Sanjay Awasthi, Eastspring
India has made significant investments in the technology stack and risk management systems that go along with sophisticated electronic trading. Considering that direct market access was established in 2008, great strides have been made in the space of automated and high frequency trading over the last six years.
Eastspring Investments, one of Asia's largest fund managers, trades all emerging markets across a diverse range of asset classes. Eastspring has an eight-person dealing desk covering equities, fixed income, FX and derivatives. Consequently, said Sanjay Awasthi, a director based in Singapore, the firm faces extremely dynamic trading environments.
"India is one such market. The stock markets, its mechanisms and microstructure, have and will continue to develop as the economy evolves," he said.
India has a significant local arbitrage community that trades cash futures, and profits from inter-exchange arbitrage. It started off with local traders, but now there are an increasing number of prop desks at brokers and banks joining in, Awasthi said.
More asset classes are on offer too, such as FX and fixed income, particularly government bonds and interest rates.
Single stock futures meanwhile continue to be very popular. "The Equity futures market is roughly two-and-a-half times the size of the cash market. The majority of retail, a lot of speculative activity, happens in SSFs," said Awasthi.
Anybody trading India needs to be acutely aware, therefore, of how the relationship between cash and futures changes over various periods of time, he noted, adding that to trade these markets effectively means not only understanding them, but also remaining agile and adaptive to any changes or developments.
Floor to screen
One such development is the active courting of HFT firms by the two major markets, the NSE and BSE. Awasthi, who is a former regulator for India's markets watchdog, the Securities and Exchange Board of India, said: "Being a large fund house, liquidity is a main concern for us. Any measure that enhances liquidity is great, provided it is adequately regulated and everybody is kept at par."
India has not "even come close to" having the same problems with HFT as developed markets, and he sees more and more institutions, both domestic and foreign, actively using algos in India.
"We are also seeing a few brokers increasingly localise their research to build algos to suit specific markets, instead of offering a standard template built for developed markets. This is a welcome and much needed development," he added.
Today, algorithmic trading, including HFT, accounts for a third of the total volume on cash markets on the BSE, the oldest stock exchange in Asia. In the derivatives markets, algorithm trading is approaching half of the total trading volume. Five years ago, these numbers were sub-5%.
So why jump on the bandwagon?
Ashishkumar Chauhan, BSE
Ashishkumar Chauhan, MD and CEO at BSE, uses analogies to explain: "People prefer a faster mode of travel, instead of walking, then bicycle, then cars, then planes. Similarly people used to go to human (bank) tellers, now they go to the ATM. The activity that gives you faster access and faster execution, people will move on to that," he said.
For stock exchanges, that has meant floor-based activity giving way to screen-based activity.
And then the economics of trading are cheaper too, he added.
For years, the BSE had been lagging behind its primary competitor, the NSE. According the Business Standard Research Bureau, the BSE had under 12% of the share across cash and derivative segments of the equity markets in 2005, down almost 33% from its share in 2000.
Today, BSE has 35% of the total market share in the equity derivative segment and almost half of the total market share in the currency derivative segment. A major reason for the surge in volume is a partnership agreement with Deutsche Boerse T7 platform, also used by Eurex. This has allowed them to handle 500,000 orders per second, with a response time of under 200 microseconds, making them India's fastest exchange.
BSE vs NSE market share
A mere 2% of the population invests in the stock market, and a major goal over the next 10 to 15 years is to try to raise that to 25%, Chauhan said.
Alongside that, the BSE is focused on continuously improving speed, cost, and functionality that caters to tech-savvy, algo-driven clients. They have eliminated caps on the number of orders per minute and also introduced an incentivised market making programme for equity derivatives, mainline indices, futures and options and 30 single-stock baskets.
By the second quarter, they also plan to allow equity single stock market making. Currency and interest rate derivatives will not be supported due to regulatory reasons.
In contrast to mature exchanges, there is no obligatory market making on the BSE. Instead, participants provide liquidity on a day-to-day basis. On days in which they fulfil their quoting obligation, BSE reimburses them all financial transaction taxes and regulatory fees.
Over fifty brokers use the BSE's colocation infrastructure, which has no "predatory pricing". It is also the only exchange in India to provide functionality that prevents self-trades. Allowing parties to cross with themselves, meaning the same party is responsible for both sides of the trade, can indicate artificial volume or interest, and the BSE surveillance systems clamp down on this.
Its biggest problem remains that the NSE has more liquidity, thereby making it more attractive to a large subset of brokers, particularly those that do not use a smart order router. NSE declined to be interviewed for this feature.
Shrinivas Viswanath, co-founder and head of technology at RKSV, a three-year old discount broking firm, said that praise is due for how execution on Indian exchanges has improved over the course of the last five years. Now, there are better lines and faster speeds - BSE has a 10GB pipe for example.
RKSV has some 20,000 clients, who trade on BSE, NSE and MCX. Daily turnover exceeds Rs 4,000 crore ($649mn), which accounts for 1-2% of the NSE turnover. Previously, it was a small HFT prop trading house incorporated in 2009 and faced some of the problems with HFT in India.
To begin with, it is expensive: there is a security transactions tax levied on every trade irrespective of whether it makes money or not. In the cash segment, this contributes to over 50% of the total transaction cost, which acts as a deterrent to investors. SEBI has appealed to the government to reduce or restructure this tax. BSE's Chauhan has echoed this sentiment in budget requests.
Shrinivas Viswanath, RKSV
RKSV's Viswanath noted that orders to the exchange are not "massively scalable".
"One can only send 200 to 400 orders a second, although you can buy more capacity," he said. "This does not allow super high frequency trading."
But there are benefits.
"You also can't flood the exchange with new orders and cancels, which is not positive from the broker's point of view but significantly better for the environment," he said.
One of the most significant changes in the India market, from a long-only perspective, has been the emergence of Liquidnet's dark pools services, Eastspring's Awasthi said, adding that "this was needed and could potentially change the way large institutions trade in India".
"It is a porous market and there has been leakage of information, and that is a concern to institutional investors," said Awasthi. "A service like the one offered by Liquidnet across most markets in Asia was in a lot of demand in Indian markets as well."
And he predicts domestic demand for such a service will grow as well.
"The local institutions, the mutual funds and insurance, have grown significantly in the past few years, their asset size is quiet large," he said. "They have become a significant contributor to institutional trading framework in India, and as markets get more institutionalised, things do get better," he said.
For now however, Viswanath doesn't see the internal demand. "It comes up in trading conferences now and again, but there isn't a drive to change the status quo," he said.
Having access to multiple venues, globally, is a major advancement necessary for India to compete with global markets, said Anand Maliwal, CTO at Destimoney Securities.
Destimoney is a three-year old financial services firm, with between 10% and 15% of total volume comprised of HFT. Strategies are written in C++ and trade is predominantly on the NSE and MCX.
"There isn't much traction on the BSE as the volumes on the derivatives segment is lacking," said Maliwal. "As people get more educated, volumes should increase. However, in its present shape, market making on the BSE is a zero sum game."
Anand Maliwal, Destimoney Securities
While conceding that regulators are still learning, the way they go about the business is "haphazard", said Maliwal.
"A couple of flash crashes led to impractical decisions and too many road blocks," said Maliwal. "The regulators should be aware of what happens globally and adapt accordingly to the Indian markets.
Both the NSE and BSE have index-based, market-wide circuit breakers in place since 2001, and since late 2013, the circuit breakers are triggered by movement in either of the two exchanges.This is already happening.
Maliwal is optimistic and expects the HFT side of Destimoney's business to double in the next three years.
"The emphasis should be on trying to increase the market size by increasing the number of participants," he said. To this effect, the firm is holding seminars, closed meetings and training sessions with clients. "Once they are comfortable, volumes will automatically increase."
Since 2009, Lares Softech, a private asset management SEBI-registered hedge fund software development and prop trading firm, has specialised in the algorithmic and HFT trading space in Indian markets. It also has a presence in Dubai, Singapore and various other countries.
All software is built in-house with the focus on ultra-low latency. It uses the latest technologies and a combination of languages like Java, C#, C++ and has zero manual intervention in testing or backtesting environments.
However, every single change needs to receive permission from the exchanges.
Brijeshwar Patel, director at Lares Softech, said: "Each change to a strategy has to be demonstrated to the exchange to ensure that it is confined within their prescriptive technical restrictions. Depending on the strategy, they can take up to a month to respond."
Minor changes, he added, have a quicker turnaround time.
As the data from exchanges get more refined and speeds improve, along with enhancing its corporate management system - a system that keeps checks on positions - and risk management system, Lares Softech is investing in machine learning and FPGA (Field Programmable Gate Arrays) technology to increase volumes.
Goldman Sachs India Labour
Lares isn't alone. One Calcutta-based prop trading house is already using FPGA. It has only three clients, but its focus is predominantly on proprietary algorithmic and high frequency trading. Daily turnover is Rs 1,000 crores with between 20% and 25% of volume coming from HFT. However, its director/compliance officer doesn't expect this to increase significantly in the next few years.
"The structure and restrictions on the number of messages per second means that there is not much improvement with FPGAs," he said.
But with expectations that HFT is going to kick off in the next year or two, technology providers are eyeing the Indian market as a major opportunity.
Founded in 2011, NanoSpeed develops low latency FPGA products for financial markets, and have worked with clients trading on the London Stock Exchange, Chicago Mercantile Exchange, among others markets in Europe, America and Southeast Asia. Clients include prop trading firms, top ten banks, and large international investment brokers.
Sanjay Shah, NanoSpeed
"NSE and BSE are expanding their horizons and volumes should increase," said Sanjay Shah, CTO at NanoSpeed. "However, HFT firms are exposed to a lot of risk. There is a barrier to entry. The idea, for us, is to streamline and make it easier for companies to do low latency trading."
That means having some building blocks in place, for example the risk checks.
"Market data is processed by the NanoSpeed FPGAs, but consumed by the clients' strategies. Outgoing trades are accelerated through the NanoSpeed FPGAs. Essentially, you provide them with the platform to accelerate the flow," he said.
FPGA is capable of handling 20 million messages per second; over 32,000 connections; and has a latency of under 0.5 microseconds. To give that some perspective, extremely fine-tuned software in C++ has an approximate 10 microsecond latency. ETFs and indices are priced in nanoseconds.
But is the technology on Indian exchanges sophisticated enough?
Shah is optimistic, and believes that market making will "take off in a big way" over the next two years.
"The NSE is putting in a new protocol. With this new protocol and FPGA, we are talking of latency less than 1 microsecond. The fact is, using FPGA, you can be assured that your order reaches the exchange faster than your competitors. You just need to decide the correct time to send the order considering the rate limit rules."
"None of this is rocket science. All it takes is someone to come up with an engineering solution to make the markets more reliable," he added.
Beyond low latency
Though a lot of high frequency trading shops are less than five years old, daily turnover accounts for up to 2% of the market. This is in markets where the leaders represent between 5% and 6% of total share.
The companies are expected to keep growing the HFT business and are investing heavily in technology and systems reliability; after all, the onus is on them to ensure algorithms don't go rogue. It's safe to say this business isn't going away.
Bob Mudhar, Citihub Consulting
Bob Mudhar, associate partner at Citihub Consulting, said that the only two real pre-requisites for high frequency trading are that markets need to be liquid and order driven.
Even so, the legacy of HFT was forged in low latency. And across the world, that's changing.
"The market has become less focused on chasing the absolute lowest latency, and more focused on ensuring deterministic levels of performance coupled with very high availability," said Mudhar. "That means the focus has really shifted towards having the most reliable systems that are fast enough (for the strategy in question). Clients will stay sticky to those firms that provide the best availability and also recover best when there is a failure."
India is no different. So, even while the exchanges, participants, and regulators are finding their footing, it's still a nascent industry. But the economy and timing seem to be in India's favour for development to flourish.
"Over the last 20-odd years, I have seen the Indian markets evolve from a very basic level," said Eastspring's Awasthi. "I mainly trade emerging markets and every year I see them change for the better."