Brian Ross of FIX Flyer talks to Buy- and Sell-side presenting the latest lessons on high frequency trading and algorithms from the Indian market.
India’s capital markets are experiencing increased interest from local and global firms and new rules are set to attract high frequency trading (HFT).
The capital markets regulator, the Securities and Exchange Board of India (SEBI), the exchanges, brokers and many investors are in favor of abolishing Securities Transaction Tax (STT). Eliminating STT will have a positive impact on market turnover, will help high frequency traders to be more profitable and, at the same time, narrow spreads should drive up trading volumes.
STT has been levied for all trades, domestic or foreign, on all transactions in either equities or derivatives markets since 2004. At the time, the purpose was to generate tax revenue and to protect market integrity by slowing down the pace of technological advancements of a few, well-funded players. Revenue generated by STT amounted to around USD 1.5bn in 2011.
It is widely expected that STT will be eliminated this spring, bringing new opportunities for HFT in one of the world’s biggest and fastest growingcapital markets.
To better understand the situation, we asked five panelists who are leading the charge in HFT in India, to share their insights with us.
You never forget your first algo. When you first got involved in algorithmic trading, what problem were you trying to solve? What was your decision process, and what technologies did you use?
Sanjay Rawal, Open Futures: We started off using algos for trading purposes and the first one we built was for a specific type of arbitrage that was getting difficult to run using manual input. We used third party software for the exchange connectivity and wrote our algo in C#.
Vishal Rana, IIFL Capital: My first experience with HFT was trying to create a straight-arb model on a real-time basis. Although it was a simple model, the most difficult thing was to clean the data. We got the data dumps and it took a lot of effort to clean it. Most of the coding was done using C++.
Rohit Dhundele, Edelweiss: At the onset of the project, the easiest yet most important task was gathering the business intelligence to be subsequently converted to algorithms. Some of the more intricate decisions were the selection of order, execution and risk management systems to ensure a stable back-bone to the platform. Other equally important criteria were a flexible programming environment and a friendly interface for users. To achieve these objectives, we had to decide whether to build or buy this technology.
At Edelweiss, we realized relatively quickly that there is a sweet spot between the two extremes of in-house vs. outsourced solutions. We have since been following this model – combining the best of both worlds, which has helped us deliver customized solutions within acceptable turnaround times, whilst still protecting our IP.
Sanjay Awasthi, Eastspring Investments (Singapore) Limited: In the Indian markets, propelled as they are by rapid information dissemination systems, anonymity becomes a key factor in determining efficient trading. It was this need for anonymity that propelled us towards algorithmic trading. Continued use and familiarity lead to further benefits by way of better execution control. Algorithmic trading has thus become an important part of our execution arsenal.
Chetan Pandya, Kotak Securities:
The first algo I worked upon and put in production was calendar rolls for derivatives. Our trading desk had huge positions to roll from the current month to the next and manual execution was leading to slippages and erroneous executions at times. Using the 2 legged order of NSE we created a simple algorithm which would roll the position at desired spread.
My first observation regarding algorithmic trading was to appreciate the difference between an individual trading manually versus a machine trading automatically. There are so many things that come naturally to a human being but needs to be told to the machine. Sometimes I wonder whether an algorithm can fully replace a human being ever. There are those nuances of the market and events that lead to erratic market behaviour that cannot be fully programmed for reaction.
Also, I had to ensure that there is no room for error when you are trading using an algo platform, primarily because of the sheer number of orders that it can process in a single second and also the inability to spot something going awry with the naked eye given the sheer speed. Hence, I had to also think of risk management capabilities of the Algorithmic platform while needing to ensure that risk management does not lead to inefficient execution due to latency.
In terms of technology, we were limited to applications that conformed to our market regulations. Once we had the base framework and architecture ready, we integrated it rapidly with our existing applications for order routing and downstream workflows.
Simo Puhakka, Head of Trading for Pohjola Asset Management, shares his experience trading in the Nordic markets, giving his opinions on interacting with HFT, using TCA and knowing whether you can trust your broker.
The prospects for High Frequency Trading (HFT) are really up to regulators. It will be a free market, but as we all know, regulatory changes affect the whole trading landscape. For example, we can see what is happening in France and the debate that is going on in Sweden, which are quite hostile towards HFT, so those countries.
Personally, I think that HFT is a good thing for the market, as long as you have the proper tools to deal with it. There are a number of small firms that have been suffering from HFT
since MiFID I because they lack the proper technology and tools to measure and deal with it. We have not suffered in our dealings with HFT, and I would actually say in many cases, it is the opposite. HFT firms seem to add liquidity and when you have the proper tools to deal with it, you can take advantage of it.
Speaking of tools, we started building our own Smart Order Router (SOR ) a year and a half ago. The goal was to create an un-conflicted way to interact with the aggregated liquidity. In this process we went quite deep into the data and turned processes upside-down with the result that we have full control of how we interact with the market.
On the other hand, I welcome technological innovation from the sell-side; for example, brokers now disclose the venues where they execute trades on an annual basis. The surveillance responsibilities that brokers have are beneficial. Many of the small, local brokers and buy-sides, however, are now finding it challenging to upgrade their technology.
Trusting your Broker
Our approach was to take control of our order flow and only use our brokers for sponsored access. We chose full control because, in some to deliver what I am asking.These questions first arose a few years ago, and we realized we needed to create a transparent, fully-controlled, non-conflicted path to the market. How you interact with different venues – even lit venues, where you have more transparency – will affect your choice of strategy. In most cases, you are better off without brokers making decisions for you. The root of the problem is, when you send an order to the broker, what happens before it goes to the venue? What control do we have over the broker infrastructure, including their proprietary flow, internalization, market making and crossing, not to mention the routing logic?
When we dug into the data, we were quite surprised to see that, although a broker was connected to all the dark liquidity, many of the fills were coming from that particular broker’s dark pool, suggesting there are preferences in the routing logic. Brokers want to internalize flow, which is not a problem, if you are aware of potentially higher opportunity costs. When it comes to dark liquidity, that is an even bigger problem, since our trades were often routed to the broker’s own dark pool or those it has arrangements with.
Australian Securities and Investments Commission’s (ASIC) Greg Yanco tells FIXGlobal how Australian markets are preparing for the future, including the launch of Chi-X Australia.
What are ASIC’s goals for an Australian consolidated tape?
ASIC has consulted with industry in relation to options to consolidate data from all venues. In Consultation Paper 145: Australian equity market structures: proposals (CP145), two options were put forward – a single provider established by tender process or multiple providers provided by ASIC. To this end, respondents overwhelmingly preferred a multiple consolidator model. As we have previously stated in the Response to Submissions on CP145 Australian equity market structure: proposals (REP237), this was based on industry expectation that existing data services can produce the most efficient outcome for users.
Submissions also overwhelmingly supported the proposal that market operators should be obligated to provide information to consolidators on a non-discriminatory basis in order to maintain a level playing field. While ASIC expects that more than one consolidator will emerge in Australia, if it becomes apparent that no industry solution is likely to eventuate to consolidate data from all markets, ASIC may revisit the issue and consider introducing a single consolidator via a public tender process.
Are additional clearing agents needed in Australia?
ASIC is aware that the topic of additional clearing agents in Australia is indeed a timely one. It is currently in discussion between industry representative bodies, ASXClear and RBA (as the regulator in the clearing & settlement space) with ASIC as an observer. Issues have arisen as to both quality and quantity of third party clearers, as ASXClear seeks to significantly increase minimum capital adequacy requirements for clearing participants, in particular third party clearers.
It is an area that ASIC will continue to monitor and a discussion that will be followed with great interest, both inside and outside of ASIC. We look forward to continued frank and candid discussions with the financial industry in this space.
How can smart order routing be most effective?
Smart Order Routers (SORs) will assist market participants in meetingtheir best execution obligations in a multi-market environment. Some participants will use SORs developed by independent service providers and some will build their own systems in-house.
Trading participants will be able to route orders automatically to different venues depending on specified criteria. In a multimarket environment the routing of orders could be split across venues depending on liquidity. In this way, ASIC expects that clients will received a better outcome overall, particularly so for retail clients, who will receive the best price across the markets unless they wish to instruct otherwise (e.g. for an order to be executed with an emphasis on speed, rather than price).
Does ASIC seek to encourage high frequency trading in Australia? If so, under what terms?
ASIC neither encourages nor discourages the practice. High frequency trading is, however, an area that is continuously monitored by ASIC, and we will respond if necessary to ensure that any such activity does not interfere with market integrity and fair, orderly and transparent obligations. In addition, market operator platforms must have adequate and scalable throughput capacity.
In the coming months, ASIC will release a consultation paper (CP) pertaining to the broader enhanced market structure. This CP will discuss, among other things, the issue of market makers in the cash equity products. We look forward to industry feedback to this CP when released in the next few months.
RCM’s Head of Asia Pacific Trading, Kent Rossiter, unmasks the Asian trading scene, sharing insights into how RCM navigates the unlit landscape, identifying the effects of dark liquidity and highlighting ways brokers can facilitate better buy-side decision making.
FIXGlobal: What are the main benefits of dark liquidity in Asia?
Kent Rossiter, RCM: One of the major challenges in Asia has always been accessing liquidity without other parties in the market taking advantage of your position and your need to complete the order. In cases where liquidity is scarce, knowledge that a relatively large order is being worked can expose investors to various risks. In such situations, it is advantageous for knowledge of the deal whilst it is being worked to be discreet until the order is filled. In dark pools run by brokers we can get priority on our orders through queue-jumping.
Dark pools support such an approach as they allow large block orders to be worked without showing size. In this way, trading in dark pools allows a trader to access a broker’s own internal order flow, without being gamed by the market that would otherwise risk non-fulfillment or less efficient pricing. As a result, size trading becomes the norm in dark pools and a trader gets to see blocks that may never have been available otherwise. With no information leakage we are not disadvantaged by the fading you see on lit venue quotes. From a personal perspective, the challenges that arise from dealing across a number of venues and the resulting increased use of technology make the role more exciting and satisfying.
FG: How do you limit information leakage in dark pools?
KR: With the exception of broker internalization engines, the trade sizes found in dark pools are often multiple of what they are on the exchange. So having fewer, but larger prints reduces information leakage, and in many cases we can get done on our size right away. Minimizing the number of times a print hits the tape reduces the chance of this footprint being picked up and working against the balance of your order. That said, broker internalization engines do their part well, keeping any spread savings among the two broker’s clients instead of giving it up to the general market.
FG: If you decide to seek dark liquidity, how do you decide between broker internalizers and block crossing networks?
KR: The type of dark venues being used for various trades (i.e. between block crossing networks and brokers) are different. As I mentioned, brokers for the most part are matching up little prints that otherwise would have been time-sliced in the general market, and when using these venues the goal is often to save a few basis points along the way while you work an order. You are not often micro-managing each fill, but through the process we are getting spread capture and price improvement. The type of stock you are often trading in these internalization engines are often larger, more liquid stocks; the type of orders often worked by algos.
Block crossing networks on the other hand, while still matching up electronically, are probably more confidential, and take up the function of what brokers still do upstairs - putting blocks together - so size is the real focus here. Both types of dark pools use the primary market for price sourcing since the vast majority of trades get printed at or within the best bid and offer. As the primary markets become too thin, it can cause price formation problems.
While it is not specific to the consideration of dark pools as an extra execution venue, we have to consider potential increased book out costs if we do use dark pools (except via aggregators, since we would only be using one counterparty), just as we have had to for years when deciding whether to execute a block with a single broker versus multiple counterparties. As dark pools proliferate there is an increased chance that we may not have part of our order in that pool at just the right time to take advantage of flow that may be parked there. Dark pool aggregators are aiming to provide the buy-side solutions to this.
RCM’s Head of Asia Pacific Trading, Kent Rossiter, points out some of the good and bad of Indian SOR and reflects on Hong Kong market structure.
Are Smart Order Routers (SORs) in India working well?
SORs sure are working in India. I am not sure what is more of a raging success in the Asian equity SOR world, India or Japan, but the cost savings estimate numbers we are hearing are evidence enough to suggest that Indian SOR development is a big plus.
For ages, there have been two meaningfully big markets; the Bombay Stock Exchange (BSE) and National Stock Exchange (NSE). Up until a year ago, when Securities and Exchange Board of India (SEBI) opened the playing field up, investors who wanted the liquidity of both had to do so by manually monitoring their screens. This was painfully labor intensive and with the thin displayed liquidity of bids and offers, difficult to actually execute. You would often find fills from one exchange or another being executed at inferior prices to the other as a dealer had their eyes off the ball. Those executions were inevitably followed by a conversation with a dozen excuses. I would be told what I was seeing on my screen was not the real situation, but a latency delayed picture.
For the most part we are only using brokers with SOR for our Indian executions, and these brokers co-locate servers so latency is no longer a concern. We are getting fills at the best prices available and from two pools of liquidity where we may have only had one in the past. Only if the order is really small would we limit ourselves to one exchange in an effort to save on ticketing charges.
SOR is just the most recent visible step in the broader trend of the evolution of markets. Accordingly, the buy-side and sell-side traders have to educate themselves and keep up.
What are the issues with Indian SOR?
It is the lack of interoperability at the post-trade clearing level that has limited the true savings many investors would have benefited from otherwise. This is a challenge that SEBI continues to address. The lack a central clearing counterparty for the NSE and the BSE causes settlement costs to be about twice what they would be if only one exchange were used, and this is a consideration for most institutions when deciding whether or not to use two exchanges. If the exchanges and SEBI could reach a solution in terms of interoperability arrangements for SORs, the cost savings and benefits of SOR usage could be passed to the end users. Until then, its true potential remains yet to be uncovered.
Gen Utsumi, a longtime member of the Japanese electronic trading community, talks about how the events of 11 March 2011 may indicate the future direction of electronic trading in Japan.
When I was a teenager, I loved computers. Back then it was really exciting to wait for the release of a new personal computer every year. My first PC was the NEC PC-6001MK2 which was the first Japanese PC with synthetic voice speaking ability – it had 64KB of memory and a cassette tape player. For more than 20 years, the world of computers was a very exciting place. There were always new technologies evolving in the industry and so many talented people shared that excitement.
Now, computers are even more advanced, but people are not as excited as before. The computer industry seems to have matured. Could we say the same for electronic trading?
Nine years ago, when I started to sell FIX engines in Tokyo, ‘STP’, ‘Electronic Trading’ and ‘FIX’ were the buzzwords. Having a FIX interface was an exciting thing and sometimes when an exchange introduced their FIX interface based on real needs, they also used it as a marketing tool. Electronic trading was a frontier of the financial industry and I met a lot of people with ‘frontier spirit’. Once an electronic trading link was established via FIX or other means, new services and strategies started to emerge, such as Proprietary Trading Systems, algorithms, Smart Order Routers (SORs) and dark pools.
These, along with technological advancement, brought a wave of colocation and low-latency products and the race is still going on. Now it seems that having ‘microsecond’ latencies is not surprising anymore. Would latency be exciting again if it were in nanoseconds? My guess is, probably not. While there are still ways to make money in electronic trading, the industry seems to have matured.
Allow me to make another analogy: Japan. Japan has also matured socially and economically. Infrastructure is well established yet Japan’s boom period has long since passed. General sentiment is gloomy due to government resignations, a low birth rate, low economic growth, huge government debt, and reduced trade profits because of global competition.
Then the earthquake hit on 11 March 2011. Surprisingly, people were relatively calm in Tokyo, considering the magnitude of the event. There were many rumors circulating regarding the Fukushima Nuclear Power Plant, but people continued doing business as normally as possible. I will not repeat the grave details here, but I would like to point out that many people are starting to say that this event was a sign of change.
Now three months later, there are signs of recovery here and there. With disaster of this scale, it is obvious that help from the government is not sufficient to respond to the needs of all those people affected. Refugees are being supported by volunteers, families, neighbors and friends. There are over 2,000 refugee camps and some camps are better equipped than others.
One particular refugee camp I know is getting considerable support including food, trucks, bicycles and other living needs as well as comics for the kids – all of which are brought in by supporters. People visit the camp every weekend from Tokyo and the people in the camp welcome those supporters whole-heartedly. There was a strong mutual ‘trust’ established between the people in the camp and their supporters. The camp next to it is not doing so well; they accept donations and goods at the gate, but they do not welcome volunteers and supporters to visit their camp. There was no ‘trust’ here.