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Kinks in the wire: Asean integration

Published in Automated Trader Magazine Issue 34 Q3 2014

Asean integration approaches next year, but a fully linked-up financial system will be several years in the making. Sophie Lewisohn hears about new initiatives between exchanges and what still needs to happen for trading to take off.

Kinks in the wire: Asean integration

Expert Insight - The Rise of the Asian Superbroker

As the global banks grapple with tides of regulation, fines and a myriad of other post-crisis issues, local Asian institutions are tooling up and stepping in to fill the gaps. The "Asian superbroker" is emerging and catching up with the big guys.

Global banks have had a tough time in the past five years. Asia is proving challenging ground, and the need to be 'local' in every market can be a stretch. This is fertile ground for local banks and brokers. Big deals have already been done and ASEAN banks generally are increasing their investment in services for international clients wanting access to Asian markets - from Singapore and Hong Kong to Mongolia and Myanmar. Indeed some are reaching out past the Asian border too. Could these Davids of the broking world really be starting to snap at the heels of the Goliaths?

Click here to read the remainder of this article Fidessa

While Europe works through the after-effects of integrating many unequal economic parts, the south-east Asian nations are nearing the creation of their own economic community in 2015.

The similarity between their charters is striking. The goals of euro architects Francois Mitterrand, Jacques Delors and Helmut Kohl rise again in Asean's Charter, whose aim is "a stable, prosperous and highly competitive Asean Economic Region in which there is a free flow of goods, services and investments, a freer flow of capital, equitable economic development and reduced poverty and socio-economic disparity."

But the similarities end there. It is tempting to view Asean as the next EU, but the groups of countries are markedly different, with different goals and different challenges.

A loose economic team since 1967 when Indonesia, Malaysia, the Philippines, Singapore and Thailand teamed up, Asean has doubled its membership to include Brunei, Cambodia, Laos, Myanmar and Vietnam. The list includes one of the world's richest countries (Singapore) and one of the poorest (Myanmar), and every political system from state-run Vietnam and Cambodia to military Myanmar and Thailand and democratic India.

The challenges in uniting such a group are clear, but there is a sense, on a tense political stage, of strength in numbers. Asean's combined GDP weighs in at $2.3tr, and is forecast by the Economist Intelligence Unit to outsize Germany's by 2018.

While a single currency is off the menu, Asean trade delegates regularly pay homage to the benefits of closer ties through the region. Tariffs between countries are being lowered with the goal of free trade throughout the region, while the financial system is planning a parallel integration.

But there are doubts about the speed with which the latter can be achieved. "There has been talk about a common trading network for as long as I've been working in Asia," said Steffen Gemuenden, CEO of RTS Realtime Systems. Recently acquired by Bloomberg, the firm has operated in the region since the 1990s. "We are still at the very beginning."

The Asean Exchanges comprise seven bourses: two in Vietnam, and one apiece in Indonesia, Malaysia, the Philippines, Singapore and Thailand. Their aim is to promote Asean stocks as a single asset class and encourage investment in the region.

Singapore Singapore
Malaysia Malaysia
Thailand Thailand

According to Pete Osborne, director of International Sales at the Singapore Exchange, it is working. "There is great interest from investors to participate in developments in the region," he said. "The Asean countries are home to nearly 10% of the world's population, and many of the economies in the region are young and growing, such as Myanmar and Vietnam."

Statistics show they are growing quickly - the FTSE's ASEAN index returned 111% over the past five years (although growth over the past twelve months has been less impressive, at 4.7%). As well as encouraging overseas investors to add Asean exposure to their portfolios, the Exchanges are working on making trading between themselves smoother.

Steffen Gemuenden, Chief Executive, RTS Realtime Systems

Steffen Gemuenden,
Chief Executive, RTS Realtime Systems

"Latency times in Asia are already not too different from the US."

Linking up

"The most significant initiative by Asean Exchanges has been the Trading Link," Osborne said. Launched by the Singapore Exchange, Thailand Exchange and Bursa Malaysia in 2012, the Link makes it possible to trade stocks of Asean countries with ease - or at least, without the need to deal with multiple brokers.

Before the Link, trading between Asean countries was laborious. Orders could only be submitted to exchanges by brokers based in the same country as the exchange, so that an investor in Thailand who wanted to buy Malaysian and Singaporean shares had to open accounts with both Malaysian and Singaporean brokers.

Now, investors in the participating countries need only deal with their local broker, who communicates with the other national brokers on his behalf through bilateral agreements. All the orders are fed into a central platform, which means more liquidity and a greater chance that orders will successfully meet and match up.

"It created a virtual stock market of over 2,200 stocks with a market capitalisation of US$1.4tr," said Osborne. Trading volumes and market velocity have increased markedly on the Malaysian and Thai exchanges since the Link was introduced (see charts).

The Link has primarily benefited smaller local retail investors, said Jessica Morrison, head of Asia Pacific Market Structure at Deutsche Bank, which provides settlement, foreign exchange and custody services to brokers using the Link. "The big institutional players don't get anything from the Link that they don't already have from using a global broker with presence in all the markets."

Until there are incentives to use the Link - like making trading faster, cheaper or significantly simpler - she does not foresee much appetite from an institutional client base. Only if it were to introduce centralised trading and simpler trade processing would the Link become attractive to the bigger players.

Among the retail investors who use it, brakes on investment remain even after the hurdle of multiple brokers has been cleared. Settling in another Asean currency opens up the risk that the exchange rate will move before the deal is done; there are still ownership limits when it comes to buying foreign stocks; and there are the tax implications of owning stocks offshore.

Unfamiliarity also poses a barrier to trading. It takes time for investors to become familiar with stocks from other countries and confident enough to begin trading. To aid this, the Asean Exchanges have launched a FTSE 180 index to showcase the top 30 companies of each national exchange. They are also stepping up their roadshows - such as Thailand's recent 'Corporate Day' when nine Thai companies met with 33 fund managers in Asia to solicit investment.

Pete Osborne, Director of International Sales, Singapore Exchange

Pete Osborne,
Director of International Sales, Singapore Exchange

"The Asean countries are home to nearly 10% of the world's population, and many of the economies in the region are young and growing."

Piecemeal partnerships

Paul McCartan, director of business development in Asia Pacific at SunGard, which runs the Trading Link, expects to see more cooperation between exchanges. "The Asean link proved that cross border relationships are possible," he said. "Partnerships are being formed, encouraging more cross-border trading."

But the challenges of furthering the links are many. "Within the south-east Asian markets, exchanges are at different stages of development," he said. Singapore has one of the fastest matching engines in the world, while Cambodia lists only two stocks on its exchange. "Each exchange has its own rules - there is no common protocol, and the exchanges' matching engines are vastly different."

Even before the complexities of the matching engines are considered, there are basic differences in the ways Asean exchanges operate. While Bursa Malaysia and the Singapore Exchange operate from 8:30am till 5pm, trading on the Philippine exchange is only possible from 9am till 12.10pm. Hanoi and Ho Chi Minh stay open only a couple of hours longer.

"Integration will take time, and stretch far beyond 2015," said McCartan. "We continue to see broader agreements on currency and settlements, making clearing easier - though there remain a lot of grey areas."

Agreements tend to be piecemeal and bilateral, rather than introducing frameworks across the entire group. "The difference in approach between the EU and Asean is vast," said David Fergusson, CIO of Singapore-based Woodside Holdings Investment Management. "In Brussels it is all about harmonisation; across Asean it is more about taking down barriers to trade than attempting to devise an ideal system."

Thailand recently entered into a regulatory cooperation pact with Cambodia, with their respective Securities and Exchange commissions agreeing to share data on daily trends and trades. It is a step forward, but also a reminder that the grouping is disparate.

One initiative to bring closer cooperation in the region is the Funds Passport, currently in consultation and due to go live in 2016. It will make it easier for funds to operate across Asia, minimising the paperwork and set-up costs, which currently have to be duplicated in each country a fund wishes to invest in. "With just one approval process, it should improve ease of access, lowering costs and encouraging people to do business," said Morrison.

The interest is already there. Algorithmic and electronic trading are becoming more common across Asean, according to McCartan.

Trading Asean

Winnie Khattar, head of Analytics in Deutsche Bank's Asia Pacific equity trading division, has seen increasing use of algorithms across equities, cash and derivatives on the Asean markets.

Paul McCartan, Director of Business Development in Asia Pacific, SunGard

Paul McCartan,
Director of Business Development in Asia Pacific, SunGard

"The Asean link proved that cross border relationships are possible."

Strategies are often different from those pursued in the EU and the US. For one thing, there is little dual-listing of stocks. "In Asia, you usually have one exchange in each country," said Steffen Gemuenden. "It's not like the States where you have the NYSE and the NASDAQ and seven electronic trading networks and 35 dark pools, and the focus is on smart order routing."

There has been a shift in trading style. "A few years ago, most investors were concerned with their volume-weighted average price, and used simple VWAP strategies in line with market volume - plain vanilla stuff," according to Khattar. Across a day, traders measured success by how far below the day's volumes-weighted average price they could execute their trades.

These days, clients are interested in liquidity at minimal cost - only trading when the market has reached a certain level of activity. "There are algo strategies which trade by sending small 'child' orders to market, measuring when there is sufficient execution volume available," said Khattar.

In these strategies, the measure of success is how little the trade impacts market prices. The arrival price - the stock price when the trader enters the market - is becoming a more commonly used benchmark, and 'slippage' - how far the price moves from the mark - is to be avoided.

Khattar has seen increased trading in the opening and closing auctions, when volatility and volumes are high and the likelihood that a trade will impact prices relatively low. "The overall portion of the day's volume traded in auctions has increased - more clients are participating in auctions using specifically designed strategies."

Expensive business

Asean's transaction costs are high relative to global markets, according to Gareth Pyburn of Insight Legal Asia. "Even the region's free-market petri dishes - Hong Kong and Singapore - have unacceptably high transaction costs relative to other developed markets," he writes on the consultancy firm's blog.

Winnie Khattar, Head of Analytics, Asia Pacific Equity Trading Division, Deutsche Bank

Winnie Khattar,
Head of Analytics, Asia Pacific Equity Trading Division, Deutsche Bank

"The overall portion of the day's volume traded in auctions has increased - more clients are participating in auctions using specifically designed strategies."

There are two kinds of costs: the explicit cost of settling a trade and paying any taxes; and the implicit cost of interacting with other orders in the market, causing the price to move. "Sophisticated traders are aware of both kinds of costs," said Khattar.

"Explicit fixed costs are decided by regulators. The implicit cost, on the other hand, can to an extent be controlled," said Khattar. "Trade Cost Analysis is becoming an essential part of the trader's toolkit, as clients assess their performance and review their trading strategy."

A big factor in the cost of trading is liquidity. The market needs to be 'deep' enough that a large trade coming in doesn't make a splash and send prices up or down.

'There is a lot of potential for growth on the institutional side and hedge funds waiting for a critical mass of liquidity to make their strategies work," said DB's Morrison. "We've seen a few of the most progressive funds start to deploy strategies already, and expect more to come in the near- to mid-term."

As well as waiting for liquidity to pick up, hedge funds await a certain level of sophistication and deregulation on exchanges. "Market neutral strategies, for example, involve short selling. And that isn't possible across all of Asean," said Morrison. While selling a borrowed stock is possible in Malaysia - albeit only on a list of approved securities - it is illegal in Vietnam.

There is also friction from time delay regulations. While some Asean exchanges allow direct market access, others impose hold-ups. Until recently, Thailand insisted there be human involvement in the processing of every trade, leading to the (possibly apocryphal) story of the stock exchange employee tasked with glancing at and approving each trade to flash on his screen, who in the end left a phone book on the Enter key and called it a day.

Asean Market Share Asean Market Share
Source: Deutsche Bank Asean Market Share
Jessica Morrison, Head of Asia Pacific Market Structure, Deutsche Bank

Jessica Morrison,
Head of Asia Pacific Market Structure, Deutsche Bank

"We've seen a few of the most progressive funds start to deploy strategies already, and expect more to come in the near- to mid-term."

Colocation and next steps

Increased direct market access is paving the way for more automated trading; another development in the wings is colocation. Of the Asean exchanges, only Bursa Malaysia has colocation - and the data centre is not even in Asia but in Chicago, where the Bursa's derivatives exchange is hosted
by CME.

Latency times in Asia are already "not too different from the US", according to Gemuenden. The region's exchanges are provided technology by global software vendors. Technically, the capacity to support colocation is already in place, but the appetite for it is at an early stage.

"You need the market mechanics, but you also need a broader financial system in place to support the activity," said Woodside's Fergusson. "Asean lacks the massive mutual fund holdings and pensions industries of the US and Europe which give volume to the market." He anticipates that these will develop as the region becomes more prosperous, bringing volume and trading possibilities with them.

Steffen Gemuenden expects to see colocation introduced by other Asean exchanges within the next five years. "It will take time to develop the market, grow the volume and the list of products available to trade. Colocation may not arrive this year or next year, but it is the next step."

Allowing funds to plug their trading equipment directly into stock exchanges' data centres would enable more sophisticated trading strategies - but the regulatory framework in the region may not be ripe to support them.

Regulations are changing all the time - but not in a steady and predictable direction. "It's hard to be confident that what is legal today will still be acceptable in six months' time," said Fergusson. "Regulators can make snap decisions - there aren't the same lengthy consultations you see in the EU or US. Exchanges suspend trading more often than you'd think. It's not a predictable environment to trade in."

Morrison expects to see a combined regulatory body forming over the next few years to oversee the Asean exchanges, and facilitate improved sharing of information. "When there is confidence that trades will work and that markets are clean and safe, investment will increase. It's a classic formula: less complexity equals more confidence and more investment, spurring growth."

But reducing complexity is no easy task. It must include cross-border regulations coming into sync, alongside tax harmonisation, commonly-agreed settlement procedures and a system for mitigating currency risk.

Though its acronym makes it easy to perceive as a coherent region, when it comes to trading, Asean is anything but.

Kinks in the wire: Asean integration