The Gateway to Algorithmic and Automated Trading

Hong Kong does the math. Focus on cost + infrastructure investments = more algo trading

Published in Automated Trader Magazine Issue 27 Q4 2012

If mainland Chinese markets are in the toddler phase when it comes to algorithmic trading, Hong Kong markets look fairly grown-up. But industry executives say they still have plenty of scope to get bigger, faster and stronger.

There is a discernible appetite for more algorithmic trading in the Hong Kong market, according to David Wilkinson, senior director of business development for Asia Pacific at data centre provider Equinix. The driver, as elsewhere, is the need to squeeze trading costs. "We've seen a desire to learn more, and there is already a high level of existing knowledge," he said.

Algorithmic trading is a standard feature across the market, especially concentrated in Hong Kong in derivatives trading, which is exempt from the territory's 0.1 percent stamp duty on cash equities. "The level of sophistication in terms of algo use in Hong Kong is quite high amongst the international money management group," said Rob Laible, head of Asia ex-Japan cash sales trading at Nomura.

Rob Laible

Rob Laible

"Anything listed on the Hong Kong exchange people trade via algorithms, whether it be warrants, ETFS, derivatives et cetera," said Greg Lee, Deutsche Bank's head of Autobahn Equity electronic trading for the Asian region. "In the futures space now there are a lot more algorithms for listed futures, and in the FX space as well people are rolling out algorithms."

High frequency trading also features outside the cash equities market.

"Are there people who run market-making strategies in the Hong Kong equity market? No. Typically spreads are too wide, costs are too great, so there is no market-making structure in cash equity instruments," Lee said. By contrast, HFT is focused on warrants, index instruments, futures and arbitrage strategies, along with long-short investors using automated strategies.

Consulting firm Greenwich Associates said in a report earlier this year that there has been a sharp uptick in the use of algorithmic trading strategies across Asia; they now account for 22 percent of Asian equity trading volumes. The report says institutions using algorithmic trading expect the proportion to grow to 26 percent in three years' time.

"We see about 25 percent of orders (in Hong Kong) coming through some sort of algo engine," said Chris Jenkins, head of trading technology provider TORA's Asia sales and operations. "It's either via the buy-side, which is rarer, or more often via brokers." The biggest users tend to be hedge funds, especially long-only funds, trying to avoid market impact for block trades.

Jenkins said about 60 percent of orders are based on VWAP, but a recent trend has been increasing interest in more sophisticated algorithms. "They're a basic form of distribution for brokers now; everyone is using vanilla algos. What you'll see now is growth in more sophisticated algorithms, built around sophisticated strategies."

Low-latency network specialist BSO Network Solutions sees strong growth underway. UK managing director Fraser Bell said Hong Kong-based demand for his company's services had grown 125 percent so far in 2012. The company provides networks for investors between Asian markets, which include Hong Kong and China, and Europe. "We see a macro trend of lower latency, and more bandwidth," he said.

Fraser Bell

Fraser Bell

The Hong Kong market structure is very different from its mainland China neighbours. Retail investors in Hong Kong account for a far smaller proportion of volume - about 26 percent of cash equities transactions and 23 percent of derivatives, against 70 to 80 percent for cash equities in Shanghai and Shenzhen.

Around 2 to 3 percent of transactions in Hong Kong are via dark pools, though they are an unusual variety. The 15 or so dark pool operators, mostly the biggest brokerage firms, are licensed members of the exchange. "The Hong Kong market has a monopoly on trading in the equities market enshrined under law, so it will be the only lit market in Hong Kong until that law is changed," said Lee Porter, head of Asia Pacific for dark pool operator Liquidnet, which is one of the 15.

Dark pool trades are reported back to the exchange, avoiding some of the issues on data fragmentation and lack of a consolidated post-trade tape experienced in European markets.

Other features of the Hong Kong market are in line with the rest of the more developed Asia Pacific markets. Quantitative investment styles are well-established. A broad range of financial instruments is traded.

And just like market regulators in Europe, India, Singapore and Australia, Hong Kong's financial watchdog is now thinking hard about electronic trading, including algorithmic trading. In September, Hong Kong's Securities and Futures Commission was due to finish a consultation with the industry about rules.

As in other markets with less well-developed algorithmic trading, the Hong Kong regulator wants to head off the kind of problems developed markets have experienced.

"It's keeping a very strong eye on what's happening out there in more mature markets and seeing what's going on, and trying to avoid some of those pitfalls," said Richard Bentley, vice president of banking and capital markets at Progress Software. "So it's: 'We've opened Pandora's Box, how do we close it a little bit?' "

Lee Porter

Lee Porter

The commission says in its consultation document that the increased use of direct market access and complex trading algorithms are welcome developments, increasing market efficiency and providing options for investors. But it says: "As trading becomes an almost instantaneous process without significant human intervention, corresponding effort is required to ensure the integrity of the market and that trading via direct market access or by the use of trading algorithms are conducted in a fair and orderly manner."

Market participants say the draft proposals mostly look clear and sensible. "They're doing the right thing by trying to engage the brokers and the investment community," said Laible at Nomura.

Hong Kong is also gearing up on the infrastructure front. The HK exchange is building a $1.5 billion data centre, due for completion next year. A new underwater cable linking Japan, Malaysia, Singapore and the Philippines, offering faster links between Tokyo and Singapore exchanges, will connect to Hong Kong later this year.

Bell of BSO said his company has seen interest in new routes becoming available, especially faster links between London and Singapore. "We've got high frequency trading companies looking at this route," he said. "It's just about within range for particular types of trading. It used to run at about 190 milliseconds. We think it's going to be around 165 or 170, and that gets very interesting for a lot of high frequency traders."