According to some versions of the history of mathematics, one of the oldest algorithms was the Russian peasant algorithm, a method of multiplication using a binary structure. Nobody really knows whether Russian peasants used it, or where it originated. But if Russian peasants did dream it up, that long-established adroitness with algorithms, plus a Soviet-era legacy of strong focus on maths and applied sciences in the education system, might go some way to explaining the relatively high levels of algo trading in Russian markets compared with other BRICs. Mary-Ellen Barker reports.
"Russia is interesting - it's managed to achieve relatively high levels of algorithmic trading and HFT, but it's done so with less investment and fewer steps than other markets have taken," said Aite Group analyst Danielle Tierney.
And the biggest growth for algorithmic trading in Russian markets is happening in an unusual corner. Until not long ago, FX was typically down near the back of the asset-class queue for adoption of algorithmic trading, after cash equities and derivatives. But in Russia, it has been part of the first wave. Traders have been battling to contend with low levels of volume and volatility in nearly all markets around the world for most of the last 18 months or so. Russian FX is a striking exception.
One of the main reasons most experts cite is that high volumes of Russian FX are traded on the Moscow Exchange, unlike most other FX markets. The exchange's head of FX and money markets, Igor Marich, says 40 percent of spot FX transactions on the exchange are driven by HFT, and another 14 percent by other algo strategies.
FX trading accounts for about 40 percent of all volume on the Moscow Exchange, and average daily volumes across all FX instruments have risen 25 percent during 2012 to $14.7 billion. Average daily volume in dollar/rouble, the biggest currency pair accounting for more than 80 percent of volume, was $12.37 billion in 2012 against $9.87 billion the year before. In any swaps longer than overnight, average daily volumes grew 40 percent to $1.6 billion in the first nine months of 2012.
Evgeny Somov, Aton
"A client can trade FX just as he would trade an equity," said Evgeny Somov, senior DMA sales at broker Aton. "That makes this market very interesting for algo traders for arbitrage or hedging because you have the same transparency in price and volumes as you do with equities, so it's pretty straightforward, and you also have a market that's often got more liquidity than the equity market."
Moves by both the exchange and the central bank have helped fuel the growth. The central bank policy of keeping the rouble's floating band fairly wide against its dollar/euro basket has helped power rouble volatility. And the Moscow Exchange, fresh from the merger that brought RTS and MICEX exchanges together at the end of 2011, has progressively broadened access to FX trading. The first step allowed banks licensed to trade FX to offer direct market access to primary clients. The second step, completed in December 2012, widens access to open direct FX trading on the exchange to licensed brokerage firms. Marich said trades by Russian subsidiaries of foreign banks and non-resident DMA customers accounted for a combined 35 percent of volume during 2012.
"By the end of 2013, we plan to allow direct clearing membership of foreign broker-dealers, with the aim of facilitating greater activity on our foreign exchange market by foreign investors, allowing them to reach the market through fewer intermediaries," Marich said. The exchange now has 3,000 direct and indirect FX market participants registered on its system; it has 600 members.
Sergey Romanchuk, Metallinvestbank
Sergey Romanchuk, head of FX&MM at Metallinvestbank, one of the biggest players in Russian FX in both spot and futures, says that easier access to the market will help grow volumes further during 2013. "Over time it could accelerate the number of clients. I don't think it will be a dramatic increase, but over the next year I expect it to bring a 10-20 percent rise in volume," he said.
The appeal of Russian FX is clear to Pavel Vidov, head of trading at proprietary trader and boutique broker Intrast, which generates most of its revenue from algo trading, including HFT.
"The FX market now is probably the only market where you can get some real volatility and excess gain," he said. "We're not trading there right now, but we have plans to see what we can do there, probably over the next year."
Pavel Koryakin, CEO of IT Global, a small company which develops custom trading software and helps customers execute the algorithms they have designed, believes one of the unique features of algo trading in Russia is the presence of many very small teams of individuals. The driver is relatively low costs, and of course the hope of fast return, among a growing band of highly educated geeks.
"For $100 a month you can connect to the exchange," he said. "The perception is that trading is cheap, in terms of the returns you can expect compared with starting other kinds of businesses. But in my experience you have to work very hard to make money from trading."
High Frequency Challenges
Growth in HFT has already brought some challenges. In September 2012, the Moscow Exchange introduced an additional commission fee structured to create an economic disincentive for generating high volumes of orders in proportion to completed transactions, which was beginning to become an issue for trading platforms.
"So it solved the problem," said Metallinvest's Romanchuk. "These penalties are very small, but they prevent participants from flooding the market with orders that have no economic sense. I think it's been quite a successful measure, because it has eliminated the problem." Romanchuk said other measures to increase minimum tick size, increasing the granularity of prices, had also helped reduce ''high frequency noise".
Marich said the exchange has plenty more plans to stay competitive with its OTC rivals. In January it extended trading hours to midnight Moscow time, and ultimately it aims for 24-hour trading within the next couple of years. It has broadened its product range, introducing a Chinese yuan/rouble currency pair, and will launch overnight yuan/rouble swaps next year. It wants to develop liquidity in pairs against currencies of several of its neighbours, including the Ukrainian hyrvna, Belarusian rouble and Kazakhstan tenge.
Changes in FX trading on the exchange are all part of a series of wider initiatives by Russia to open capital markets and help propel Moscow into position as an international financial hub. Late in 2012, Russia established a central clearing repository and linked it up to provide direct access to Euroclear and Clearstream clearing and settlement systems. The newly merged exchange has launched a new trading platform, called Spectra, and centralised its data centres.
"It's all in keeping with what they're trying to do to make themselves into a global financial centre," said Aite Group's Tierney. "The takeaway for me is that there's good continuing development."
Damian Bunce, Renaissance Capital
"If you're a typical algo trader and you're running a strategy in developed markets you're in a difficult position, and that's why many people are looking to emerging markets, and why Russia is becoming interesting."
Renaissance Capital's CEO of electronic trading, Damian Bunce, said Russia is now in the spotlight for algorithmic traders because conditions both inside and outside Russia are right. The backdrop is an unfavourable western environment, coupled with the excitement of emerging markets.
"There's reduced volume everywhere, there's reduced volatility, and the reality is that most algo traders rely on one or both of those factors to make money. And there's increasing regulation, plus higher taxation. So if you're a typical algo trader and you're running a strategy in developed markets you're in a difficult position, and that's why many people are looking to emerging markets, and why Russia is becoming interesting."
Algo traders had first turned to other markets, including Brazil and India. Now it's Russia's turn.
Once investors take an in-depth look, there are plenty of things to like. Bunce said they find that Russia has no stamp duty; there's a level playing field for non-domestic players; there is an exchange that is rapidly adopting western standards with technology that is up to scratch; liquidity is interesting, and regulation is not prohibitive.
"Purely from a liquidity perspective, if you look at the asset classes here the RTS index (an index of 50 stocks) is very liquid, one of the most liquid contracts in the world, and the dollar/rouble futures contract is also very liquid, not to mention the arbitrage that exists with markets such as London IOB, the CME, and FX markets like EBS," Bunce said.
Aton's Somov also believes a stable and relatively light regulatory environment is one of the attractions, along with efficient systems already in place to deliver low latency and handle all the usual connectivity protocols and relationships. "We see a situation where a lot of companies are facing regulatory changes in their home markets, so they have to think of alternatives. They look to other markets like Russia, where regulation is less significant, and therefore it's simple to implement their trading concepts."
After FX, where next? Some believe the new hot area for algo trading could become the Russian rouble-denominated treasury bond market, which is steadily becoming more easily accessible for foreign investors. Until early 2011, all trading was routed through the exchange, so investors had to trade via local brokers. OTC trade was permitted from the start of 2012 and now access via Clearstream and Euroclear will give non-residents a much smoother path into the market by simplifying settlement and so making transactions cheaper, and by making it easier for some foreign investors to meet their own compliance rules. Demand has already heated up, driving prices higher by nearly 14 percent during 2012.
Yields of just below seven percent look appealing, though they are forecast to flatten out by 50 basis points or more during the next year. "I believe it's one of the most attractive government bond markets in the world," Aton's Somov said. "Generally the economic situation here is much more positive in some countries in Europe and the US and yields are still pretty high, so I believe there will be more demand." The knock-on impact in futures markets is what will bring opportunity for algo trading, he thinks.
Metallinvest's Romanchuk is cautious about the likely growth for algo trading in bond markets, where it is now hardly present. He agrees increased foreign presence in the market will bring more hedging, and therefore open the door for more algo trading. "It could be a reason for more development of algo trading in bonds, but I'm not so confident that even the tight correlation between FX and debt markets could really reshape the market so much that algo trading would dominate."
Algo trading is already firmly established in Russian equities and equity derivatives markets. It accounts for about 70 percent of turnover in equity derivatives, and about 50 percent in cash equities. A unique feature of those markets for algo traders is the arbitrage opportunity created by the strong presence of Russian companies on the London Stock Exchange with dual listings in Moscow. Russian companies have flocked to float in London, drawn by a deep pool of capital. The exchange says that 65 Russian companies have raised about $69 billion in issuance there since 2004; the most recent, telecoms company MegaFon, raised $1.7 billion in November 2012. Russian companies account for about 90 percent of the LSE's international order book, according to Renaissance Capital's Bunce. Russia has a huge multi-year privatisation programme underway, forecast at around $8 billion in 2013, though depressed stock markets have hampered progress.
For Intrast's Vidov, London-listed global depositary receipts arbitraged with local markets form an important component of his trading strategies, especially while proprietary trading is the main driver of revenue. "Most revenue comes from algo prop trading, especially because the brokerage business is so down right now," he said.
Building up the buy side
But the drift to London highlights one of the biggest challenges for the Russian market - the lack of a developed buy side, which could help reverse that trend. The insurance sector is small and relatively undeveloped, and so is the pension industry. Private pension funds, held back by a public distrust of financial instruments and a lack of tax incentives, make up just two percent of financial assets in Russia, according to the US State Department's 'investment climate' review of Russia published in mid-2012. The review said the life insurance market is minuscule, accounting for only three percent of insurance premium payments.
In November, Russian President Vladimir Putin backed a plan to reduce employers' payments into retirement savings starting in 2014, which fund managers believe could be a retrograde step for capital markets. According to Bloomberg News, Russian Finance Minister Anton Siluanov told a conference in Moscow the same month that investment from Russia's pension, insurance and mutual funds is equivalent to eight percent of GDP, compared with a global average of 120 percent.
Russian markets need internal long-term capital, Metallinvest's Romanchuk said. "It's not just capital, it's demand from investors who are looking at different time horizons and different strategies. We need long-term investors for real growth of the market."
Pavel Vidov, Intrast
Intrast's Vidov agrees. He said possibilities for sophisticated statistical arbitrage strategies are limited by the lack of depth in equities and equity derivatives markets. "That's the main problem I believe we have right now, because in terms of direct access and in terms of development of trading systems, I believe the stock exchange is pretty well-developed compared to European and American markets."
The problem is a shortage of demand for liquidity, rather than a shortage of liquidity itself. "If you're making markets, you're more interested in the demand for liquidity. You can either get that from high volatility in the market, where you can earn some excess gains because you're taking risks for people who want immediate execution, or this demand for liquidity could come from real demand from the buy side - and that is what is lacking here."
For foreign investors, there is also the problem of Russia's reputation for lack of transparency, political risk, corruption and legal uncertainty. Russia ranks 133rd out of 174 entries in Transparency International's corruption perception index.
For the general economy, perceptions about transparency and corruption are important factors, but Russian domestic markets and the financial industry are transparent by international standards and noticeably cleaner than other sectors of the Russian economy, according to Metallinvest's Romanchuk.
Aton's Somov agrees. He said investors look at the macro aspect, including corruption. "But what people also look at is infrastructure, and how appropriate, transparent and efficient it is for their trading. And in this context I would really agree that the financial industry is definitely one of the most efficient, transparent and western-like sectors of the economy." He said the steps the exchange and regulators are taking to open financial markets shows the commitment to change.
The next big shift will start this year with a phased programme at the Moscow Exchange to switch from a T+0 settlement system to T+2. The T+0 system now operating means investors have to deposit money via brokers on the exchange ahead of any trades, or deposit stock if they plan to short. Netting out between trading and settlement is not possible, which makes trading expensive in terms of risk capital costs.
The aim of the change is to bring Russia into line with international practices and remove another roadblock for foreign investors, but there are some mixed feelings about it. "It's a big drive to appeal to international investors, but it's at the expense of domestic brokers and the exchange," said Renaissance Capital's Bunce. "For brokers like us, T+0 provides a revenue stream. And because then we're posting our money on the exchange, the exchange has a lot of cash. It takes that cash and places it with the central bank for overnight interest, and that's an important revenue stream. So I would rather it wasn't happening, but on the other hand maybe it will encourage people to trade here who haven't before."
He doesn't expect a flood of investors as a result, though. "I don't see it as a gold mine - it will take a lot more than T+2 to make more people decide to invest in Russia. But Russia is making great progress in opening up its markets."
Aton's Somov believes it is another important step on a path to liberalisation of markets and to the reversal of the drift of capital towards London. He also points to the change as an example of the positive benefits of the merger of MICEX and RTS. "Those discussions about T+0 had been going on for years, but only now that we have one structure have we had some movement."
And there is broad agreement that all the changes to woo foreign investors can only be good for the growth of algorithmic trading. The opportunity is great, and growing. If it's all about risk and reward, there are greater risks and greater rewards in Russia, said Renaissance Capital's Bunce. "If you're an algo trader, it can be a great market. It's still relatively uncrowded, and you will see anomalies in the market here you won't see elsewhere. Volatility has been pretty low everywhere, but there's no question that when there's volatility in Russia it's massively more volatile than elsewhere. Algo traders like this craziness because that's when they capitalise."