FIXGlobal speaks with the buy-side in China about the prospects for China’s equity market, IPOs and how new technology and competition will improve domestic trading.
GDP and Trading Volumes The property market might continue to cool down in 2012, but it is not reasonable to expect the Chinese economy to shrink significantly this year because the Chinese government will allocate resources to other sectors of the economy. Because of the Lunar New Year effect, it looks as though Chinese Consumer Price Index (CPI) is heading upwards. Based on adjusted CPI, the property asset bubble is a political issue rather than an economic one. The Chinese government has pledged to continue monitoring property prices, and its strong fiscal position gives them various options in terms of how they address this situation. Trading volumes are expected to be much the same as 2011 and inflation should be heading downwards.
Major Driver: IPOs or Economics? There has been a rapid increase in the number of IPOs in China, but the regulators are questioning the quality of some of the IPO companies. Of those companies newly listed in 2011, valuation declined quite significantly. Investors used to think an IPO was like a lottery – buying new shares virtually guaranteed a profit. Many investors did not consider the actual valuation and quality of the company, and many are now realizing that not all investments are worth their list price.
The Chinese equity markets are in a transition stage; they are moving from being somewhat amateur to being much more economic and investor-driven. There were instances of listed companies in one industry that changed industries after the IPO (often moving into property development) and occasionally changing the name of the company, leaving investors uncertain about their strategy and focus.
Listed companies used to have considerable power, but the market is changing in a positive direction. However, we do not know how quickly the market will become transparent and trustworthy. The regulators, media and institutional investors are now more serious about issues of valuation, transparency, corporate governance, etc. The regulators should consider increasing Qualified Foreign Institutional Investor (QFII) and ways of improving the dissemination of information to investors in order to set a good example in the domestic market.
A primary focus of the Chinese Securities Regulatory Commission (CSRC) this year is insider trading. Addressing this matter will improve the quality of listed companies and give investors greater protection. The regulators are working on improving access to information for investors and institutional funds will benefit significantly from this transparency. Regulators are concerned with addressing both the difficulty of access to information and the quality of information about IPOs, and it is quite likely that they will be able to improve both aspects.
Applying New Technology The biggest technology upgrade implemented in the past six months has been algorithmic trading. Most Chinese buyside use their brokers’ algos, but in China, domestic mutual funds are not allowed to route orders to brokers. So what many dealing desks have done is to install the brokers’ algo engine on their side, so for every algo they choose, they go through their server and send the order to the exchange. In this way, dealers achieve efficiency in their algo usage because they do not use any brokerage; as a dealer, they are almost like their own broker. Algo trading also provides the buy-side with more precise post-trade analysis; specifically, the ability to analyze how much alpha has been captured and the transaction costs involved.
The primary benchmark used by most Chinese buy-side traders is Implementation Shortfall (IS), which is used to generate information to help the fund manager improve their investment strategies. For example, it might provide data about the delay cost created by an investment decision made an hour after the market opens, showing the fund manager that if the decision had been made earlier they could have saved a certain amount on the investment.
In the last 18 months, the credit crunch has distorted equity market conditions significantly, but there are some trends that appear to have continued, despite recent shortfalls in liquidity. To provide some context on these trends, we analyze and quantify the mechanics of trading over a significant period of time, across a wide range of different markets. We confine our study to looking at trading patterns of the most liquid stocks1 in the countries studied.
One of the clear advantages of this cross sectional and historical approach is that it allows the identification of outliers. For equity trading, the clear and consistent outlier is still the US, where trading in the most liquid assets is still faster, and smaller, than the busiest non-US assets.
We attempt to show how significant differences in trading environments are, by looking in detail at the month of October in 2008. We compare all venues analyzed and attempt to place them on the evolutionary line travelled by the NYSE. While interesting, we note that such a comparison implicitly assumes that exchanges will travel the same line. At the very least, the regulatory regimes in different regions should make us question this assumption.
Lastly, we look at bid offer spreads and how they have evolved. These spreads are an important part of transaction cost. We look in particular at how they have evolved over ‘Crunch’ period and beyond.
The Evolution of Size and Speed in Global Equity Markets Over the past ten years, with the growth of program trading, algorithmic trading hubs have moved from novelty to ubiquity. They now manage a sizeable portion of trading activity in major markets. In doing so, they have transformed what was in effect a paper driven process, where traders would calculate what to execute when, into a fully automatic one. Transaction costs have been pushed down to the limits imposed by profitability. What has this process looked like in terms of trade speed, and size? We consider speed first.
We measure speed in terms of typical intertrade duration; that is, the typical time, in seconds, you would expect to wait for one trade to follow another. Results are aggregated over the countries, for the top ten most liquid stocks, per year. We concentrate on continuous, automated trading.
For the US, typical trading duration has compressed steadily. Intertrade times for liquid assets are typically less than 1 second. Indeed, for NASDAQ, intertrade duration for liquid assets is significantly less than this. In terms of the greatest increase in trading speed – and possibly the greatest increase in automation – Europe stands out.