Electronic trading is becoming more commoditised in Asia, which shifts focus to which market reforms could create the next opportunity for extension to high-frequency trading (HFT) strategies.
That was the conclusion of a panel of electronic brokers, exchange officials and service providers organised recently in Hong Kong by Citi.
This commoditisation does not mean HFT has reached a level of acceptance or size in Asian markets akin to, say, that in America. Rather, it means it has become established but is unlikely to advance further without changes at the level of exchange policy, regulation, taxation, and other inputs to market structure.
David Jenkins, managing director for Asia at FTEN, a real-time aggregator of risk data that’s part of Nasdaq OMX, says HFT is becoming mainstream in Asia, thanks to the adoption of technologies by exchanges and specialist traders.
“As this technology becomes more common, it becomes harder for HFT players to differentiate their strategies,” he says. “That’s especially true if the exchange is also improving its latency.”
Robert Barnes, CEO at UBS MTF [Multilateral Trading Facility], notes that since 2009, Asian exchanges combined have recorded more equities order-book turnover than matched on European exchange order books, and this is before the advent of HFT strategies into Asia aside from Australia and some in Japan.
HFT contributed a surge of activity to UK, France and Germany when these strategies arrived in Europe. However, Ian Smith, head of Asia electronic execution at Citi, cautions that while HFT may be moving towards the mainstream, it isn’t mainstream yet, at least not in terms of the ultra-fast strategies deployed in the US.
Smith notes that only a handful of firms account for the lion’s share of HFT volumes in Asia. Also, new technology may mask what’s really traditional, long-only activity.
“When long-only, low-latency flow gets executed through a broker’s algo or via a smart-order router, it can often look like high-frequency trading,” he says.
Nor is this likely to change, because regulation in many Asian markets makes HFT difficult. Technology was once a problem, but exchanges such as Tokyo, Singapore and Australia now provide platforms that can accommodate very high capacity and low latency (latency means the time it takes to communicate a packet of data; low latency means very fast).
In other cases, such as Hong Kong, the friction comes from stamp duty and costs arising from consequences of fixed post-trade fees per ticket, as average trade sizes shrink on order books.
Moreover, new broker technology isn’t likely to advance HFT much further on its own terms, at least not in Asia.
Smith says that one vendor approached Citi with an incredible technology that gets latency down to nine microseconds.
However, he says in the Asian context such speed doesn’t make much difference: “When the TSE moved from trading speeds of three seconds down to milliseconds, that was a fundamental shift for that market. I don’t think a technology that runs in microseconds will have that kind of impact.”
Jenkins agrees: “Sure, you can go faster, but is this creating liquidity, or just noise?”
Moreover, platforms among the region’s exchanges have also homogenised. As they have stepped up their IT commitments, exchanges have sought to sell it on to others. Australia and Singapore, for example, run on the same platform.
The same is likely to go for exchanges in the region. Ryan Wuebbels, head of relationship management at Hong Kong Exchanges and Clearing, says: “Every exchange asks itself, ‘How fast is fast enough?’ You need to be fast, but there’s a rule of diminishing returns, and we don’t see a business case for entering an arms race.”
He sees HKEx’s future competitive advantage coming not from latency, but from how it uses its ‘next generation’ data centre and hosting of vendors to provide more choice to both the buy- and sell-sides.
If HFT has reached a plateau, the next step for its development may not be in front-office trading systems, but in changing market infrastructure.
Endre Markos, regional head of execution to custody at Citi Securities Fund Services, notes that so far, HFT technology has focused on the front office, while the middle and back offices have gone relatively ignored.
“This means a lot of back offices are still using fax machines instead of iPads,” Markos says. “Can we transfer some of that tech knowledge and apply it to the full lifecycle of a trade?”
Robert Barnes at UBS says technology is best applied to help participants understand the full cost of a trade, and identify slippage in best execution.
He notes that in Europe, investors can get a better execution result from algorithms; the order-book trend is one of shrinking trade size, and with no change in tariffs, costs increase as a percentage of value traded. This is especially true of post-trade fees, which correlate more with number of trades.
To address this, Europe is adopting a model where cash-equities clearing houses interoperate to provide users a choice of central counterparties (CCPs).
“This CCP ‘user choice’ model enables each firm to achieve economies of scale by consolidating clearing across markets with the CCP,” says Barnes.
He sees an opportunity for Asia to win with this model. “Each market can retain its sovereign clearing house and link it to others.”
This is because stocks increasingly can trade on multiple platforms, at least in Europe. In Asia, this trend is also emerging, thanks to alternative venues in Japan and arrival of new venues such as Chi-East and Chi-X Australia. The upshot: investors can save money through scale if they consolidate clearing from multiple markets.
It’s a neat idea, but one that others say is hard to achieve in Asia. Ian Smith says the Asean Link, an agreement among Southeast Asian bourses to build interconnectivity, could create more of a cross-border market for trading. But getting the clearing and custody arrangement right for that is already a big challenge. Moreover, the number of dual-listed companies in Asia is far fewer than in Europe.
Wuebbels says opening cross-border clearing to competition is likely to be viewed as too complicated. HKEx, like other exchanges in the region, will continue to pursue a model of vertical integration; even in the US, virtually every equity trade is cleared through the DTCC.
Barnes acknowledges each single country may appear a functional silo, but argues that Asia, like, Europe, has multiple markets and the scale to enable such efficiencies: “We expect the CCP ‘user choice’ model to become the rule rather than the exception for European equities in 2012. It can be done.”
Maybe, maybe not; but what seems likely is that the battle for efficiencies that will bring high-frequency trading to Asian shores now includes recognition that the trading floor needs to think more about the post-trade model.