Broadening The Base: Using The Entire Trading Lifecycle To Improve Execution
GlobalTrading Hong Kong Roundtable Write-up
Regulatory developments are amplifying pressure on trading desks to offer their shareholders and clients greater returns. At the same time, a newfound willingness for collaboration and a restructuring of the trading desk from a human and technological perspective hold out hope for greater efficiency.
Generously sponsored by BNP Paribas Securities Services, and kindly hosted by the Hong Kong Exchange (HKEX), nineteen buy and sell-side participants gathered under the security of Chatham House rules to share their experience and insights into improving execution across the trading lifecycle.
Asian regulatory priorities: managing trading behaviour
Regulators in Asia are often short on experience and resources. They prefer to add caution in the form of further regulation while they catch up. For example, brokers in Hong Kong have to keep logs of changes to algos for 2-3 years. The onus is on the market to work with local regulators or the local regulators will be tempted to simply follow the US model.
The Chinese Securities Regulatory Commission (CSRC), for example, feels pressure to collaborate in ways they did not before the market crash of 2015. Discussions of instituting an ID market in Hong Kong, recent programme trading rules and the much maligned and quickly shelved circuit breaker mechanisms are all areas where the CSRC is more open to external input than before.
“It is important that the Hong Kong regulators appreciate how to rationalise the balance between the improved oversight of an ID market and the operational efficiency of features such as an omnibus account,” noted Stephanie Marelle, Executive Officer, Hong Kong Branch, Regional Head of Clearing and Custody, BNP Paribas Securities Services Hong Kong.
Because of the ID requirements in Korea, Indonesia and Taiwan, many traders prefer to work through Delta1 desks to create positions instead of trading directly on the exchange. The real question is whether the regulators want a pre-trade ID or a post-trade ID.
Legal Entity Identifiers (LEIs) in Europe offer a similar case study for comparison. Draft requirements for European LEIs include national insurance provider for each trader, trader’s home address and date of birth. The LEI discussion is all the more pressing given these rules are not far away, provided you believe the implementation dates.
Asian trading desks typically follow the same workflow as their US or European headquarters, but local data privacy laws can be an issue. Many trading operations would benefit from further integration of front, middle and back office data as real-time information becomes a norm.
For many Chinese asset managers, their small scale in Europe and high existing costs may lead to a withdrawal from certain non-Asian markets.
China is built on an ID market so the regulators can generate reports on trading behaviour with the push of a button. After the market crash in the summer of 2015, the Chinese regulators traced trades back to certain High Frequency Trading (HFT) players for prosecution.
The CSRC thinks HFT is bad and there are insufficient protections for investors in markets where HFT is prevalent. “The discussion of HFT in China is often inaccurate because many proprietary traders operating HFT or similarly sophisticated models are grouped into the retail trading basket because they are sole traders,” suggested Chris Lee, Senior Vice President, Global Markets Division at HKEX.
In China, the market is one-directional because of a lack of adequate hedging instruments. In Hong Kong, often more than one investor view will be active at the same time meaning HFT does not only push in one direction and amplify either gains or losses. Meanwhile, the CSRC’s focus on policing HFT to protect retail investors has encouraged as many as 250 HFT firms to start trading in Hong Kong
While most industry participants understand the issues with HFT, but there is no upside for the regulators to take risk and move markets forward. There is a culture of aversion to failure among regulators. Market participants understand the benefits of HFT, but there is no sufficient mechanism for sharing those benefits.
There is progress in the region, as evidenced by the Australian Securities and Investments Commission’s (ASIC) evolution from one of the most shrill HFT detractors to a more rational perspective on the strategy. Even Korea is beginning to open up to the prospects of HFT.
Even a cursory study of high and low liquidity events demonstrates the need for proper market structure research through fundamental analysis. The CSRC appears to be caught between pursuing greater knowledge or greater stricture.
Collaboration and Efficiency: a win-win for all
Fortunately, the market is now in the same room with the regulators when these issues are being discussed.
“The Shanghai-Hong Kong Stock Connect was a significant milestone for collaboration across borders within Asia. The Shanghai-Hong Kong Stock Connect was also a catalytic moment for HKEX to expand the size and scope of the counsel they receive. Within HKEX, there is a conscious shift to viewing Exchange Participants as clients and focusing more on service. The exchange is bringing additional intelligence in-house. Hong Kong aims to be an offshore risk management tool for China via HKEX futures and options,” observed Kevin Rideout, Managing Director and Head of Client and Marketing Services for HKEX.
In the past, risk management was always handled on the trading desk. Market risk, which is simpler to manage, is still handled on the trading desk while operational risk is much harder to manage and cannot be left to the traders alone.
Regulators will expand the total amount of data they manage, and as such their role is not to make conclusions from such data but to spur conclusions from market participants.
The fastest growing costs for trading firms are compliance and new technology, and unfortunately, the cost burden tempts firms to stall further investments which in turn breeds risk. The costlier risk, by far, is the long-term threat to poorly assembled compliance and technology systems. “Despite this, it is important not to view increased compliance costs as merely about meeting regulations, but as part of the investment needed to build a robust and sustainable business,” noted Jeff Sayed, Chief Operating Officer, Equities Asset Management Services, Asia Pacific for Bank of America Merrill Lynch.
The business side of trading is embracing greater technology in its processes. As they consolidate platforms into their Order Management System, more information can be readily shared within the firm. “Consolidation of platforms is also likely to lead to greater efficiency for trading desks,” suggested Patrick Shum, Head of Trading Systems Asia Pacific at Fidelity International.
“In addition, working with outside partners to handle non-core business tasks is one way asset managers are lowering their cost burden and acquiring best-in-class systems, however, business size will differentiate what is relevant and needed,” suggested Francis So, Head of Dealing, BNP Paribas Securities Services Hong Kong.
As a counterpoint, in Silicon Valley, for example, collaboration is in businesses’ DNA, while banking is unrepentantly competitive.
The New Look Desk
Responding to the lessons of greater collaboration and technological investment, the trading desk now has a ‘new look’.
“The human mix on the trading desk is changing in ways not previously seen. Unbundling means that the trading desk can define its own value. Where quants used to be a support function to sell-side trading desks, we are now seeing quants hired to both buy- and sell-side trading desks,” noted Andrew Freyre-Sanders, Head of Equities Electronic Execution Services for CIMB Securities.
“The technology team is part of the business process today, so the business can no longer make decisions on their own,” explained Shum. At the same time, new technologies such as blockchain will soon become an alternative to self-clearing solutions and banks today are proactively participating in the discussions.
The discussion concluded, for trading desks and the technologists that support them directly or indirectly, innovation is knowing where you’re good and focusing on it – sound regulatory practices, market collaboration, data integration and smart technology. Buy and sell-side are embracing a holistic view of the trading lifecycle more than ever before. This will be the key to satisfying changing regulatory demands, generate greater return on equity and provide improved execution for internal and external clients.
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