Henry Young, Co-chair of FIX IPL Working Group and CEO of TS-Associates, inspects the methods of latency measurement and relates new developments from the F

Paul Squires, Head of Trading, AXA Investment Managers opens up about the relationship between the buy-side and exchanges, and the perceived effects of recent consolidation among exchanges.

From Trading Desk to Trading Floor

We trade on an exchange in the name of a broker, which means there is a buffer between the exchange and the buy-side. The interaction we have with the exchanges and MTF’s works much better now. The MTF’s have done a good job engaging with the buy-side over the past few years, which makes a lot of sense when you think of the evolving landscape of market structure. Historically, buy-side firms and exchanges were never quite sure if they needed to pay much attention to each other; however, there is a much more collaborative dialogue now. Most buy-side desks have mixed feelings about some of the bigger exchanges, in much the same way that some of the brokers have mixed feelings about the positioning of exchanges. On the up-side, there is a sort of national, utility element to the exchanges. For things like index funds, primary exchanges own the end of day official pricing.

Before MiFID, the primary  exchanges were responsible for more of the trade and transaction reporting and it was easier to interpret that data compared with the  fragmentation of trade reporting following the first MiFID installment. On the buy-side, we have this simplistic view that it is positive for reporting to be centralised through the primary exchanges because having liquidity in a single venue is something we see as beneficial. Also, the level of monitoring around the primary exchanges is higher than around the MTF’s, and therefore, things like governance and robustness tend to be greater. Generally speaking, we see the primary exchange as a kind of trustworthy elder statesmen in the world of market structure. Where I think the challenges around the exchanges lie are that innovation can be bogged down by their hierarchy and organizational structure, and therefore, cannot compete quite as dynamically as some of the MTF’s, which clearly have much lighter infrastructure considerations. It is no surprise that some of the primary exchanges have lost market share to the MTF’s, who have been nimble, technology focused and reactive in the face of a changing environment.

Exchange Consolidation

We find it quite fascinating to see what will happen. Given the rate of market expansion, globalization and regulatory changes - all of which lends itself to consolidation - it was an inevitability. Exchanges have to be forward thinking about what their long term roles will be and although there are different aspects to this, what we tend to focus on is cash equities only. When people think of the Toronto or London exchanges merging, they think it is kind of interesting. Deutsche Boerse and NYSE Euronext, on the other hand, is fairly mind-blowing. In a wider context, the really interesting developments for us, the market participants, are for exchanges to look into other asset classes and areas of activity to secure a revenue stream for the future. The real impetus is not from cash equities; it is very much about clearing, OTC, potentially, fixed income markets and looking at what they can do in more commercial areas.

Net Gain/Loss from Exchange Mergers

We would hope to see technical enhancements at the exchanges. By applying a rule of best practices, the things that work well for the Toronto Stock Exchange or the London Stock Exchange could be transported to the other exchange, as with Deutsche Boerse and NYSE Euronext. The technical platforms and order book layout are quite relevant, so we would hope to see some enhancement in that area. Nonetheless, I would not necessarily promote a uniform market layout or order book structure, as I do not think we need that in every single exchange we trade on. To some extent, the more that order books’ structures align, the more it helps traders who are trading multiple markets. We can  pre-constrain a lot of unique exchange rules in our systems, but there are segments where human intelligence and manual control of the various elements are vital. In this respect, we would see any alignment of market practices as a fairly positive development.

The obvious potential negative outcome of the mergers is in returning to situations where the exchanges have too much of a monopolistic position and can potentially raise costs without the market having any ability to challenge it. If the MTF’s or exchanges raise their costs, we do not necessarily see that on the buy-side because of the buffer that the broker provides. There is a fairly high margin in the commission rates we pay our brokers and they cover their costs of trading our orders on the venues, and those venue transaction prices would have to increase exponentially for it to become a direct factor for us. Of course, it does eat away at margins for the brokers, and it may come to a point where they need to pass those costs on. The buy-side is somewhat safeguarded from rising venue costs, but not completely.

Yoichi Ishikawa of kabu.com Securities navigates the developments of PTSs in Japan and their effects on markets, traders and regulators.

(1) Could you tell us about the history of PTS in Japan and its growth over the past 3 years?

The history of Proprietary Trading Systems (PTS) in Japan began with the launch of PTS trading in September 2000 as the country’s first alternative stock trading platform. Initially, two brokerages developed and launched PTS operations geared primarily toward after-hours trading for retail investors, using the closing price at exchanges and VWAP for certain institutional investors. As a result, until April 2007, PTS trading never accounted for more than 0.2% of overall market volume (monthly basis). PTS trading volume, however, gradually began to expand starting in the second half of 2007 owing to the added liquidity provided by new link-ups between PTS operators and brokerage houses. In 2008, PTS midday trading was launched, offering smaller minimum price movements than the exchanges. PTS operators expanded to six firms, and a small number of international brokers began smart-order routing (SOR) operations.

2009 brought even smaller minimum price movements - less than 1 yen - and the launch of PTS stock price streaming through major information vendors such as Thomson Reuters, Bloomberg and QUICK. As a result of these advances, PTS trading exceeded 1% of overall market volume (monthly basis) for the first time in October 2009. Although the launch of the Tokyo Stock Exchange’s (TSE) advanced trading platform, Arrowhead, at the start of 2010 resulted in reduced latency and reduction of tick size, overall market trading value, including the Tokyo bourse, has not witnessed a significant increase. While PTS trading value, too, has not seen much in the way of growth, PTS trading is now primarily used by brokerage houses for algorithmic and electronic trading to capitalize on arbitrage trading opportunities to leverage the price discrepancy between the Arrowhead System and the smaller PTS price ticks. Arbitrage trading will likely grow to represent over half of all trading on the kabu.com PTS platform.

(2) What are the implications of the growth of alternative platforms/PTS - On clients?

Since 2009, Japan Consolidated Tape, which displays the best price from multiple markets (traditional exchanges and PTSs) using streams from major information vendors, has become the focus of attention regarding the trend toward a reduction of tick size, including less than 1 yen. While institutional investors are considering using SOR to efficiently execute trades at this best price, the challenges faced include: developing systems (OMS, back office administration, etc.) to link with PTSs, which have not been used until now; the formulation of internal rules and regulations; and dealing with environmental changes arising from greater liquidity in the Japanese equities markets, including PTSs.

- On sell-side firms?

Brokerage houses have focused attention on organizing internal policy governing PTS usage, the pursuit of reduced latency using collocation and the review of whether PTSs represent a viable alternative market trading platform and the capabilities of SOR, such as whether orders can be routed efficiently to multiple markets. From a policy perspective, after the start of 2010 several brokerage houses in Japan have revised their best execution policy to clarify SOR connections to PTSs.

As for settlement cost and counterparty risk, a growing number of firms, including those who previously avoided connecting to PTSs, are now considering using PTSs more intently because the Japan Securities Clearing Corporation (JSCC) will offer clearing services to alleviate these risks from July 2010. On the other hand, in terms of technology, the ability to develop advanced and sophisticated IT systems, including reduced latency networks and direct feeds from the markets, represents a pressing need in the battle for best execution, especially considering prices can fluctuate by the millisecond in SOR.