In a rare act of cross-industry collaboration, buy-side traders and sell-side brokers have created a standardised due-diligence process to comply with incoming electronic trading rules in Hong Kong.
Members from five industry lobby groups published their new “e-trading information template” on their websites this week following months of discussions.
It comes after the city’s Securities and Futures Commission (SFC) unveiled controversial rules this March requiring intermediaries to carry out real-time monitoring of algorithmic trading. The rules are due to become effective next January.
Their introduction will see responsibility for certifying whether clients are sophisticated enough to use algos lying with brokers, and also with fund managers with a type 9 licence, rather than the regulator.
The SFC issued its conclusions on the new regulatory regime following an industry consultation period, but concerns have been raised particularly from brokers.
With no prospect of the SFC making concessions to its rules, this coming-together of the industry shows how brokers and fund managers have set aside competing commercial interests to formalise governance so as not to fall foul of the rules.
Primarily, their shared 23-page due diligence document contains a series of explanatory boxes breaking down amendments made to the codes of conduct for relevant licenced trading parties.
It lists whether the new e-trading requirements, such as those ensuring trading system adequacy, are applicable to managers, and if so, what kind of information managers will ask their algo service providers when carrying out their due diligence.
“Due to these new e-trading rules, buy-side investors have new requirements to conduct due diligence on sell-side firms’ algorithms and e-trading systems,” says Nick Ronalds, head of equities at the Asia Securities Industry and Financial Markets Associations (Asifma), one of the lobby groups to develop the document.
“This saves an enormous amount of duplication that would be created if each buy-side client were to develop individually within their firms various lists of due diligence requirements for their brokers.”
Heide Blunt, managing director of Alternative Investment Management Association (Aima), says most hedge fund managers are mindful of their due diligence responsibilities for ensuring the e-trading systems they use are reliable; that these systems are tested before deployment; and have appropriate security controls to protect the trading systems from abuse.
“As fund managers are now required to perform appropriate due diligence on algos and electronic trading systems, in many cases they will need an increased level of transparency from their service providers to ensure their understanding of the adequacy of the system; they will also need to receive notice where modifications to these algos are made by the service providers,” says Blunt.
For more complicated trading strategies, such as those used by hedge fund managers, their need for transparency and due diligence might than be higher than, say, a traditional long-only manager.
Given this, Matt Saul, head of Asia Trader Forum, says that while the electronic trading information template is a useful tool, it is only a starting point.
He notes that buy-side firms will still have to make their own determination on the level of due diligence they need to perform on their brokers depending on each manager’s trading strategy; that while the template helps give a standardised approach to managers, it is not intended to be a one-size-fits-all solution.
The five industry groups to contribute to the due-diligence template are Aima, the Asia Trader Forum, Asifma, FIX trading community and the Hong Kong Investment Funds Association (HKIFA).