Market participants are gearing up to trade more in Japan now that Arrowhead, the Tokyo Stock Exchange's new whizz-bang trading platform, is proving a success.
"Arrowhead has had a smooth start," says Kumiko Oe, head of equity trading for Asia-Pacific at AllianceBernstein in Hong Kong. "Spreads have narrowed and the speed is more efficient. It's a net positive."
Global buy sides and prop desks, as well as Japanese clients savvy with the use of algorithmic trading and quant strategies, had been hindered by the TSE's previous lack of speed. For domestic investors used to the luxury of watching trades and analysing price movements before making a decision, an environment where trades are made in milliseconds is more of a challenge.
The TSE is likely to attract more global investors, however. The new platform has had an immediate impact, boosting average daily volumes by 10-20% and reducing spreads by 25%, says Christina Makiguchi, head of Credit Suisse's Advanced Execution Services division in Tokyo.
Brokers say the new platform has led to a surge of enquiries from high-frequency traders, prop desks and other investors in the United States. "Global investors can port their market structure to Japan more easily," notes Carrie Cheung, director of electronic trading at Bank of America Merrill Lynch in Tokyo.
Because high-frequency traders don't want to base themselves in Japan, they are not moving suddenly to trade there. But they are now preparing documentation and lining up co-location deals with brokers, which suggests a steady increase in trading activity over time, says Glenn Lesko, Asia chief executive at Instinet in Hong Kong.
As a result, brokers are building the infrastructure to attract more global investors to trade Japanese equities. Credit Suisse, for example, has introduced a high-speed version of direct market access called Velocity. Arrowhead has been accompanied by the TSE's decision to allow co-location of brokers' servers onsite, to facilitate high-speed trading. Clients trading on Credit Suisse's platform can achieve one-way latency (reaction speed) of 200 microseconds.
Credit Suisse says it plans to expand this service to other markets in Asia, including Australia, Hong Kong and South Korea.
In Japan, there remain obstacles to creating an environment fully compatible with America's, but US market-makers may hesitate in any case, given the under-developed nature of alternative liquidity pools in Japan. Some regulatory issues remain. For example, proprietary trading systems (PTSs, Japan's term for multilateral trading facilities) cannot be used for short sales.
This June, however, a hurdle to using PTSs will be lifted when trades are allowed to be cleared directly at the Japan Securities Clearing Corporation, a centralised clearer for exchange-traded equities. Until then, trades on PTSs must still be cleared separately, which is costly. PTSs such as Kabu.com are also working on better links with brokers.
Investors like to trade in markets with many alternative venues, because competition from such platforms in Europe and the US has forced stock exchanges to become more price-competitive and improve their technology. The situation in Japan is different, because 95% of all equity liquidity already trades on the TSE. Now, with Arrowhead, the TSE is also relatively inexpensive and may be faster than its rivals.
This creates a challenge to PTS's raisons d'etre. Although they can capture high trading volumes for certain stocks and they provide the comfort of anonymous trading, PTSs will remain marginalised unless they can aggressively lower their costs, say brokers.
That said, buy sides still want the price discovery that alternative venues can provide. PTSs can also offer tighter tick sizes. Although regulations such as those related to short-selling and clearing are hurdles, the bigger problem has been the lack of smart-order routing – connections among brokers that allow clients to compare prices instantly across venues and go for the best deal.
"The pricing on PTSs can be better, but there's little liquidity, because there's no sweep by smart-order routers," says Guido Glowania, vice president of electronic trading for Asia-Pacific at BoA Merrill Lynch in Hong Kong. "Smart-order routing would show the best price and volumes."
Only a handful of brokers in Japan have built this sort of infrastructure, including Credit Suisse, Merrill Lynch and UBS.
"The competition is about technology," says a broker. Now that Arrowhead has taken away PTS's edges in pricing and speed, they need to highlight other ways to compete. Anonymity alone may not be enough, but they could offer better ease of access or provide better data.
Chi-East, the new joint venture between Chi-X Global and the Singapore Stock Exchange, has announced its intention to trade equities in Japan, as well as in other markets, such as Australia.
It is expected to enter the Japanese market later this year, and brokers say it has the experience and infrastructure to better address these factors. Indeed, the TSE built the new system in part to address the likelihood of such competition. For equity investors, Arrowhead's cheaper and faster platform may be just the beginning of accessing the Japanese market.
"The Street has brought more technology to Japan, including algos and smart-order routers," says Instinet's Lesko. "All of this is more effective now that Arrowhead allows traders to get live data from the TSE. It may seem like this would hurt the PTSs, but in fact we expect it to lead to a proliferation of trading off-exchange."