Higher volatility in Japanese equity markets, coupled with a more flexible short-selling regime, is likely to boost high-frequency trading volume in domestic stocks this year, say clearing brokers and system vendors.
HFT accounts for about 40% of Japanese trading volume, according to market estimates, and Tanuja Randery, chief executive of low-latency trading infrastructure vendor Marketprizm, has seen a significant pick-up in HFT activity in Japan over the past six months.
So far this year, she has seen a “quadrupling” in the number of clients requesting market data and order-entry infrastructure to support HFT, but she declined to provide specific volume numbers.
Japanese equity markets have experienced sharp volatility recently – the Nikkei 225 plunged 7.6% on May 23 alone, representing the biggest single-day drop since the March 2011 tsunami, and a sharp reversal from the near-3,000 point (around 50%) gain the index racked from the start of the year to May 22.
While ‘Abenomics’ has brought levels of optimism to Japan not seen in 20 years, equity markets will likely continue to experience significant uncertainty – the Nikkei fell almost 1% after a June 5 policy speech made by prime minister Shinzo Abe lacked clarity in the eyes of the market.
The Nikkei has since recovered somewhat, closing at 13,514 on Monday, a 5% increase over Friday, although sources expect the see-saw to continue, which should contribute to more inquiries about HFT, Randery argues.
While some claim the increase in HFT activity in Japan is the cause for the recent heightened volatility, Sean Lawrence, CEO of ABN Amro Clearing Tokyo, a clearing broker for HFT trading firms in Japan and Australia, says this is not the case. It’s more likely due to the influx of investors into Japanese markets, as opposed to more HFT activity, he argues.
“My view is that the recent volatility seen in Japanese equities reflects a higher level of engagement from institutional investors and retail investors,” says Lawrence. “As Japanese equities trading volume has increased significantly this year, investors trading Japanese equities would react to uncertainties related to the macro-economy or US monetary policies in the same way they would if trading in a market outside Japan.”
Yasuyuki Konuma, executive officer and director of new listings at the Tokyo Stock Exchange, agrees, noting at AsianInvestor’s second annual Institutional Investment Forum last week that HFT could in fact help to reduce volatility. He pointed out that on May 23, the share of HFT as a percentage of total market volume was lower than average.
“If it had increased, we could have identified it as one of the contributory problems, but it didn’t,” he said. “We have seen flash crashes overseas. But HFT does not necessarily accelerate volatility in the market. In fact, it may be absorbing excessive volatility.”
Lawrence says the rise in HFT activity can be attributed to the new colocation facility offered by the Japan Exchange Group (JPX), formed earlier this year by the merger of the Tokyo Stock Exchange (TSE) and the Osaka Stock Exchange (OSE). (Colocation allows brokers and trading firms to directly place their servers next to the stock exchange’s servers, which reduces the time of obtaining market data and order submissions to microseconds.)
The facility, which gives users access to cash and derivatives across the TSE and OSE, has increased interest in HFT activities, Lawrence says. In the past, Japanese markets had a structural barrier to entry as the markets were divided, he notes, which led to higher costs and thus reduced revenues for trading firms.
“With the new JPX colocation site and combined exchange systems, we should expect organic growth in the order of 20% in derivatives trading volume across all the option and futures contracts listed on the JPX target derivatives platform, OMX,” he says.
Daily trading turnover for Nikkei 225 has hovered above ¥1.5 billion ($152 million) for most of this year, a sharp uptick from ¥500 million in June 2012, according to Bloomberg data.
The new short-selling rules, introduced by the Financial Services Agency in April, should also contribute to more HFT traffic, sources say. At the moment, the FSA restricts short-selling to stocks that are trading at least equal to, or above, the stock’s last traded price. Essentially, it means short-selling is banned on falling stocks.
However, starting in November, the ban will only be in effect for stocks that have declined 10% or more from the previous day’s close. Lawrence says the amended uptick rule will favour HFT, as it reduces some of the limitations that had previously restricted short-selling.
As HFT firms hedge their exposures during the trading day, markets with less restrictions on short-sellers are generally more attractive, which will benefit HFT in Japan, sources say.