Trans-Pacific Trading

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In an increasingly globalised world, Shane Neal, Head Trader of Matthews International Capital Management talks to FIXGlobalTrading about the benefits, and challenges, of trading in Asia from the US.

What are some of your key issues and opportunities being a US buy-side operating in Asia?
I think the majority of the issues Matthews faces trading in Asia are faced by any firm trading the region; liquidity, volatility and anonymity, to name a few. We have a propensity for identifying smaller- and medium-size companies to invest in, so a disciplined, and often patient, approach to trading is required. Market participants in Asia are sometimes less inclined than traders in the US or Europe to trade in block form; whether due to a lack of trader discretion or because they are benchmarked to a specific participation rate or volume weighted average price (VWAP). Block specialist desks, and dark pools designed for block trading, have started to help change this attitude and demonstrate the usefulness in increasing average execution size and lowering implicit trading costs.
Matthews’ trading desk maintains live trading coverage during all Asia and US market hours from our headquarters in San Francisco. Matthews is the largest dedicated Asia investment specialists in the US, and having our traders and investment team based in a strategic location in San Francisco allows our investment team enough distance from the noise in the market to focus on our long-term investment objectives. Our open work environment provides collaboration among traders and portfolio managers and has been vital to fostering dialogue about execution strategies as part of the investment process. When covering the “night” trading desk (Pacific Time), we are often the “eyes and ears” for the investment team regarding day-to-day market colour, and act as a hub for disseminating pertinent information and filtering much of the market noise.
The advantages of market connectivity through an execution management system (EMS), a sophisticated order management system (OMS), compliance capabilities, and direct market access make remotely trading into Asia an efficient and cost-effective operation. I’m unclear as to the value proposition for some firms to relocate their Asia trading operation to the region. The argument for improved service quality or an information advantage doesn’t hold, in my opinion; I don’t see how trading into India is made easier simply because one’s office is in Hong Kong, as opposed to the US or Europe. For smaller firms that don’t have dedicated staffing during Asian market hours, time zone differences may pose a hurdle when it comes to potential settlement issues, compliance needs or short windows of opportunity for interesting liquidity, like stock placements. Fortunately, at Matthews, we have a deep and diverse team with a range of perspectives and expertise. Our singular focus on investing in Asia means that everyone at the firm, from back office staff, IT to Compliance is committed to supporting our investment objectives in Asia.
How does the regulatory environment and differences between meeting SEC regs and Asian regs present a challenge?
We apply the “best execution” guidelines, familiar in the US, to our Asia trading efforts. As liquidity continues to fragment in Asia, the buy-side will increasingly rely on smart order routers in seeking the best price and utilising transaction cost analysis (TCA) for measurement, as well as other qualitative factors that contribute to broker execution quality.
Foreign exchange transaction costs have been a topic of discussion in the US recently. The lack of transparency in the OTC FX market has motivated the buy-side to work with their foreign exchange dealers and banks to improve time stamping, which is necessary to measuring execution quality. The benefits of negotiating FX trades, and the efficiencies of multibank FX tools are increasingly important. Because FX trading in the restricted markets of Asia must be executed in compliance with local market regulations, such as proof of an underlying security requirement, limited market hours and central bank reporting, market practices have necessitated custodian and sub-custodian involvement. Improved transparency around the costs associated with these trades is important for the buy-side if competitive FX pricing is an unrealistic option.
Post “flash crash”, and in the wake of a recent high profile technology malfunction, the Securities and Exchange Commission is taking steps to tighten regulations in ways that are similar to those used by regulators in Asia to curb erratic price fluctuations and to identify large market participants. In May, the SEC, along with the exchanges and FINRA , approved plans to implement limit up/limit down price bands that are more protective than the current single stock circuit breaker system, and seem to evolve from pricelimit mechanisms used in many markets across Asia. Last year, the SEC also adopted a rule establishing a large trader reporting system to improve the Commission’s ability to identify and monitor the trading activity of its largest participants; in many ways, analogous to ID systems in Taiwan and Korea.
Regulatory requirements, such as ownership filing and foreign ownership limits, vary across the Asia Pacific region and the US, so we rely on our knowledgeable compliance team and an OMS technology that can accommodate the gamut of compliance rules and testing.
How has the electronic trading environment changed, what technologies or developments have made your job easier or more difficult in the region?
I think milestones in the evolution of buy-side trading technology include market connectivity through an OMS and EMS, the proliferation of algorithmic trading access across Asia, and post trade analysis through TCA platforms. These technologies contributed most to risk reduction, and empowered the buy-side in managing their order flow. Adoption of these technologies in Asia lagged the US and Europe by a few years, but the variance among the regulatory environment and market microstructures are wider in Asia than in any other region. The algorithmic trading providers who offer specialised strategy consultants, customisation and local market experts are an asset to the buy-side in understanding the appropriateness of certain algorithms for a particular trading situation.
As liquidity across Asia continues to fragment, the trading tools used by the buy-side must continue to evolve to handle greater market data demands and smarter access to liquidity in order to achieve the highest execution quality. We’ve also sought more granular data from TCA recently. Venue analysis using FIX TAG 30 has been interesting, as not all liquidity appears to be equal, and we better understand where spread saving may be misinterpreted. For example, a broker may highlight a potential for saving half the spread by executing via a dark pool, rather than executing at the far touch in the displayed market. However, closer inspection could reveal some of these dark prints were outside the stock’s trading range in the lit market, when the stock was about to reverse direction—thus costing you half a spread. You would have been better served by posting at the near touch. Some dark pools have better logic to avoid this. Graphically plotting your fills and measuring reversion help in understanding the value and potential shortcomings of different dark pools.
What comes next? Regulatory or technological — what changes would you like to see in Asia and what would their impact on trading be?
Regulatory change happens at a more measured pace than technology, often based on sound reasoning like need for risk analysis and testing. In Asia, market structure reforms that foster competition and will thereby increase fragmentation and reduce trading costs through lower spreads have occurred first in markets like Japan, Australia and Hong Kong. The announcement by Japan’s Financial Services Agency (FSA) that proprietary trading system (PTS) trading will be exempt from the 5% Tender Offer Bid (TOB ) rule is a positive development for Japan. This rule stated that while trading, were a company to attempt to acquire more than 5% of the outstanding shares of a company they would have to submit a takeover bid to all shareholders. There are a number of market participants who avoided interacting with PTS liquidity until there was more clarity around how this TOB rule would apply.
It is inevitable that PTSs will gain market share as new participants realise price improvement and liquidity opportunities. Regulatory changes in other markets of Asia may occur slower and take cues from the successes in other markets as they mature. Continuous trading in Taiwan, centralised clearing in India and the elimination of the tripartite boards in Thailand would improve efficiency in my book.