Hong Kong Exchanges & Clearing's next generation technology upgrade via its Orion Programme is forecast to spark increased investor interest in using algorithmic strategies to trade the domestic equity market.

The HK$3 billion upgrade encompasses investment in the exchange’s core cash and derivatives trading platform, connectivity network, and a new data centre that provides a co-location hosting service for low-latency algorithmic trading strategies.

Initially HKEx plans to launch low latency trading and securities pricing information services in the second and third quarter of this year. Together with a co-location hosting service slated for the fourth quarter, the HKEx says the new network will boost a maximum round-trip latency of 1.5 milliseconds.

Senior management at regional brokerages in Hong Kong, who were briefed by HKEx officials at the end of March, say they are still conducting internal research to see whether they would invest in acquiring such low-latency trading capability.

Some applauded the infrastructure upgrade as promoting diversity in electronic trading strategies and contributing to liquidity – which would appear to benefit the city’s equity market as trading volume is still dominated by the HKEx, where accounts for 95% of market turnover.

Some believe that local brokerages might begin to consider high frequency trading strategies for some of their business lines, adding more players to the few US or European proprietary trading firms that have  been operating in Hong Kong.

“As local players we need to react even if we don't think the initial incremental value to the overall business is high," says Andrew Wu, IT director for KGI Asia in Hong Kong.

"Global investment firms and dealers already have expertise playing in multiple markets in high frequency, so if the Hong Kong exchange has that co-location infrastructure, local brokerages would need to respond by developing their capabilities as well. Otherwise they might risk lagging other global players."

Another head of electronic trading at a Japanese securities brokerage, who declined to be named, says that based on experience from the launch of low-latency trading platform Arrowhead by the Tokyo Stock Exchange in January 2010, trading on multiple alternative venues, or proprietary trading systems, has been facilitated in Japan. Arrowhead features a two millisecond order response time, putting it on a par with the likes of the New York and London exchanges.   

“When Japan introduced a low latency platform, one could start posting orders on multiple venues because Arrowhead was on a par with other trading platforms in terms of latency and through-put, that is critical for some smart order routing strategies,” he says.

Apart from the potential for more high frequency trading, other algorithmic trading techniques – those such as the “iceberg” order type that seeks to slice up a large block of orders into small pieces to lessen market impact – could also benefit from HKEx’s technology upgrade.

However, for market participants the decision to use co-location, or other services under “Orion”, is often based on factors other than simply seeking faster speed.

The source says it remains critical that the benefits from acquiring HKEx’s new connectivity and trading capability must outweigh the cost -- that includes not only the cost of building the infrastructure, but also clearing and settlement costs.

Ultimately, he notes, the overall improvement from better performance and execution would have to outweigh the costs of trading, clearing and settlement.

The HKEx controls and owns its central clearing and settlement system; and under the Securities and Futures Ordinance both dark pools and other electronic communication networks must be authorised as automated trading services (ATS) operators.

ATS providers can trade HKEx-quoted shares off-exchange only if they are also exchange participants and clear and settle their trades through the HKEx clearing house, adding to operators’ cost.

Since July 2010, the Japan Securities Clearing Corp, a central counterparty that clears various exchanges’ trades including those of TSE and Osaka Securities Exchange, has started clearing trades for PTSs too.

Prior to this, PTSs needed to engage the clearing services provided by banks. Nearly 15% of the market in Japan is now traded off-exchange, according to industry estimates.