Algorithmic China

By Shen Tao

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.

What are algos used for in China: execution, complex event processing (CEP), pairs or basket trading, etc?
Currently, algorithms are used for pure execution, mostly for single orders. Pairs and basket trading require a compatible OMS platform, which is already under development. We believe such functionalities will be available to Chinese traders in the next six months. Also, while many traders understand the concept of complex event processing, it will take a while before anything like this is put into real production.

What testing and due diligence is required before an algo can be deployed in a Chinese market?
We see different patterns of testing and due diligence processes across mutual fund users. Regarding speed to market, Beijing-based companies seem more enthusiastic and are quick to make a decision, whereas Shanghai-based companies tend to be more cautious. Generally speaking, algorithms will undergo testing for at least a month before they are put into use.

More companies are seeking dual listings in China and in Hong Kong, the US and elsewhere, but is arbitrage growing at the same rate?
Arbitrage cross market is unlikely to happen on a noticeable scale with Chinese capital flow controlin place.

What new products are your clients asking you for? What new algo products are in development?
Clients are requesting DMA and algorithms that will replicate the trading capabilities of hedge fund strategies as well as algos that are designed primarily for standard mutual funds (long only). Some clients are also demanding strategies for illiquid stocks, volume deals (e.g. single order accounted for a substantial fraction of average daily volume), Market on Close or list order types. All of these are under development or consideration, according to their respective commercial potential.

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