

Labour Day

14-Aug

Pakistan

Independence Day

10-Oct

Taiwan

National Day

15-Aug

India

Independence Day

13-Oct

India

Vijaya Dashami

15-Aug

Korea

Liberation Day

13-Oct

Taiwan

Double Ninth Day

17-Aug

Indonesia

Independence Day

14-Oct

Hong Kong

Chung Yeung Festival

21-Aug

Philippines

Ninoy Aquino Day

14-Oct

Japan

Health-Sports Day

26-Aug

Philippines

National Heroes’ Day

15-Oct

Indonesia

Eid al-Adha

28-Aug

India

Krishna Janmastami

15-Oct

Malaysia

Hari Raya Haji

31-Aug

Malaysia

National Day

15-Oct

Pakistan

Eid ul-Azha Day 1

02-Sep

Vietnam

National Day

15-Oct

Philippines

Eidul Adha

09-Sep

India

Ganesh Chaturthi

15-Oct

Singapore

Hari Raya Haji

16-Sep

Japan

Respect for the Aged Day

16-Oct

India

Bakri Id

16-Sep

Malaysia

Hari Malaysia (Malaysia Day)

16-Oct

Malaysia

Hari Raya Haji

18-Sep

Korea

Mid-Autumn Festival Day 1

16-Oct

Pakistan

Eid ul-Azha Day 2

19-Sep

China

Mid-Autumn Festival

23-Oct

Thailand

Chulalongkorn Day

28-Oct

New Zealand

Labour Day

Singapore

Malaysia

www.asiaetrading.com z Q3 2013 z Asia Etrader

Directory 48

heading

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 Asia’s Best Sales in the 2012 Institutional Investor AllAsia 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 BofAMLís 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

back pages

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 worldís leading financial market participants, including trading venues, buy- and sellside 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, execution and order management trading systems for equities, foreign exchange and listed derivatives. With offices in Asia, Europe and North America, FlexTrade has a worldwide client base spanning more than 175 buyand sell-side firms, including many of the largest investment banks, hedge funds, asset managers, commodity trading advisors and institutional brokers. For more information, visit FlexTrade Systems at: www.flextrade.com or follow news of the company on Twitter at www.twitter.com/flextrade or LinkedIn at: www.linkedin.com/company/flextrade?trk=top_nav_home. Call: +65 6829 2569; e-mail: sales_asia@flextrade.com.

Would you like to see your company listed here? Contact: support@asiaetrading.com for details. Asia Etrader z Q3 2013 z www.asiaetrading.com