Hong Kong’s stock exchange should shoulder some of the burden for monitoring risks from electronic trading, brokers argued at a conference in the city yesterday.
They branded as unfair proposals on regulating electronic trading from the Securities and Futures Commission, in that they appear to put all the onus for reducing risks from high-frequency trading on brokerages.
The SFC proposed in a consultation released in July that brokers should be ultimately responsible for pre-trade control and post-trade monitoring of client orders done through direct electronic connectivity, such as direct market access.
For algorithmic trading, the regulator has also proposed putting the onus on brokers to prevent manipulative, abusive and erroneous orders from hitting the market, and to have testing procedures in place to ensure algos work properly even in extreme market situations.
The proposed rules give the impression that brokers effectively assume the role of a regulator, standing between investors and the exchanges so that "it's the fault of the brokers if something goes wrong", said Toby Lawson, Newedge's head of financial futures, options and cash equities execution for Asia-Pacific.
"Brokers have a role to play: to ensure participants are properly accredited. So from a credit, operational and counterparty risk perspective we need to monitor our customers," says Lawson, speaking at the Trading Architecture Forum in Hong Kong.
“But the level of establishing filters [on algos] that would ensure the integrity of the market, and that it is a fair and orderly venue to trade from both a regulatory and technology perspective, [that responsibility should be] at the exchange level."
Robert Laible, global head of sales trading for Asia ex-Japan at Nomura in Hong Kong, echoed this view. The regulator needs to be careful that the new legal framework for electronic trading is not too onerous for brokers, he says.
If brokers have to explain to their clients why they need to do additional due diligence on these clients’ competence level to be able to trade electronically, but similar requirements are not imposed on trades done verbally through cash trading desks, electronic trading would be prohibitively costly for brokers, says Laible.
Meanwhile, from a systemic risk perspective, Lawson says it is important that all participants – including exchanges – share the responsibility of reducing risks posed by HFT. He estimates that such strategies account for close to 40% of the listed futures and options market volume in Japan, Korea and Singapore.
"Exchanges are market-neutral and should assume the role of [ensuring] the market is a safe place [and monitor] systemic risk,” notes Lawson. “Those pre-trade or post-trade filters [for algorithmic trading] should happen at the exchange level to ensure safe and orderly market conditions exist for everyone.”
Otherwise, he argues, brokers might be incentivised to tweak their system and compromise their risk safeguards for commercial reasons, which in turn would create more risks for the market as a whole.
Based on Nomura’s market share of HFT in Japan, these strategies account for as much as 30% of equity trades there, says Laible. He sees clients using HFT to arbitrage derivatives listed in Singapore and Japan.
The term HFT covers various kinds of high-speed trading strategies such as market-making, arbitrage and momentum trading.