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Schroders’ Head of Asian Trading, Jacqueline Loh, shares her thoughts on trading in Asia, offering comments on which markets are primed for change, how to find value in dark pools and whether unbundling is as useful as people say it is.

Asian Fragmentation

Fragmentation arising from multiple sources of liquidity is a necessary step in the evolution of best execution and in the long term, fragmentation will increase the quality of trade executions in Asia. What it means for the buy-side is investment in infrastructure spending to develop new order routers and the like, so we can electronically seek out and have exposure to multiple liquidity sources. For the sell-side, it means acceptance that there will be more competition for the same block of business in the marketplace. It means different things for different buy-side firms as well.

Investor IDs

When I think about the investor ID markets in Asia, I am not sure any model is particularly productive because ID markets make it administratively more difficult to trade. IDs can make best execution very difficult to implement, especially if cash and stock checking is the primary consideration. Some of the ID markets, namely Taiwan and Korea, allow trading through omnibus accounts and that seems to be the way it is evolving. The ID markets are slowly going away, but having said that, the most productive example is probably China because the brokers seem to have a handle on exactly how much cash and stock you have in your account, and therefore how much you can sell and buy. You cannot overspend or oversell, and it is relatively easy to take part in IPOs.

Trade allocation used to be a problem with investor IDs; for example, explaining to compliance and regulators why the prices are not exactly the same between accounts. In these cases the use of omnibus accounts really help. Executing through omnibus ID means you know exactly what is in an account and do not experience many of the issues associated with overselling or settlement. It is a lot cleaner.

With retail-heavy markets, anonymity is the primary consideration for us. We tend to trade more using electronic means and make use of dark pools in retail-heavy markets. In addition to that, the algos we use will be more price-specific, rather than volume-participation models, which are more price impacting.

Best Execution, in the Dark?

You would think that dark pools would have more success in markets where spreads are currently wide and there is a need to be anonymous, which would imply ASEAN markets. In practice, however, it has had more success in Hong Kong, and that is because there are more users of electronic trading there. Perhaps the users are a little more sophisticated as well insofar as they are willing to take accountability for their executions. Which is, in fact, what defines electronic trading.

In our experience, dark pools make a difference in terms of liquidity, however, the question is what creates that difference? Is it the electronic trading system feeding through the dark pool that provides the benefit or is it the dark pool, itself? I would say it is the former, but that may depend on each user. routers. I hope the Securities and Exchange Board of India will consider further change including allowing stock crossings and clarifying the rules regarding P-Notes.

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.

Guosen Securities’ Shen Tao reveals the latest trends in algo usage by Chinese asset managers, domestic mutual funds and Qualified Foreign Institutional Investors (QFIIs).

Who are the primary customers for algorithmic products in China?
Algorithmic trading started in the Chinese A share market some time in 2007. In 2005, the first commercial FIX engine went live to accommodate the execution needs of the Chinese A share market of Qualified Foreign Institutional Investors, or QFIIs, as part of the plan by the Chinese government to allow regulated capital market investment by foreign investors. After an initial experimental phase of FIX connectivity with global trading networks, the local FIX trading platform became solid enough to interface with a real algo engine. In 2007, some leading global investment banks (predominantly, QFIIs from the sell-side) began to offer algorithmic trading facilities for their clients and their own proprietary trading desks. Most of these facilities were located offshore (e.g. Hong Kong) and connected to the Chinese brokers’ FIX gateway via a financial trading network such as Bloomberg.

The earliest providers and users of algo trading in the Chinese market were solely QFIIs and their clients. In 2008, although the global market was in turmoil and many infrastructure budgets were cut across the international financial community, there were still some firms seeking expansion opportunities for the future. Among them, some global banks with local brokerage joint venture subsidiaries began to build their onshore algo facilities. At about the same time, some leading purely local brokers also started their efforts in algo development, Guosen among them. We started in March 2008 and also targeted QFII investors for algorithmic trading, however, we understood the future of algorithmic trading in the Chinese market would rest on the domestic mutual fund industry. In late 2009, the Guosen algo platform was almost ready and the aforementioned onshore algo facilities run by the sell-side joint ventures of global banks also went live. The day of the algo had finally arrived for China.

In 2010, with support from a leading buy-side OMS vendor Hundsun; Guosen and UBS began their efforts by offering an algo solution for local mutual fund companies. In November 2010, UBS won its first success with two Beijing-based mutual fund companies, with Guosen securing a third six months later. Since that time, more than a dozen mutual fund companies have started using algorithms from UBS and Guosen. 2010 was the first year of the algo, from a local perspective. Currently, the momentum of mutual fund companies adopting algo platforms continues. We estimate that by the end of 2011, in terms of assets under management, over 40% of the local mutual fund industry could be covered by broker-provided algo services.

In retrospect, QFII investors were the founders of the market, but soon, the local mutual fund industry will become the primary user of algos. In addition, we foresee insurance companies adopting algo trading soon.

Annie Walsh of CameronTec spoke to FX users to better understand the topical issues and challenges facing the OTC Foreign Exchange market and the central role FIX can play in addressing these challenges.

 Undoubtedly the capital markets in 2011 will be remembered for many history-making moments including some of the largest currency moves the market can remember. We have witnessed the global foreign exchange market — the most liquid financial market in the world with an average daily turnover in the vicinity of USD4 trillion — bear the brunt of one political crisis after another, causing widespread volatility and difficult to pick currency moves.

 
Currency friction in Europe and between the US Administration and China will no doubt remain a prominent feature of the global economy for at least the next 1 – 2 years. On top of this remains uncertainty of government, particularly in Europe, and the implications for continuity of fiscal and monetary policy.
 
Many investment banks too in their search for alpha have been left wondering ”where did the black box get it wrong?” following lack lustre P&L performance, almost industry-wide over recent months.
 
Without a formal open or close, the FX market presents a true ‘follow the sun’ global market, with inherent levels of opportunity and risk.
Against this uncertain backdrop, the FIX Protocol has great potential to centrally feature in what is undoubtedly the single greatest threat (opportunity, if you prefer) facing the global OTC FX market. That is of structural uncertainty compounded by impending regulatory change to be ushered in, courtesy of Dodd Frank, and MIFID II and III.
 
With no unified or centrally cleared market for the majority of trades, and little cross-border regulation, due to the over-thecounter (OTC) nature of currency markets, these are rather a number of interconnected marketplaces, where different currencies’ instruments are traded. Inevitably OTC FX will move, however grudgingly, away from its long-standing (self-serving) model of self-regulation, toward greater levels of transparency, regulatory oversight (either directly or indirectly) and centralised clearing.
 
A Two Speed FX Market
As currently drafted, spot, outrightsand swaps are to be exempt from Dodd Frank’s requirement to be traded via Swap Execution Facilities (SEFs) and be centrally cleared; FX options, Cross Currency (CCY) swaps and Non-deliverable Forwards (ND Fs), however, are not. A perhaps unintended consequence of this two speed approach is the potential for jurisdictional arbitrage, product/financial re-engineering and further fragmentation of execution venues and liquidity.
 
In the short term, it also means that the sell-side needs to fundamentally reconsider strategies for design, development and deployment of Single Dealer Platforms (SDPs). Multi asset class SDPs will now necessarily evolve to become simultaneously both an execution venue as a destination and a gateway to a SEF, depending on the instrument traded.
 

上海证券交易所（上交所）白硕总工程师介绍STEP协议的重要性及其在中国的发展

On 5th July, 2011, more than 115 domestic Chinese buy-side representatives gathered at the Westin Beijing Financial Street for the OnDemand event to discuss issues related to the Qualified Domestic

Dr. Bai Shuo of the Shanghai Stock Exchange (SSE) explains the importance of the STEP Protocol and its development in China.

One of the advantages of being a late starter is that you get to see what everyone else is doing and assess the best model for you. This has been the case in China, where its financial markets didn't evolve their way into electronic trading; rather they simply started with it. The question now is whether China will join much of the rest of the world in speaking FIX, or whether it will continue with its homegrown protocols.

China took advantage of its status as a relative late bloomer among the world's financial markets, by building a high-capacity, fully electronic trading infrastructure from the outset. As its capital market liberalization plans unfolded in the 1990s, the authorities were quick to realise that a highly-automated, paperless, technology-driven marketplace was the key to encouraging efficiency, standardization, accuracy and straight through processing (STP).

As such, both the Shanghai and Shenzhen stock exchanges, launched in 1990 and 1991 respectively, were established on these principles and set the foundation and standards for highspeed electronic trading. The result was rapid growth in the country's investment community, as well as a boost to the domestic financial technology companies, that moved swiftly to keep pace with the demand for high-speed trading.

While China's markets are still, comparitvely speaking, in their infancy in terms of breadth and depth, this early groundwork has created one of the most highly automated trading systems in the world. While other emerging markets are still struggling to move on from legacy infrastructures or manual trading processes, China has instantly catapulted into the realm of fully STP and virtually seamless T+1 clearing and settlements in its domestic equity markets.

Since the 90s, China’s capital markets have continued to evolve, mainly through a combination of gaining experience from the international financial markets, and domestic innovation.

Automated, but not standardized
However, in keeping with several Asian exchanges, China’s marketplaces have their own unique proprietary protocols. So, while trading in Mainland China’s various marketplaces may be completely electronic, there is no single, standardized messaging standard used to transact. These factors have, to some extent, stymied its potential to develop.

Shanghai and Shenzhen stock exchanges both use their own unique protocol, while the exchange gateways to the order entry systems and network are operated via their communication subsidiaries, STOCOM (Shanghai Stock Communication Company) and SSCC (Shenzhen Securities Communications Company). Similarly, the Dalian and Zhengzhou Commodities Exchanges, as well as National Interbank trading platform, each have their own interfaces.

Still a way to go ...
When China joined the World Trade Organisation in 2001, it made clear that its preference was for a prudent and steady approach in the liberalization of its economy. The approach for the financial market was twofold: sustainable development, without threatening the development of the domestic financial sector; and allowing China's investors to gain experience in global markets without getting burnt.

While China has made incredible progress, there is still an extremely wide gap between its domestic set-up and that of the international markets. In particular, with the absence of alternative liquidity venues, its heavily-regulated stock exchanges (and its tight integration with the depository) and efficient clearing system, it is understandable that many Chinese investors still shy away from alternative venues and complex products.

To achieve this sustainable development sought by the Mainland authorities, many in the investment community are increasingly looking for ways to bring in more foreign technology, expertise and knowledge and it seems that FIX is one of the tools that can be used to narrow the gap.

FIXGlobal Face2Face forums were born of a desire to move away from salesfocused conferences, and towards real dialogue within the industry. The events are about education, experience sharing and critical assessment, of the development of electronic trading on a local, regional and global level. This month Face2Face hit Shanghai, and judging by the lively Q&A sessions that followed a full day of expert speaker sessions, China is more than holding its own in the electronic trading debate.

Another invitation to another conference pings into your inbox. The speakers have fabulous titles and an alphabet of letters after their name. The event promises to change the way you look at global markets, regional markets, and everything has a China angle. And yet, how many conferences end up feeling like sales pitches. And, in the spirit of honesty, how often, have we all witnessed a guest speaker’s presentation which has had a pretty solid chunk of sales-speak at the beginning, middle and end? Fast forward to Shanghai where, earlier this month, approx 180 people from the local and international financial community gathered together to debate the role of electronic trading in China at the FIXGlobal Face2Face. Almost two thirds of the vocal audience was from the buy and sell-side of the trading industry.

Don’t throw the protocol out with the vendor
Kicking off with an up-to-the-minute review on electronic trading trends and innovation were Citi’s Grace Lin and HSBC’s Gavin Williamson and Alan Dean. Of particular interest was the perspective of the speakers on the key drivers for asset manager, brokers and exchanges looking to develop or upgrade their electronic trading and FIX capabilities. A flurry of questions followed, with one brave individual suggesting the FIX messaging was too slow for the current high frequency – low latency environment. Alan Dean provided the most categorical answer… “Then you need to re-look at your vendor, as with FIX we are talking low micro-seconds.” Nothing like being put straight!

View from the Exchanges
Next up was an update on the development and implementation of FIX STEP/FAST at the Shanghai Stock Exchange (SSE). CTO of the SSE, Bai Shuo described the protocol as a variant of FIX, adapted for the local market. This streamlining – taking out aspects not relevant to the local market and adding in those the industry wanted – were essential to promote the protocol effectively to its users. A look at performance data of FIX STEP/FAST left other delegates in no doubt that Shanghai was poised to provide scalable capabilities that would attract a broad range of market participants.

High Frequency Trading (HFT) is creating waves the world over, and Asia is no exception. With the challenges HFT presents being highlighted by many, and the benefits it offers markets being stressed by many others, Ronald Gould, Chief Executive Officer, Asia Pacific, Chi-X Global, focuses on their likely prospects in the enticing markets of China.

Developments in market structure generally occur in conjunction with three things. First, such developments require a receptive regulatory environment, one that permits change and encourages innovation. The second requirement is trading venue technology, generally coupled with the existence of more than one trading venue. Trading technology availability is improving but it would be wrong to suggest that markets everywhere are equal in this respect. Finally, there needs to be a user environment that is supportive of market change and willing to help drive innovation. These ingredients are observable in varying measure across markets in Asia, some at the forefront of change and others warily fighting against it. In most places in Asia, the current status of market change is in limbo as a result of hesitance on the part of one party or another to begin the process. Our own experience indicates that Japan, Singapore and Australia are leaders in this change while others are either cautious or opposed.

If we survey the market structure scene in Asia, some places present a more ambiguous picture than others. One of the most intriguing and perplexing pictures is China, a market filled with potential, intriguing to investors, clearly interested in innovation and change but whose plans and objectives are often opaque to the outside world. Given China’s growing importance to investors, an effort to make the picture of change clearer must be a useful one. First, it is helpful to establish a baseline from which to start, a description of the situation today.

According to figures published at the end of 2009 by the World Federation of Exchanges (“WFE”), China is now the world’s second biggest equities market based on total market capitalization. Free float is much smaller however, as both State and corporate holdings are still substantial. The market is heavily dominated by retail investors, of whom there are more than 50 million with active accounts and more arriving daily. Institutional investing is at an earlier stage although mutual funds have grown rapidly and Exchange Traded Funds (ETF’s) represent a major growth area as well. Because many of China’s largest companies were previously state owned and with shareholding still tightly controlled, turnover rates among institutional investors are very low. While a block trading facility exists in Shanghai, it is not as yet widely used and probably needs upgrading if it is to attract a greater audience among investors. The new generation trading system for the Shanghai Exchange was launched in Dec 2009, purchased from Deutsche Boerse and adapted with the help of Accenture for rather different market conditions over several years. Latency is not something that gets much scrutiny by investors in Shanghai but it is not a characteristic as yet highly valued. The question we confront today is whether we are at an inflection point for change in China, a point at which the instinct for innovation begins to drive a greater openness. Let’s look at the evidence.