Leopard Capital Fund Manager, Thomas Hugger of Leopard Asia Frontier Fund and Managing Partner of Leopard Capital LP, goes through some of the major difficulties faced in various frontier markets in Asia.

In the frontier markets, even though you have electronic data services such as the internet, social media, and Bloomberg, it is very difficult to get financial papers or balance sheet papers, and other fundamental papers for some of the companies in these locations. Even if you go to Bloomberg and search on Bangladesh, you don’t have the balance sheet there. If you go into Bloomberg and look at Mongolian stocks, you will often find the price, but the description says, “The company currently has no available information on their current line of business as of 08/2008”. These are often blue-chip companies, and sometimes we have visited them or we have networks there, but there is limited information available.

But this is frequently because business is based on a more personal note, and I would say physical representation gives a big advantage. Our strategy on the private equity side complements this, so everywhere we have firms, we have offices. So we have an office in Cambodia, we have an office in Laos, we have an office in Haiti. When we are successful in fundraising for Myanmar and Bangladesh, we will have offices there too.

For private individuals it is still very difficult to invest in these markets. Go to a private bank in Hong Kong or Singapore, tell them you want to buy stock in Laos or even Vietnam and they will often tell you “Oh we are sorry, we cannot execute”.

Even for the institutional funds, including the bigger ones in some of the smaller markets, many still cannot trade because there are some restrictions, one of the main issues is they have no international custodians. That’s why the big guys often cannot invest in Laos, Cambodia, Mongolia or Papua New Guinea.

Principal difficulties
The hurdles start from very basic things, when last year I made my first trade in Mongolia, I called up the firm I wished to trade with. It was very difficult to reach a person because the fixed line was poor. So I had to call a mobile. I placed the order and I had to confirm it by email. There are some rules in Mongolia that mean that the broker can only place the order in the system if he has it written and signed, and it has to be on an order slip and the client has to sign it. So the broker sent me print-outs of the order sheet, which was in Mongolian. Then I had to sign it and to scan it and email it back and then the order was placed. In some markets people compete for nano-seconds, and this trade took me hours.

An execution in Papua New Guinea takes sometimes two, three days. I often need to call the local broker to chase them up. Sometimes the brokers don’t execute orders and say “Oh no, it was not done today”. So I have to wait for a week or even sometimes a month just to execute small tiny purchases. Of course in Papua New Guinea don’t call them in the afternoon; they are probably not in the office.

Then also in Mongolia, the fee I paid for the first broker was somewhere around 5% in commission and government fees. So I went there found another broker who gave me considerably cheaper executions. In international terms it is still outrageously expensive. Then it took me about four months until I had all the papers process done and when I asked for trade reports I would just get an email saying what I had bought. In this situation there was no contract, nothing, so I requested a contract note. I was probably one of the first foreign institutions for them, so I sent them examples of contract notes and what I expect for my fund, and within 24 hours I had the notes.

Execution pains
In Mongolia, I don’t have live prices on Bloomberg, so I found a website that has a five minute delay. I always check the prices online and I always place limit orders because the spreads can be more than 100%.

The daily turnover in Mongolia is less than US$100,000 and there are maybe one or two liquid stocks and the rest are just super illiquid.

There are also some capital controls, for example in Vietnam, before the broker can execute a trade he calls my custodian and determines a limit. Then the custodian will give the broker his limits and then he can execute. For each broker I have to designate the people, the name and phone number, ID number or fax number of who can ask for the limits in order to get the approval from their custodians.

In Mongolia or Vietnam or in other markets, I cannot sell stock and then buy with the profits, as I am required to wait until the money hits the account again.

One big hurdle is that, for foreign investors it is not easy to access these markets. For me as an emerging fund it is worth it and I went through the pain. It takes months until we have all custodians and brokerage accounts set up.

There is also a problem with ID markets, because if you go to London or New York, you don’t need an ID, you just have an account somewhere and your bank will get a broker and so on. But it is an administrative hurdle and I don’t understand why these exchanges add this pain for foreign investors. Although I think it is also not only the exchange, it is flowing down from the regulator.

Difficulties in opening accounts
In Vietnam it took me seven months to get a trading licence. There is no standardisation of the process between any of these markets. When you have to go back and forth it can take a long time.

For example, to open an account for Pakistan I went to the Pakistani Consulate here in Hong Kong with all the documents and they said they cannot do it because my firm is registered in the Cayman Islands. I went about 10 times to the Pakistan Consulate and finally they made an exception.

Some of the brokers have asked for extensive information to open an account and this can prove very time consuming.

On the other hand, a Pakistani guy with a brokerage, one of the leading companies, came to my office and he asked, “Do you mind opening an account with me?” I said, “Hey listen I’m going through this with such a pain with all the brokers. I don’t want to do this process again I’m nearly at the end of the tunnel”. Then he said, “Okay, listen give me your certificate of incorporation and the MMA of the funds and I promise you it will take two days”. And two days later the brokers account was opened.

As the regulatory juggernaut gathers pace, Alexander Neil, Head of Equity and Derivatives Trading at EFG Bank examines the issues behind the tape, and what the buy-side wants. 

Many of my buy-side peers have given up hope on a consolidated tape (CT), but the success of a CT is absolutely paramount now, even more so than it was a few years ago. Not just for industry insiders, but for politicians and the outside world to be shown that these can be transparent markets and that we are not penalised by misguided efforts to force volume onto lit markets, abolish dark pools or volume-enhancing factions such as certain HFT activities. In such a low-volume, low-commission environment I feel the stakes are especially high to get this right from the first day, and not let it drag on and into MiFID III . It shouldn’t be this hard to track trades in Europe and it’s funny to think that whilst we’ve seen a real race to zero in pre-trade latency, it feels like the post-trade space is being drawn out over years!

The Holy Grail is a ‘quality’ tape of record at ‘reasonable cost’. But what is a fair price for market data? Is it really something that can be left to market forces, or is it one of those things that should be regulated like electricity prices. After all, there are social responsibility aspects to market data, as ultimately higher costs for the buy-side are implicitly passed on to the broader (investing) public.

There were initially three routes that the European Commission (EC) wanted to take us down. The first route was to employ the same model as they did for execution and let the invisible hand of the market find the best solution and pricing through healthy competition. The second option was for a prescribed non-profit seeking entity to manage the CT, and the third option would be a public tender with just one winner. The EC seems to be leaning towards the fully commercial approach, and it has set the stage for a basic workflow where APAs (approved publication arrangements) collect and pass on the data to Consolidated Tape Provider(s) (CTP). But, if market forces alone could find a compromise between cost and implementation, we would have an affordable and reliable European Consolidated Tape (ECT) in place already, and MiFID II could instead concentrate on new problems.

So my first concern with the purely commercial approach is that so far, it hasn’t worked; incumbent exchanges are still charging pre-MiFID levels for their data (despite, or indeed because of, their diminished market share in execution), and the only real effort to break the stalemate (namely, the MTFs throwing down the gauntlet) will end up just penalising the buy-side more in the short-term. If the regulator doesn’t address data pricing head on, the buy-side may well end up suffering the effects of a scorched-earth move (wasn’t ESMA granted more powers than its predecessor CESR after all?).

Industry Initiatives
However, it’s not all bad. The COBA Project has recently announced a proposal which promises to address these commercial obstacles and has initial support from exchanges and other venues which contribute more than 50% of total turnover. Their solution establishes a new commercial model for Consolidated Tape data which lowers the cost and incorporates the best practices recommendations developed by FPL and other industry working groups. The best practices provide details on how trade condition flags should be normalised thereby enabling consolidation of trade data across exchanges, MTFs, OTC and even BOAT. FPL’s best practices recommendations also bring together wide representation from across the industry, and has been concentrating on data standardisation (including timestamp synchronisation and a clear distinction between execution times stamps and reporting time stamps).

The Coba Project is spearheaded by two former exchange and MTF people, and seems to be the most ambitious in terms of setting a deadline (Q2 ’13). For their sake I would like to see that good work recognised, but the EC has not officially endorsed them and I see this as one of the main failings so far. Without this endorsement or intervention, I worry that the whole effort will run out of steam. And if that happens (if the regulator doesn’t give the industry a nudge) I worry it will ironically signal the failure of the freemarket approach and the regulator will have to make an embarrassing U-turn and go for the prescribed, utility model. Remember the case of BOA T, which had the potential to become an ECT, but it perhaps wasn’t endorsed enough.

So we’re in a position where the exchanges and data vendors are rushing to try and come to a mutually beneficial solution BEFORE the regulator steps in and forces a US-style consolidated tape, and by doing so, potentially remove the commercial benefits for exchanges and vendors.

Being a CTP in itself will be a tough business though, and I wonder if there’s such a thing as a commercially-viable CTP proposition: Not only will they operate in a highly regulated business, but a few years down the line there’s the possibility that Europe goes the same way as the US and starts looking at moving away from a CT and instead getting direct fees from the exchanges (a sort of parallel industry, not quite direct competition). Not only that, but because under current proposals their product will be free after 15 minutes, I expect more investors might just accept a 15 minute lag and get the data for free.

Paul Squires, Head of Trading AXA Investment Managers systematically analyses the consequences of structural market change and sell-side head count reduction across the street.

Amid the current market and trading environment the expression “A Perfect Storm” springs to mind because, clearly, the entire industry has seen decreasing margins and volumes since 2008. At the same time, there has been an arms race to invest in technology just to maintain position. Those two things aren’t exactly the best backdrop for cash equity. Furthermore, even if the cash equity business is seen as a loss-leader for other more profitable asset classes, Basel 3 and global banking reforms seem to be impinging upon those commercial realities as well. 2012 was a very tough year for banks and brokers, and I think we’re finally seeing a little bit of fallout from that in terms of strategic reorganisation. It’s not just a seasonal thing now; many in the industry had sustained hope that it was just a tough period, that we would come out of it and that volumes would return to 2008 levels; however, I believe people are realising it’s much more structural.

Splitting Hairs
Commission Sharing Agreements (CSAs) are increasingly an essential facility for the buy-side. CSAs were really the avenue to enable CP176 (FSA consultation paper on unbundling). They reduce the extent to which trade execution might be constrained to where fund managers are getting their advice and service. In other words, the buyside executes with the broker where they have a CSA (provided they can give good execution), paying both an execution and an advisory component at the same time thus building the advisory pot, which can then be used to pay for independent research (or gives the fund managers the freedom to pay for advisory services from a broker whose execution service is not as strong).

More recently, the FSA has said that fund managers weren’t embracing the opportunity to split the different commission components as much as they had hoped, and the FSA is pushing again for that to happen. This is entirely appropriate from a client’s perspective, in my view. It’s the client’s money that’s being used every time the buy-side trades; if you’re paying a bundled commission, that’s effectively the client paying for the execution service and the advisory service and they should expect the best decision for both elements of that.

There are a couple of areas of focus within the current consolidation of advisory services and execution services. On the execution side, we’ve seen most impact from a more strategic ‘top-down’ view of sales trading. In the past, electronic sales trading was seen as supplementary to the traditional cash equity sales trading. There’s been a hard push to set up the provision of algorithms, and that has created a duplicated set of execution services. Now, my desk has taken a decision to focus our contact with our primary cash equity sales traders, but enabling them to see our algorithmic flow. This means that if we’re trading a significant volume of a stock and the cash sales trader can see what we’re doing, we’re optimising all our execution avenues. There is electronic access to multiple venues, but there is also the traditional broker distribution channel.

As part of our regular trading reviews, we explained to our brokers that our cash sales trader is the one who knows our account and our style of trading. We’ve had the historic relationship with them and they are best placed to disseminate the most relevant market information to us very quickly. For example, if we self-direct an algorithmic order, they could see that we were looking to buy a chunk of a French small cap; if they happen to see flow in that stock from another source internally, then they would be able to pick up the phone and say, “I know you’re working an algorithm, but if you’re interested, we’ve got the natural seller.” This is the level of service we want, but it’s taking the market quite a long time to get to that point. Based on our conversations, we’ve discovered that we are in the minority in wanting the sales trader to see the algorithmic flow. In contrast to our view, we believe many in the buy-side see anonymity as the key benefit of an algorithm.

A lot of the buy-side use algorithms almost primarily for the anonymity, which means they end up with a duplicated set of coverage with electronic coverage and cash sales trading. Clearly, that’s an expensive way to organise coverage for a typical asset manager whose volumes have declined substantially in the past couple of years. Therefore, I think we will continue to see brokers moving their electronic teams much closer to the program team or the cash sales traders.

Sell-Side Headcount Changes
The impact on the buy-side isn’t just caused by the fact that the headcount of sales trading has shrunk, it is that the number of clients has expanded. There are now so many small hedge funds and boutique asset managers. In many instances, the sales trader is doing his best to pick up the phone and put the orders into the system but, in our view, he often no longer has time to closely scrutinise the markets and stocks in the way that we used to benefit from.

At AXA Investment Managers, we trade with approximately one hundred brokers a year. But within that, it’s a very concentrated focus with our top 20 or so brokers being absolutely key. In addition, there’s a significant tail of brokers that we need access to less frequently for very specific orders.

There will likely always be two or three brokers, who, while market consensus suggests a certain direction, may feel that it’s worth their while taking a different view and who see an opportunity to gain market share by going against the trend.

Does a buy-side firm these days need more than two or three execution-only brokers who are the traditional sort of agency guys who are very driven to get your flow? They do a lot of work to be close to the market; talk to a lot of people; give you a lot of market colour. I think what this means is that the emphasis has shifted from the buy-side trader picking up the phone to someone on the sell-side who then directs how to execute your order, to the buy-side trader now having all the relevant tools. This concept of “best selection” as a process for us is one of the main aspects of “best execution”; in other words, the due diligence before we decide exactly how we are going to trade the order. Do we pick up the phone because, in fact, we just want a risk price; we want instant liquidity and the immediacy of execution? Do we want to park it passively in a couple of dark pools, and know a particular algorithm that is going to do that for us? Do we want to just pick up a phone to the sales trader and say, “Just keep it to yourself for a while, but I’m looking to buy a chunk of this particular stock in case you see anything in it”? Maybe we want to have a look around the shareholder list, see who might have been active in it and see if we’ve got any opportunities to do cross a block naturally? There are so many different ways to execute now and hence this concept of ‘total liquidity management’.