Are the markets crumbling or multiplying? With Josephine Kim, Director, Asia Pacific Electronic Sales – Global Execution Services, Bank of America Merrill Lynch.
How is market fragmentation changing and developing across Asia? Japan had the first mover advantage in Asia as the first to welcome fragmentation, but it has not really blossomed, compared to Australia where we have seen a lot more volume growth on the new venues and execution channels. Hong Kong is quite interesting because most people really want to get fragmentation into that market, but there are limitations such as regulation and the proliferation of fees. Brokers do offer internal crossing engines, so a lot of clients are benefiting from those.
India is also interesting because it had two exchanges for years and recently got a third. We do not see that much activity, but at least it is creating a lot of buzz in terms of how fragmented the market is. It will be interesting to watch.
How are other Asian markets developing? It typically depends on how the exchanges are preparing themselves. If you look at Japan for example, they opened up to various alternative venues and were pretty open-minded in terms of sharing their liquidity with other independent venues. But then the exchanges decided to merge to be more competitive as they realised that liquidity is something they want to keep. Australia is forcing the exchanges to share liquidity with best execution rules.
Korea and Singapore are the two markets most likely to come next, although there are other venues like Indonesia and Malaysia where a few broker-dealers offer limited crossing engines. Korea is a very active market, especially for futures and options, so a lot of people are interested in trading, but then again, they do have the investor ID restrictions and they are trying to implement a financial transaction tax so that is going to kind of hinder the attractiveness of trading.
Singapore is slightly different because the market depth is not as attractive as Korea. Singapore used to be a hub for US and European-based high-frequency trading firms, but it just seems to be losing its ground as a hub. Having the longest trading hours in Asia may open more doors for investors from different time zones but without the market depth, it will still be a challenge for Singapore to attract investors and independent liquidity providers. Minimum crossing rules also draws interesting opinions from people as some believe this will enhance and control the market participants and reduce toxicity of the pool albeit the overall reduction on actual crossing opportunity.
How does that variation across markets affect the trading environment? The buy-side used to choose an execution broker based on the level and quality of research and their trading ideas. Today, the buy-side tends to go with the broker that has the liquidity. So, the buy-side traders are often watching the market and watching their stock, so they can see who is on the order book panel, and they tend to put their entire orders on the brokers with the most liquidity. A lot of this change is tied to unbundling, but it is also to do with the liquidity and facilitation as they often find it difficult to trade when there is less liquidity available in the market.
Are changes such as CSAs enabling that unbundling and enabling that separation between research and execution? Are these tools coming into existence to meet that desired change or are these tools enabling that change? These tools are definitely opening the doors for the traders to choose from. It is simply an option that, because of this policy, the buy-side head traders have the independency to choose the best execution brokers and feel less obligated to trade with the best research providers.
On the sell-side everyone is becoming more liquidity sensitive. The buy-side trading instructions are becoming more complicated; the buy-side still want to have the baseline of a simple VWAP or POV as their first and second algos, but when the liquidity comes in, they do not want to miss out that opportunity, so a liquidity seeking type of smart algo, with a combination of base benchmark, seems to be being used more commonly.
How are the liquidity profiles of those venues changing? Let’s use Australia, as an example. It is mandatory there to provide best execution to the client. That means that it is the broker’s responsibility to find the best execution price, across the dark or lit; it is not a choice anymore, it is an obligation. So, because of that, we started looking at the quality of liquidity pools. The number of liquidity pools has gone up a bit such as Chi-X Australia launching in 2011; and there are numerous exchange provided dark and lit pools – see Table A-1. The quality of each venue has risen as various enhancements or improvements have come online. We now care more about where orders are getting crossed within the dark liquidity, whether it is getting crossed at mid or better, or whether it is having any price reversion after the fill has been made. So, I think that quality is top of mind now.
If you look at the market share, we are still talking about a small portion of the pie – see Table A-2. One has to also have context of this and understand how dark liquidity is performing in the US and Europe – see Tables B1 and B2.
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.
By Gary Stone, Chief Strategist, Bloomberg Tradebook.
The French phrase déjà vu literally means, “already seen.” Have you ever gone to the cinema and felt that you have seen the story before in a different film? Well, Dances With Wolves (1990), FernGully (1992), Last Samurai (2003), District 9 (2009) and Avatar (2009) are different films, however their plots all resemble one another.
Sequels are another example. Story or plot “resemblance” is actually a common occurrence in the film industry — perhaps because producers believe that if the story was successful before, it will be successful again. Over the past 19 years, the equities markets have evolved and transformed. Now, a similar evolution is under way in the Foreign Exchange market. Will the FX story resemble the equities experience? Of course, the market structure and the details will be different but, like films, this story feels eerily similar.
The evolution of the equity market started in 1996. Over the ensuing 17 years, trading technology became more sophisticated. Now, other asset classes and markets across the globe appear to be following a similar evolutionary trajectory (Figure 1).
Equities started as a manual market where orders were communicated to voice brokers. Market makers in the OTC Nasdaq marketplace and members of the NYSE used electronic bulletin boards to display their IOIs or “axes.” Sell-side brokers developed and distributed in-house electronic platforms to communicate to their buy-side customers to capture their flow.
The FIX Protocol, emerged — standardising how platforms could “communicate” with one another. This enabled vendors to develop broker-neutral platforms and solve fragmented buy-side workflows. Electronic order routing then began as a workflow and straight through processing solution.
As transparency improved, so did trust and empowerment. The buy-side sought greater control over orders. Different pricing models (maker/taker) and innovative order-type algorithms (e.g. Iceberg, Pegging and Discretion) to help control execution were developed. Competition in the marketplace emerged, thus fragmenting liquidity. Soon “smart order routing” aggregated the fractured liquidity and the early adopters on the buy-side started to deal directly in the marketplace.
The empowered marketplace that we now know in the equity markets gained significant momentum when algorithms that controlled all aspects of the execution were released. The buy-side and sell-side, rather than controlling each slice of a large order, were able to use algorithms to try to achieve a desired result. Early adopters significantly reduced implementation costs with these algorithms. The Association for Investment Management Research (AMIR/The CFA Institute) and mutual fund boards began to discuss electronic trading and algorithmic execution as part of “best practices” in buy-side trading rooms.
FX is standing on the shoulders of the equity experience. Many of the execution innovations developed in the equity market are being “tropicalised” and are starting to be adopted by FX market participants. During 2012, FX electronic trading grew both in usage and sophistication. According to a 2012 Streambase Systems survey of more than 240 institutional FX traders primarily located in EMEA and the United States, 69% of participants said that they used multibank platforms for execution, up 17% from 2011. However, the marketplace is now starting to make the leap beyond simple order routing. This is why the FX “film” is starting to feel eerily similar to the equity evolution.
Both the Streambase survey and the Bloomberg Tradebook FX experience suggest that that buy-side and sell-side participants are demanding more algorithmic execution capabilities to enable them to control how they want their orders to be transacted in the market.
The FX market is a highly fragmented market of different pools of liquidity. Banks have developed their own pools of liquidity and many ECNs have emerged as alternative sources. The Streambase survey noted that “liquidity aggregation algorithms” (smart order routing) were among the most commonly used execution algorithms by buy-side (54%) and sell-side (64%) survey participants. More advanced order handling execution management algorithms — algorithmic trading strategies that manage all aspects of an order to achieve a desired result — are also starting to gain traction.
Algorithmic trading strategy usage topped 48% in 2012, a 14% increase from a year earlier. The survey also suggested that further growth can be expected as 75% of the buy-side participants said that they plan to use or increase their use of algorithms for execution. Algorithms can be tactical or benchmark driven. The survey noted that the buy-side has begun to leverage the more sophisticated algorithms including; (passive) Floating (30%), time-slice (29%), TWAP (22%) and VWAP (29%).
Tradebook’s experience is consistent with the Streambase’s findings. More and more traders are using algorithmic trading strategies with increasing degrees of sophistication to implement their institution’s investment approach. Tradebook’s clients’ total notional executed with algorithms grew by more than 23% from Q1 2012 to the end of Q1 2013. Buy-side traders used tactical algorithms such as IF/Done, One-Cancels-Other, Economic Event and Target orders that control when an order is released into the market. Usage of more sophisticated algorithms such as Reserve Scale Back (efficiently manages the accumulation/distribution of a position/order), Discretion, Passive Pegging, Time Slice and TWAP also grew significantly.
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’.
Adrian Fitzpatrick, Head of Desk Central Dealing at Kames Capital expresses strong opinions on the current state of fixed income market structure. What needs to be changed to improve the market?
What is driving managers into equities? A lot of it depends on which market you’re looking at. If you look at the European markets, there has always been a high weighting in bonds. There’s never really been the equity culture to the same degree as you have in the UK. Obviously in the UK a lot of it is driven by the insurance companies that have actuaries to dictate where the split between equities and bonds lies. Before these pensions’ time bombs, the safest investments for most people were bonds. However, we are all working on the assumption that bonds are currently completely overvalued, but as long as there’s Quantitative Easing they are going to hold these abnormally low levels of yields.
The other thing is institutions don’t want to stand out from the crowd. If everyone’s in bonds and bonds fall then you are going to fall together. There’s so much short term-ism in the market, you can’t afford to be an outlier for a long period of time and then not be right. I think risk assets now are relatively cheap; you look at the yields on risk assets compared to the yields on government assets, some of the credit assets like high yield are still quite reasonable. The bond markets are over valued , but it’s probably not going to change until the QE bubble bursts.
So the macro economics is feeding into that bubble? Yes definitely. It’s like we said about the dotcoms: Why are you buying things that are at that level? We all know if you go back historically and look at bond yields in the UK, they should be around 4½/5%. But at the current level, it’s only sustainable as long as the Bank of England and the government are prepared to keep rates abnormally low because of the state of the economy. So can we see that carrying on to 2013? Definitely. (See diagram on next page)
You’ve got the government printing money, so all you have to say is, “Where are you going to put your assets?” Unfortunately in the environment that we are in you just can’t stand that far away from the crowd for a period of time.
What is the main problem with the fixed income market? Effectively the market is not transparent, unlike the equity markets, which are. In equities you can see commissions, you can see the prices, you can see what gets printed. In the bond market you can’t. Platforms have been around for a long time, the likes of Tradeweb, Market Axess, and Bloomberg Tradebook, etc. These will keep gaining more traction because you can send them multiple requests for quotes and they are creating a virtual marketplace, which the regulators will like.
It’s not uncommon to send a trade down electronically to one of these platforms, and for all the banks to just pass; there’s no obligation to make a price or to make a marketplace. They make the price when it suits them. Personally, having traded multiple asset classes, that, to me, is not a marketplace.
You end up working with the fund manager to try and find the other side of liquidity. It’s such a captive market that effectively sooner or later, there has to be some outlet valve that gives institutions the opportunity elsewhere. Obviously, when you look at equities you had the establishment of crossing networks many years ago, of which Liquidnet and E-Crossnet were forerunners. Now what you are seeing on the bond market, through Blackrock’s Aladdin and UBS PIN, are various other brokers trying to get that same result.
What they are trying to do is encourage the institutional investor to create more of an electronic market. The biggest problem is in equities you have, for example, Vodafone, but in corporate bonds you can have 12 credits for the one stock; therefore it’s very difficult to identify a specific one and find a natural cross against it. So it needs to be a slightly different approach for bonds, just because it is a different discipline. You have different variables in bonds, the spread, which obviously a lot of fund managers work off, and you have the underlying Government bond.
The banks are going through what happened in equities. But equities aggregation is now the key; tools have been created that aggregated across the different dark pools to allow you to send one order to many venues. I think that what is needed is an institutional crossing network similar to Liquidnet. We need to create competition away from the banks. However, this isn’t necessarily all the bank’s fault because they say “we provide the risk and therefore we should be able to choose when we make prices.”
However, the biggest institutions are very close to the banks; they can dictate when they want to trade.
For us as an institution, it becomes incredibly difficult not just sourcing liquidity, but being able to trade out liquidity when we need to, because you are totally at the behest of the investment banks. In equities you can trade by program, by algorithm, you can ask for a risk price. You may not like the price, but the market will always make you a price and you can decide whether you actually want to take it.
In bonds, a broker will send out what’s called an “axe”. The axe is effectively the bond equivalent of the IOI. You’ll phone to follow up on the axe but they can back out. There’s no obligation.
In government bonds, where the electronic systems are more established you can trade more effectively, and it is getting there, but the credit part of the market is just completely arbitrary.
Who is going to drive reform? It will have to be driven by the regulators, in the UK by the Bank of England, and it has to be driven by institutions. The problem is institutions aren’t members of the market. Institutions don’t have the IT infrastructure or the IT spend to be able to create new platforms unless you are a Blackrock or a Pimco.
In the US they use TRACE, and we need a similar system as we need to establish ways for institutions to understand who is doing what, so you can target business to the broker or investment bank. And if not, there should be some form of platform that allows institutions to cross up against each other.
Emmanuel Doe, President of Trading Solutions, Interactive Data examines narrowing structural differences between Asia-Pac and the rest of the world.
Asia Pacific is fast emerging as a hub for electronic trading globally. Despite the fragmented geographic structure of the region and a complex regulatory landscape, international traders are finding Asia-Pacific increasingly compelling as a business opportunity to help differentiate their trading strategies from other participants.
Many firms are increasingly attracted to the Asia-Pacific region because of its diversified range of markets. In terms of high frequency trading the developed markets – Australia, Japan and Korea – have evolved their infrastructure based on European and North American best practices. The developing markets, such as China, Hong Kong, India, Singapore and Taiwan, are investing in technology upgrades and are catching up with the more established markets.
However, despite the attractions of these markets, a number of operational and infrastructure challenges still remain for traders.
The regulatory landscape within Asia-Pacific is complex due to the lack of a single regulator driving the regional equivalent of a MiFID or RegNMS style regulation that would place multiple markets into a coherent framework, drive standardisation and potentially reduce clearing costs.
Some national regulators welcome overseas firms and competing execution venues, while others are more cautious. Transaction costs also vary and in some of the markets can be significant due to stamp duty and transaction taxes, which are charged on top of commissions and spreads.
This is likely to change as more global firms enter these markets. Asia Pacific’s advantage is that it is still relatively immature compared to the US and Europe and so can learn from the developments within those markets and consequently adopt a more balanced approach to reform
Given the distances between major trading venues, network latency is an extremely significant factor for electronic trading in the region. For example, the direct route between Tokyo and Hong Kong is approximately 2.5 times the route between New York and Chicago, or approximately 4.5 times the distance between London and Frankfurt. This inherent latency does have an affect on the decision on where to locate trading operations in the region and how to execute multi-venue trading strategies.
Location also tends to be determined by the type of trading strategy employed, such as single market cross-asset, multi-market intra-region, or multi-market inter-region. Hong Kong is seen as the key venue for traders looking to access China, while Japan has strong links with Chicago and Singapore for futures trading. Singapore is fostering links with the emerging Southeast markets (Malaysia, Vietnam, Indonesia, the Philippines, and Thailand) via the Association of Southeast Asian Nations’ (ASEAN) trading link up to facilitate increased cross-border trading in the region.
Demand For Co-Location And Proximity Hosting
Co-location is nothing new in the West and the trend is now extending eastwards in order to minimise order roundtrip latency for firms executing on the various Asia Pacific exchanges.
With the increased focus on the region, there has been, in turn, greater demand from trading organisations for enhanced connectivity and co-location availability. Many of the region’s major exchanges have responded to this. According to research by GreySpark1, 61% of exchanges offer co-location services and 39% offer proximity hosting.
There has been a sustained period of technology investment in the leading markets of Australia, Hong Kong, Japan and Singapore as well as in the emerging markets that are trying to compete with the traditional liquidity centres. This investment has included trading system upgrades to boost capacity and speed, adoption of standard technology offerings from NYSE Technologies and NASDAQ, and the introduction of Direct Market Access (DMA).