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Tony Mackay, who founded Chi-X as a spin-off from his former employer, Instinet, says there is no way the network will get off the ground in Asia if its business model is simply one of undercutting national stock exchangesÆ pricing.
Mackay is now co-based in Hong Kong, where the network has opened an office. It also has people on the ground in Japan, Singapore and Australia. Chi-X has applied to be regulated as an exchange in Australia and is preparing to follow suit in Japan.
Unlike its original parent, Instinet, Chi-X is not keen to be regulated as a broker. Instinet continues to steadily divest shares to financial institutions, mainly broker/dealers, that trade high volumes on Chi-X. It sees itself more as a utility. (Chi-XÆs ultimate parent is Nomura, which owns Instinet.)
In Europe, it went live in London in May 2007, where it adopted a more obviously competitive relationship on the back of its technological platform û but also thanks to European-wide regulation (Mifid) that scrapped restrictions on competitive trading platforms and clearing.
There is no Asian equivalent to Mifid, and across the regionÆs markets, any trades done on an alternative network would have to still be reported to the national exchange û which undermines Chi-XÆs ability to match counterparts on an anonymous basis.
The regionÆs exchanges are nervous about letting in a competitor such as Chi-X. When it opened doors in London two years ago, it was capable of handling 30,000 trades per second û versus the London Stock ExchangeÆs mere 200. It has since won 15% market share û which in some stocks means as much as 40% of the market.
It has done so thanks to its adoption by statistical arbitrage traders û the likes of Citadel Group and DE Shaw, big hedge funds that execute literally tens of thousands of transactions across asset classes at any given moment. Market makers, investment banksÆ prop desks and traditional buy-side investors participate on the other side.
There are a number of such players in Asia that would like to execute similar strategies here, but cannot because the market infrastructure wouldnÆt support them. There are also many traditional money managers keen to see the high spreads in Asia come down, liquidity improve, and efficiency gains achieved.
Mackay realises that, without something like Mifid, there is nothing to compel national regulators to allow Chi-X to operate with a free hand. Chi-X has therefore established a new company, Chi-Tech, which is vending the same technology used by Chi-X.
Mackay notes that the LSE responded to Chi-X and other electronic networks (including Bats, Turquoise and Nasdaq) by spending around $100 million to improve its systems û a hefty commitment, and even then it wasnÆt as fast. Chi-Tech is prepared to sell similar IT to Asian exchanges (which typically struggle to reach 100 trades per second) for $10-15 million.
ôWe want to make the market bigger and more efficient first. Then we can all grow,ö Mackay says. ôWeÆre not going to start a pricing war.ö
In theory, if a number of Asian markets work with Chi-Tech, it can serve as the ôglueö between them, allowing cross-border market-making and trading.
Chi-X is also hoping to help make clearing more efficient. Its competitive advantage in Europe was strengthened by working with a multilateral clearing facility run by Fortis, which charges only 10% of what European exchanges levy to settle trades û a savings that has attracted a lot of business from institutional money managers.
The credit crunch has set back its plans: Mackay was hopeful of winning approval in Australia last autumn, when Lehman Brothers collapsed. He doesnÆt think the severe pressure on prop desks and hedge funds û many of which have closed û will stymie Chi-XÆs opportunity, however. In particular, the diversified, short-term, market-neutral nature of statistical arbitrage means these strategies remain intact. Its practitioners are partnerships that are more disciplined about their own money than a typical investment bank prop desk.
Volumes in Europe are down as much as 50%, however, because activity among prop desks, traditional hedge funds and long-only managers has been sharply curtailed. ôThe whole market has become smaller for everyone,ö Mackay says.
The March edition of AsianInvestor magazine will feature an in-depth look at alternative trading networks and exchanges.
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