The reputation of high-frequency trading has suffered a comprehensive mauling of late, particularly in the US. The publication of the book Flash Boys: A Wall Street Revolt by Michael Lewis concentrated the minds of regulators and prompted both angry retorts and a strong sense of soul searching within the industry itself. Whether the book was a fair representation of the industry is still open to debate, but there is now far more awareness on both sides of the Atlantic about the world of HFT.
Europe and the US are not the only places in the world where high-frequency trading has laid down roots. The Asia-Pacific region also has a healthy HFT presence, with some markets seeing a large proportion of overall trading volumes carried out by high-frequency players. The growth of HFT in Apac is often ignored as the battles between practitioners and regulators play out in the more established markets. But the global nature of finance and trading means the region has a number of opportunities for those with an appetite for trading electronically.
“High-frequency trading started in Asia-Pacific when the traditional US and European players started establishing a presence in the region as competition intensified at home,” says Hani Shalabi, head of advanced execution services for Asia Pacific at Credit Suisse. “People also move around, start their own fund or join other firms. There are plenty of well-established local hedge funds and prop houses based in Hong Kong and Singapore already. We are also seeing increased focus from Chinese players participating in the industry.”
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The Asia-Pacific region has a wide spectrum of markets with a high-frequency element to them, but naturally some have embraced the trend more than others, with two in particular leading the pack.
“Asia-Pacific comprises around 11 electronic markets, but the region as a whole is not as mature as the US and Europe,” says Shalabi. “Australia and Japan are the most developed markets in the region and they are alive and well.
“In the second most-developed group, there is Hong Kong, Korea and Taiwan. The challenge for these markets is they have a prohibitive government stamp tax. Korea and Taiwan charge 30 basis points on the sell and Hong Kong charges 10 basis points for the buy and the sell. That said, index arbitrage and statistical arbitrage traders rely less heavily on this model because it is already factored into their strategies and they don’t trade unless they are making a profit. These stamp duties were in place in Asia-Pacific before high-frequency trading took off in the region, but they do slow down trading somewhat. The exchanges themselves are always conflicted. They have a duty to increase their own liquidity.”
Outside of these main markets for high-frequency trading in Apac, the scope for electronic trading diminishes, but that does not mean banks do not still see requests for access.
“We have seen a lot of interest in trading India and China, but regulation makes it very hard,” says Shalabi. “Accessibility is the problem in China. In India, you are not allowed to sell what you bought that day, which makes it hard for high-frequency trading. That leaves Malaysia, Indonesia and Thailand, which are illiquid markets. Index arbitrage can happen, but it’s difficult to take these markets and make them active. They also don’t have colocation.”
Japan has gone further than most in the Apac region in embracing the HFT industry and appears to be reaping the benefits. According to estimates from financial services consultancy Celent, around 38% of all equity trading in Japan is now high-frequency. The Tokyo Stock Exchange is estimated to take around 67% of this total HFT volume, with the rest going through other platforms, according to Celent. And it estimates volume of equity trading on the TSE that is high-frequency is between 25% and 35%.
According to Neil Katkov, senior vice-president at Celent, the buy side in Japanese HFT is mostly composed of hedge funds – predominantly foreign – and the proprietary trading arms of investment banks.
“Japanese regulators have allowed the introduction of a low-latency and fragmented market structure in response to market participants’ demands, especially by the big foreign brokers and the buy side in Japan, but also out of recognition that failure to do so would lead to Japan’s market becoming marginalized in Asia and globally,” says Katkov.
“Still, they view HFT with caution, and maintain a regulatory structure that restricts buy side direct market access. The TSE also does not allow proprietary trading systems to be colocated with their matching engines as a barrier to ultra-low latency trading. Japanese regulators are heavily influenced by the stance taken by the US towards market structure; if the US decides to restrict HFT, Japan would be likely to follow suit.”
Katkov believes that the reason Japan is such a successful place for HFT in Apac is because it is one of the biggest trading markets in Asia, with big participation by foreign firms, a low-latency market structure, and venue fragmentation. He also attributes success to the fact that the TSE’s institutional marketing department has been aggressively promoting the venue for low-latency trading to foreign market participants.
In the Australian equity market, high-frequency trading is estimated to account for around 25% of total market activity, according to the Australian Securities Exchange. The ASX says about 25% of all trading occurs off-market in a range of dark pools and off-exchange trading mechanisms. ASX is the largest equity market in Australia and currently executes around 90% of lit trading, it adds.
“Our regulators understand the challenges arising from changes in the way global markets operate, the impact of technology, the commercial drivers for global market service providers, and the expectations of investors,” says ASX chairman, Rick Holliday-Smith. “They are doing a good job navigating through a new and more complex landscape.
“Domestically, our equity market regulations are among the best in the world,” says Holliday-Smith. “As a result, ASX currently has no significant concerns about the impact that newer forms of trading, such as high-frequency trading and dark pools, have on our market. Asic [the Australian Securities and Investment Commission] has prioritized the interests of end investors and, in so doing, the more aggressive trading strategies that we observe overseas are not attractive under Australia’s regime.”
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Best execution in Australia is an obligation placed on you, the brokers, rather than the exchanges. In contrast, in the US best execution is an exchange obligation Elmer Funke Kupper, ASX |
Earlier this year, Elmer Funke Kupper, ASX managing director and CEO, said the exchange believes Asic has done a good job of reacting to a fragmented market structure in Australia; he also highlighted four areas of regulation that mark it out from the US. The first of these is that maker-taker pricing is not permitted, which means no customers are paid for order flow. The second is that regulatory fees are applied to both orders and trades, putting an economic cost on high order-to-trade ratios. The third is that minimum tick sizes have not been narrowed, concentrating liquidity. The last is that price improvement must be meaningful, moderating the amount of execution away from lit public markets, particularly retail flow.
“In addition, best execution in Australia is an obligation placed on you, the brokers, rather than the exchanges,” continued Kupper. “In contrast, in the US best execution is an exchange obligation. By forcing exchanges to route away flow that can find a better price on another exchange, HFT finds it easier to interact with investors.”
The world of HFT is often poorly understood by both the general public and those in the financial markets. The diverse strategies and players that make up the HFT universe are often represented as one block, when the reality is often more nuanced. The Apac region has a number of different types of HFT practitioners pursuing different kinds of strategies.
“When I look at high-frequency trading in Apac, I look at it as having three different types of practitioners on the equity side,” says Credit Suisse’s Shalabi. “Firstly, there are the traditional market-makers, or equities liquidity providers who need speed and liquidity; the countries that offer them are Australia and Japan, which are quite advanced in terms of colocation.
“The second group would be the statistical arbitrage traders who are less speed driven but need a lot of liquidity, with the most advanced markets coming from Australia, Hong Kong, Japan, Korea, Taiwan and Singapore. The last group is the index arbitrage traders. They need index futures that are quite liquid, which can be found in the markets as illustrated before. Speed is important to them, but not a critical component.”
The saturation of traditional markets for HFT, combined with the increasing sophistication of the markets in Asia-Pacific, has provided a new and exciting frontier for electronic traders. Markets such as Japan and Australia provide relatively welcoming conditions for HFT practitioners and lead the way in the Apac region. But the vastly differing regimes in the region present a strong challenge to anyone looking to trade outside of Europe and north America.
Issues around taxation and regulation still provide barriers in many markets to HFT developing beyond a rudimentary level. But in some instances, these barriers remain in place because authorities are cautious about practices within HFT that have received widespread negative attention in recent times. And this is an image that the industry could struggle to shake off in parts of Asia-Pacific for some time.
But as long as the opportunities exist and the exchanges continue to develop the technology to accommodate HFT, the flash boys are likely to remain a fixture in the Apac region.
