A new generation of trading heads has emerged among asset managers and institutional investors in Japan.
Unlike their predecessors, these buy-side dealing chiefs want control over execution via the use of algorithmic strategies and connectivity.
Michael Green, head of Japan equities and electronic client solutions in Asia for JP Morgan, says clients are adopting strategies with greater direct control over order execution, resulting in an increase in direct market access (DMA) order types. Algorithms also provide anonymity.
There are other clients trading Japanese securities who are also taking a “blended” approach – dividing orders up into two parts for electronic and broker-dealer execution.
“Some clients will send a certain portion of the order through broker-dealer high-touch desks, relying on the dealer’s ability to source liquidity to minimise market impact," says Green. "Simultaneously they may send some of the parent-order into an algo to have it work quietly in dark venues, whilst also taking a portion of the order and execute it by themselves using DMA, with the aim to pick a price level opportunistically, or to get aggressive on a certain level to have complete control over that part of the order."
Such use of algorithmic strategies and DMA technology, which allows buy-side firms to send orders directly through a broker-dealer’s pipe to an exchange, has the advantage of being cheaper than entrusting an order to traditional sales traders.
It is exactly such a shift in execution style that has seen trading volume on the benchmark Nikkei 225 via alternative venues such as Chi X or proprietary trading systems such as SBI grow to 15%.
Japan stands as one Asian market where fragmentation has benefited investors with lower execution costs and faster execution.
Such a structural evolution among the investment community has come amid tech investment by traditional exchanges which has trimmed execution response time to milliseconds.
In 2010, the Tokyo Stock Exchange migrated onto its ¥13 billion upgraded cash-trading platform Arrowhead, cutting order response time to two milliseconds, from three seconds.
Hong Kong Exchanges & Clearing is also upgrading its cash and derivatives trading system this year in an on-going HK$3 billion project expected to reduce round-trip latency to 1.5 milliseconds.
Such upgrades and investment has enabled market participants to look at various algo strategies, and today investors can consider a broad spectrum other than traditional time-based order types such as VWAP (volume weighted average price), TWAP (time weighted average price) and opportunistic order types.
In recent years investment banks’ quantitative trading teams have been criticised for not exercising control over their own algos, so much so that these algos ended up being blamed for disrupting trading systems or dragging markets into a circuit-breaking downward spiral.
But Green notes that improvements in technology have still paid dividends for the average retail investor, who is able to select venues on which to execute at a fraction of the cost from years ago. These are done in a way the client knows where the market is and what their likely market impact will be prior to execution.
Outside of Japan, Green anticipates increased algorithmic trading demand will come from futures and options, especially in markets with good liquidity both in cash equities and derivatives, such as Korea and Singapore. Proliferation of e-trading products and execution methodologies in asset classes outside of equities will also continue.