The Gateway to Algorithmic and Automated Trading


Published in Automated Trader Magazine Issue 36 Spring 2015

It's been almost 15 years since the original BRIC grouping was minted, referring to Brazil, Russia, India and China, with South Africa getting tacked on in 2010. Much has changed in the world since then, and though the regions push forward with cooperative arrangements among themselves, there is a big question mark over the relevance of these emerging markets as a group. Automated Trader tries to stitch together the macro and micro realities.

Philippe Carré, Global Head of Connectivity, Capital Markets, SunGard

When Jim O'Neill, former chief economist for Goldman Sachs, first decided to group seemingly disparate countries, coining the term "BRIC", he unleashed an enviable example of out-of-the-box theorising that actually ended up having practical outcomes. There are now BRICS summits, cross-exchange listings of indexes and a joint development bank, among other initiatives.

How successful these have been is a matter of debate, however. Economic growth in some of the BRICS has disappointed in the past few years, which has spurred a major rethink on the whole concept.

That rethink can miss the point, said O'Neill in an email. The BRIC concept was never based on the countries' economies growing strongly every year and China is not disappointing relative to the original assumptions, while India is accelerating. It is really just Brazil and Russia that are flagging, he noted.

By 2016, the combined size of the BRIC countries will be as big as the US, bigger than the EU and is underpinned by a development bank, he added. In the long-term, they are set to outpace the G7 nations (Canada, France, Germany, Italy, Japan, the UK and the US).

"I know it has become less fashionable and some people say it is less useful, but obviously I don't agree," said O'Neill. "If you assume the reason why the concept became so popular was on the premise that they're headed towards being bigger than the G7 by 2037, which is what we originally said, this is still quite feasible."

As a late joiner, South Africa was added on due to its developed commodity sector and advanced financial markets, O'Neill said, and though he congratulates the move, he remains critical of the country's inclusion on economic terms.

Economic or politics?

It's exactly these kinds of departures from the original argument that has commentators saying the BRICS are actually a political concept.

What Jim O'Neill tapped into, said Philippe Carré, SunGard's global head of connectivity for the Capital Markets unit, is that the polarity of the world was changing and investors needed to look past the usual G7 economies.

"The BRICS are very large countries with large populations, a growing middle class with aspirations," he said. "The concept invented at the particular time to force people to look slightly outside of the box became so strong that those countries started to get together, recognising that they could be a counterweight to the usual suspects," he said.

At the same time, it's not often that a Brazilian hedge fund wants to trade Russia, or that China banks want to go straight to trading Brazil. Cooperative BRICS initiatives may show ongoing commitment, but how successful are they really?

That, said Carré, depends on how success is measured. On the plus side, there are cross-border listings and trading, as well as access to local financial pools. There's also a willingness to accept resources from the outside world and to borrow to strengthen the grouping.

He pointed to South Africa as a case in point. In establishing an alliance, the Johannesburg Stock Exchange benefits from a strong message of openness and promotion, already boosted by an existing relationship with the London Stock Exchange.

The JSE has attracted some heavy hitters. Firms like Virtu Financial are market makers and companies that have stated a presence in the colocation facility include: exchange members Credit Suisse Johannesburg and Peregrine Equities; and infrastructure providers Fixnetix, IRESS and SunGard.

There's also a cross-listing aspect. Russian groups, for example, are increasingly listing across the other BRICS exchanges, as well as Turkey, said Carré.

"There is a willingness from authorities to help on facilitating these relationships, and this probably sends a very strong message about the openness of the community to institutions coming from other BRICS countries," he said.

But it is unlikely to present serious competition to other supra-nationals.

"Is BRICS destined to become a competitor to the Western World? I don't really think so, because they also interact with international institutions, like the IMF or WTO, on their own," Carré said.

E-invite's in the mail

One thing is for sure, the march to electronic trading is a global phenomenon that has been embraced by all the BRICS.

"Exchanges are definitely trying to pursue open strategies, saying we will welcome you with open arms, we need your liquidity provision capabilities," he said. "If you look in the case of China, they are opening more of the market because they want more established groups to come in and help structure the market, to not depend very heavily on retail trading."

One of the most obvious examples of the way China is going about opening its markets is its newly established Stock Connect link between Hong Kong and Shanghai. The initiative has been the topic of much discussion and analysis since going live late last year.

And it is also an example of how market structure changes can lead to political consequences. In China, the link is changing the relationship between the mainland and the island.

Martin Lockstrom, CIO and chairman of the Shanghai-based fund QuantCore Capital Management, said the Stock Connect reflects harmonisation between mainland China and Hong Kong, but as a consequence, Hong Kong is losing its shine gradually. That may be what underpins social unrest between the two regions, which erupted near the end of 2014.

"The protests you have seen in Hong Kong, is not so much a matter of democracy in reality, but rather the fear of losing the unique status that Hong Kong has always enjoyed in the past," he said.

He added that Hong Kong will continue to have advantages for some years to come, at least for the financial industry. But in other industries, such as shipping and sea ports, Hong Kong is feeling the heat of competition from some 20 cities along the coastline in China.

"In many respects, Hong Kong is not the gateway to China that it used to be, but there are tax advantages, like Hong Kong doesn't have any capital gains tax," Lockstrom said. "And there are still barriers for places like Shanghai to be really top breed financial hub in the world, convertibility and income tax, for example."

Javier Tordable
Javier Tordable, Global Executive for India and the BSE Partnership, Deutsche Boerse

Just as China is strategically welcoming foreign investors, so too are Indian markets trying to attract liquidity.

India's come around to electronic trading later than the developed markets, but the last five or six years have seen rapid uptake, said Javier Tordable, global executive for India and the BSE partnership at Deutsche Boerse.

"There are trading houses with hundreds of traders connected to screens. Open outcry has completely disappeared," Tordable said. Like China, it's also a big retail market - representing some 30% of volume on the Mumbai-based exchange, BSE.

Deutsche Boerse has partnered with BSE, among others, and licensed its T7 trading technology to the Indian bourse, allowing it to compete at the cutting edge of latency. Since then, BSE has been actively recruiting HFT firms.

India's quant explosion

The quant community in India has "really exploded", with some 150 Indian broking firms using some kind of quant tool to trade on the markets, said Ashishkumar Chauhan, managing director and CEO of BSE.

Three years ago, total algorithmic trading was about 13% of volumes, today that figure is more like 34%. More than 90% of orders, and 30% of trades, on both the BSE, and its major competitor the NSE (National Stock Exchange), come from algorithmic traders.

Regulators have put controls in place to manage this, with trading systems requiring certification for risk controls and checks, as well as algorithm approval.

"Regulators clearly understand that it is not something which is harming the market. It is good for the liquidity of the market and what they have done is put in some prudential alarms," he said.

Getco was the first foreign automated trading firm to receive regulatory approval in India in 2013. Since then, Gurgaon, located near New Delhi, the political capital, has become India's algo trading capital, where firms such as Tower Research Capital and WorldQuant keep affiliate offices. Some of the biggest domestic trading firms, meanwhile, are Edelweiss and Quadeye.

"India is becoming a very attractive case and is gaining momentum, even if you look and compare to China, which has stagnated at this stage. The timing comes very right at this point to make India the number one priority out of the BRICS," DB's Tordable said, adding that the top priority is greater Asia.

In terms of India's position within the BRICS, some things work and others don't, said BSE's Chauhan.

The BSE is part of a BRICS exchanges alliance that cross-lists derivative products. The benchmark equity index cross listing has not been particularly successful, he noted.

"The whole cooperation was envisaged in multiple stages to get around a closed-door regulatory mind set," he said. "But (the) Indian retail investor is quite unaware of investments abroad."

US indexes, like Dow Jones and S&P, are "hardly" traded, he added.

"Investors seems to have currently a preference for high growth economy and not for stable economy like US. Global pan-Indian indexes have grown over the past seven years, so, (investors) compare that to the rest of the world and find the rest of the world less interesting," he said.

BRICS Market cap

Rising to the top

There are yet ideas for a collective BRICS product. Chauhan said that a BRICS equity index derivative or BRICS bond benchmark could still be in the works in the future, even if progress has stalled. Moreover, currencies are one of the key areas for cooperation among the five R's of the BRICS - real, rouble, rupee, renminbi and rand respectively. It's a bit ironic that the BRICS development bank reserve fund is in USD.

In contrast to the observations of the BRICS becoming a political grouping as opposed to a relevant economic one, there is compelling quantitative evidence that the five countries naturally rise to the top among the emerging markets by some metrics.

Christopher Gannatti, WisdomTree Asset Management
Christopher Gannatti, Associate Director of Research for WisdomTree Asset Management

Christopher Gannatti, associate director of research for WisdomTree Asset Management, the US ETF industry's fifth largest provider, said that when it comes to the firm's equity income smart beta strategy, China, South Africa, Russia and Brazil are four of the top five exposures in emerging markets.

The only reason India is not included is because this strategy is dividend-weighted, and quirks of regulations make dividends an unattractive option for domestic firms. But India could well be "the country of the future in the BRICS" based on performance measures in 2014, he added.

BRICS exposure in WisdomTree's equity income index in 2007/2008 was about 20% underweight the BRICS. The MSCI index would have been 40% to 45% BRICS-weighted at that time, Gannatti noted.

That has completely changed as the countries become cheap on a dividend yield basis, which is how the firm's portfolio is calculated. "The strategy is looking for valuation opportunity, and the opportunities within the BRICS are cheap right now," he said. "There is no person who is running the guard rails, it is literally the quantitative rules-based methodology getting excited about them."

How well that lines up with an unfolding macro story is yet to be seen. Last year saw a significant shift, with the rise of India and fall of Russia.

MNI Indicators collects business and consumer sentiment data for three of the BRICS - Russia, India and China.

Philip Uglow
Philip Uglow, Chief Economist, MNI Indicators

Of the three, India is benefiting from renewed optimism on the back of an election that saw Narendra Modi become prime minister. "India entered 2014 on a wave of optimism, with the caveat that some of our more recent data has shown overall business sentiment as well as production and new orders coming off quite a bit because the Modi government has lost a bit of its sheen," said Philip Uglow, chief economist at MNI Indicators.

China meanwhile has been choppy. "China is certainly slowing, and the authorities aren't going to sit back and idly watch it slow down too fast. Neither do I think they are going to try and boost the economy too drastically either," Uglow said.

The authorities, he added, don't want to be perceived to be "pump priming" as in previous years of massive stimulus measures, which resulted in fears of a bursting credit and housing bubble.

"It is quite important they make sure they tighten up regulation, make sure that liquidity or lending is not going to those areas where they don't want it to go," he said.

Not surprisingly, a very negative tone emerged in Russia after EU and US sanctions over the conflict in Ukraine combined with a sharp drop in the oil price.

"The mammoth surprise towards the end of last year was oil, and that will have an impact on all three economies and in differing ways," he said. "For India it has been undoubtedly beneficial. Unfortunately for Russia it has been a killer blow. There has been inherent damage done to the economy of Russia, and there are growing concerns on how the country will finance itself over the medium-term."

Surfing volatility

From a quant trading perspective however, volatility on Russia's markets, particularly the derivatives market, isn't exactly a bad thing, said Tom O'Brien, head of International Sales for the Moscow Exchange. "We have had great volatility on the back of the collapse of the rouble," he said.

A number of quant traders and market makers sit behind Russian brokers like Otkritie, BCS, and Renaissance Capital. O'Brien declined to provide specific names, except to say that there are some "big ones that you would see in Chicago or London".

One source told Automated Trader that some of the main domestic firms are GorTec, Metallinvestbank and Quantstellation. Some international firms like GSA Capital are active in the FX market, and the source believed that Virtu was conducting market making activities.

Tom O'Brien
Tom O'Brien, Head of International Sales, Moscow Exchanges

The source also said that there are about 20 major players making significant volumes in terms of HFT, but that there is "little exit of old faces or entry of new faces".

It's difficult to discuss Russia without discussing the political situation, but all evidence points to continued integration with Europe in terms of the capital market. Looking away from HFT at long only, the Moscow Exchange has opened up settlement with ICSDs (International Central Securities Depositories) Clearstream and Euroclear across all assets, it has a segregated account structure, there is a special clearing membership for FX, and sponsored access, O'Brien noted.

From a microstructure point of view, the Moscow Exchange has opened up, with PoP (point of presence) in London and a new partnership with TMX Atrium, which gives access from all of the infrastructure provider's PoPs, given the necessary regulatory approval.

"You can come in and access our markets from anywhere and that's for spot FX, derivatives and equities. Russia now recognises the concept of sponsored access and the Moscow Exchange is in the process of updating its rules and technology to allow it," O'Brien said.

There has been a raft of changes in Russia to make the market more attractive such as moving from T0 to T+2, which enables short selling and reduces the cost of trading because funding is reduced from 100% to 20%, or less for equities, O'Brien said. Also, Moscow Exchange now allows collateral to be posted in USD and euros.

If there is an area of concern, it's that some countries, like the UK, have floated the idea of cutting Russia off of SWIFT, the international payments system.

Earlier this year at Davos, Andrei Kostin, CEO of VTB, one of Russia's top banks, warned that excluding the country from SWIFT would be "war", according to media reports.

Such an action was criticised as "problematic because it could perhaps undermine confidence in this system", according to ECB policy maker and governor of Austria's central bank, Ewald Nowotny, who was speaking to reporters in Brussels. Russia is reportedly drafting law to regulate a local equivalent to SWIFT in response.

In 2014, SWIFT issued a statement, expressing "regret" for the pressure: "SWIFT is a neutral global cooperative company set up under Belgian law…As a utility with a systemic global character, it has no authority to make sanctions decisions."

International expansion

Brokerage firm BCS Financial has been operating in Russia since 1995. It started out as a low risk agency driven model offering broker credit services, but has in the past few years pursued an expansionist strategy.

One aspect of that strategy is to build up internationally - an effort that used to be run from Cyprus and is increasingly being migrated to London. Tim Bevan, managing director and CEO of BCS Prime Brokerage, said the UK is set to become the headquarters of the investment banking arm.

Tim Bevan
Tim Bevan, Managing Director and CEO, BCS Prime Brokerage

The prime brokerage, Bevan explained, has been supporting high frequency arbitrage players (he declined to be more specific), and has about 25% of the value traded on the derivatives and equities markets. It's also an agency model, so although BCS provides financing, it doesn't take the other side of a trade.

The Russian market does not have a strong institutional investor base - big pension and insurance funds - and has been traditionally driven by retail. But at the "sharp end", Bevan noted, there is a high level of technological skill, meaning those retail traders have become reasonably sophisticated HFT prop shops.

"What the market is missing is that institutional base to trade against. A market can only house so many market makers and arbitragers," Bevan said. "There was talk of pension fund reform but that really hasn't happened and there is no evidence it is going to happen in the initial to medium term."

One aspect of the Russian trade is arbitraging depositary receipts between the Moscow Exchange and the IOB (international order book) in London, Gazprom DRs being the most popular. Russian quant funds are increasingly starting US, Brazilian or Asian strategies as well, Bevan said.

At the same time, BCS is looking for non-Russia related revenue streams - focusing on Europe initially as wholesale banks retreat from "vast tracts of client business" leaving gaps in the market for financing and market access services.

"We will always be a Russian-focused broker, but we are not only that. We are looking hard to search out new opportunities, of which I think there are plenty, especially when the broker landscape is changing so rapidly," he said.

For Moscow Exchange's Tom O'Brien, one of the major concerns voiced by clients is on the issue of capital or currency controls, a situation that has never been the case in Russia during any of the major crises.

"Can they get their profits out? That is really what worries them…even if we go through factually in the past, it ties them up a bit that there is not going to be any in the future," he said.

In terms of the other BRICS, O'Brien noted that Russia can be easily compared to Brazil for FX trading because both regions have on-exchange platforms. "The clearing and counterparty risk are actually handled by the exchange…most of the trading actually happens on the exchange platforms and that is why they are quite liked by the quant traders. They are normal central limit order books."

Brazil's options

Brazil is one of the success stories out of the BRICS, said Delfos Machado, managing director and head of equity trading for the Americas at HSBC, particularly because of its thriving options market.

On the back of that, the exchange, BM&FBovespa, openly welcomed quantitative and high frequency traders, in order to grow volume, though with limited success. Domestic market makers are listed on BVMF's website and include firms such as BTG Pactual, Itauvest DTVM and Credit Suisse Brasil. International market makers trading on the exchange include such firms as Virtu Financial, as identified in an SEC filing, and Optiver, according to a source.

The winners have been options market makers and to a lesser degree arbitrage players, Machado said, while the stock market makers are in a different situation.

That's because 2006 and 2007 saw a large number of IPOs in construction and oil exploration.

The market is experiencing some challenges balancing growth and debt exposure, Machado said, which is affecting a lot the vast majority of recently launched companies and so, stock market making is a more difficult space.

Domestic scandals don't help the situation. State-owned oil producer Petrobras is embroiled in a corruption probe and had its bonds cut to below investment grade. It now faces massive liquidity issues.

To provide another example, in 2013 as the oil and gas firm OGX was in the process of going into default, its weight in the index combined with the lack of shares to lend created a major short squeeze on the borrow of the stock but not on the price, making life painful for long/short fund managers.

In terms of the rest of the BRICS, Brazil is the most open, Machado noted, but China is moving in the right direction with the Stock Connect, a development that HSBC is keenly interested in.

"We were one of the top houses when China opened up the South Connect, the Hang Seng to Hong Kong," he said. "China is where a lot of growth in equity volume in BRICS is going to come from."

Emerging into the frontier

In its report looking at the shift of risk from banks to buy side, software provider Misys found some interesting trends in emerging markets.

For one, there is a substantive amount of capital, but it's not staying put.

Money that is being managed in Singapore represents substantively lots of high net worth money, close to $3 trillion, almost equal to Switzerland.

"It's doing a round trip.…here is far stronger comfort with the track records with managers outside of APAC," said senior risk advisor for Misys, Bradley Ziff.

So, although capital from Greater China, Singapore and Southeast Asia may well be invested in Asian assets, management is based in the region, for tax purposes, but the managers themselves are off shore, Ziff explained.

This poses real challenges to emerging and frontier markets, because it means money is not going to infrastructure development in their own regions.

"At this juncture, there are still benefits for having a London or US manager investing your assets in emerging markets, as opposed to having somebody who is still building an investment record in Taiwan, for example," Ziff said. "The high net worth in many emerging markets-Asia, Middle East, Africa, Russia as examples-are not parking and investing that capital in Asia. They are shifting that capital out even if that is a fund (that) itself is focused on the region."

But there is also recognition that investment in riskier jurisdictions is a social imperative.

Whether or not China is proved to have the right approach, certainly the country has emerged as a leader in investing in difficult regions, like Afghanistan, Pakistan and parts of Africa, and is a go-to lender for countries dealing with tough economic realities.

Banks in Asia, but also in Latin America and the Middle East, are coming to terms with the fact that they need to become more comfortable with risk in order to bridge inequality gaps through economic development.

Some of the regions with significant resources, as well as banks that have massive investment capacity, are still facing overwhelming political risk in such a strategy.

At one bank in the Middle East, the chief risk officer told Ziff that among his largest concerns was not only US interest rate policy, but the threat of the violent group calling itself the Islamic State, which has wreaked havoc in Iraq, Turkish Kurdistan, Syria, and even Libya.

"He told me, 'imagine what happens if they cross over into our country, the same way they have in Syria, Turkey and Iraq, or the similar horror caused by Boko Haram in Nigeria? What do you think happens to my banking system?'" Ziff said, recalling the conversation with the CRO.

But that doesn't mean the asset management and sovereign arm of the bank are ready to accept infrastructure risk in Syria either, so the challenges are deep and long term.

Sanctions risk

Standard Chartered Bank provided a perfect example of the reputational risk faced by firms when it was slapped with a hefty fine for violating economic sanctions against Iran.

matt gibbs

Matt Gibbs, Product Manager, Linedata

Now, nobody wants to be in Standard Chartered's position when it comes to the EU and US sanctions against Russia.

"Sanctions are decided on the Tuesday, they are in place on the Wednesday," said Matt Gibbs, product manager at Linedata. "You need to be able to put those in quickly and make sure there is pre-trade compliance. With those kind of legal problems you can't really ask for forgiveness afterwards."

The speed of the execution for some firms is paramount he added, so eliminating latency in any pre-trade compliance risk check is important particularly in light of the way relationships within the buy side are changing.

"Traders are looking at portfolio managers almost like clients, and trying to prove their execution value. So when a trader decides it is time to hit the market electronically, they really need to do that at that moment in time and get their fills back