Bob Giffords - Independent Banking & Technology Analyst
Ralph van Put, CEO of All Options, a trading firm based in Hong Kong highlighted the enormous gap between the two worlds. "The US is very different," he said. "Over 70% of flow in 2009 was algo trading, generated by a tiny percentage of firms. One firm alone trades 2 billion shares a day, creating huge competition. In Asia high speed is relatively less important, so there's a long way to go."
However, Chi-X's imminent launch in Asia could change all that. "We have big ambitions in Asia this year with three initiatives," said Jim Pak, chief strategy officer and global head of products at Chi-X Global. "Chi-X East will be a joint venture with the Singapore Exchange targeting pan Asian, off-shore, dark OTC trading. Then we have an on-shore lit market in Tokyo and finally Chi-X Australia at the end of the year. We hope to bring many high frequency traders with us from Europe or North America to really add to liquidity and shift markets from being quote to order driven."
So are global capital markets converging around a new generation of technology savvy traders? "High frequency traditionally covered two broad categories: electronic market makers and arbitrageurs," explained Jeffrey Wecker, president and CEO of Lime Brokerage in the first webinar. "We now need a broader perspective to include algorithmic execution, program trading, large basket trading, and index arbitrage, where indexes and component stocks are traded electronically to exploit the gaps. Even retail investors with an electronic front end are using high frequency techniques"
Wecker reminded us that the regulators created fragmentation with Reg NMS in the US or MiFID in Europe, which inevitably resulted in computer assisted, high speed trading. "Spreads, commissions and trading costs have compressed dramatically," he noted. "Clearly high frequency traders have had a hand in that but were not the only drivers."
Of course, not all algo trading is high frequency. People who look at market fundamentals are not high frequency, as I would call it," said Steffen Gemuenden, CEO of RTS Realtime Systems "High frequency trading has often been vilified," added Scott Caudell, head of global architecture at Interactive Data 7 Ticks, "but it's many different things: firms with very different capital and resources are competing because the costs of entry are coming down at both ends of the market. Now people can have direct access to a market they didn't even see before."
So everyone is rushing to explore the new world, especially Equinix, the global co-location provider. "The huge number of vendors creates a democratizing environment," observed Stewart Orrell, business development director for Equinix, "where anyone can start up without a huge organization and leverage our investment or that of other technology providers. That enables smaller and more nimble players to generate competition and drive down costs."
Ralph van Put
"Even if the costs per trade for any one market are coming down, putting together a network to access all exchanges is raising costs," said Wecker at Lime Brokerage, "and that inevitably favours larger firms."
With so much technology innovation the panelists were finding it a pretty exciting time. "Switching and routing times are plummeting," said Caudell at Interactive Data, "people are even putting algos on hardware like FPGAs, but it's massively driving up costs. So, since the 2008 contraction, we've seen a big transition from doing critical things in-house, to looking outside just to bring down costs."
Equinix, however, was doing its share in both east and west. "By cross connecting 300 market participants in 5 Asian data centres with 25 data providers and 25 execution platforms we hope to drive down costs and reduce complexity for our customers," said David Wilkinson, senior director of business development for Asia Pacific at Equinix.
High Frequency Trading Asia
New Latency Challenges
If high frequency trading was forged in the fires of the low latency arms race, technologists are now being pushed to the limits in both east and west.
"The key issue now is how to process volumes in an efficient way, not so much low latency, said Orrell at Equinix, with reference to the US and European markets. "Who can handle the volumes, as opposed to speed, will determine the winners."
Gemuenden at RTS agreed. "Connectivity to markets is not the real challenge, It's the volume of data, processing all the updates across fragmented markets. Competition has been good. It's changed the market structure and spreads have narrowed." Moreover, he felt that speed will come to an end as costs rise exponentially. "The key issue will be risk management, said Gemuenden. "There's much more investment in pre-trade controls and increasing interest from regulators and clearers."
Meanwhile, Equinix's Asian clients are struggling with enormous distances. "Most firms entering Asia plan to access multiple markets from multiple data centres, either on day one or else soon after," said Wilkinson. "There is very little cross border direct access. The latency from Singapore to Tokyo is 70 to 100 milliseconds. People might begin in Singapore because it's very welcoming: the convenience of English, an attractive fiscal context, and good links to other countries etc. However, typically they would need to set up trading servers in other countries or use local brokers."
Indeed, there are even more challenges for speed demons in Asia, as Alex Lamb, executive board member for RTS Systems explained. "Our customers develop their own algos which have to work in very different environments," he noted. "Some exchanges put limits on volumes and sell capacity, so a trader might only do 10 orders a second in one market but hundreds or potentially thousands per second in another. Traders have to start thinking about the efficiency of every trade so strategies may be quite different to the US or Europe. However, once the exchanges become more comfortable about participants managing their flow and risks, those restrictions may soften."
Nevertheless, position is everything. "Equinix locates data centres not just close to the market and its preferred service providers, but also close to transmission points for submarine cables," concludes Wilkinson. "Connectivity is king, so we are carrier neutral. We have a database, called Equinix Guide, to help customers map out their options for telecoms based on target venues, data centres, and international carriers. Having global access but local operators is key to efficient operations."
Testing Times and Other News
The Western Webinar also looked at the challenges of back testing. "We provide different types of backtesting tools," said Gemuenden at RTS, "but the concept has changed. Originally it just looked at the best bid and offer; now it's migrated to full market depth. There are challenges to get historical data, so we collect it on the fly with a simulator for fills."
"Backtesting is terribly important," added Caudell from Interactive Data, "but it's very hard to replay so many complex parallel feeds with all the microbursts and different inputs. It's much better to have 'forward testing', working off live feeds in parallel rather than 'backtesting' working off message archives."
"There's also a growing interest in machine readable news from users," added Gemuenden, "so our algo trading software connects to many newsfeeds, processing news events in milli- or microseconds, but actual usage is still limited. The challenge is how to interpret the news to generate alpha; it's a matter of costs versus benefits."
Caudell agreed. "Machine readable news is still a very small segment in the complex event processing world," he said. "Very few people are doing it and doing it well."
Go East Young Man
Many firms are seeking their fortunes in glittering Asia, but all that glitters is not gold. "The biggest difference we have to face," said Pak at Chi-X, "is the diverse regulatory environment. In both Europe and North America the regulators actively promoted fragmentation and high frequency trading with Reg NMS and MiFID. In Asia, each market has its own nuance, and there's no regulatory catalyst. However people are very forward looking about how capital markets should develop. Each country will decide how fast they want to move."
"There are many challenges," added Wilkinson. "In Korea or Japan few people speak English and all documentation will be in local languages. Equinix tries to help where we can. Then there are legal importation rules. People may try to bring technology into Hong Kong without the correct Chinese approvals. That has tripped up some people."
"Given that volumes are still small," added Lamb from RTS "external players may also find it difficult to reuse their Western models and drop them into Asia without tailoring them to local capabilities."
One way to deal with the challenges is of course to use a broker. "There are many prime brokers who have been here for ages," said van Put at All Options, "and offer DMA or unfiltered, sponsored access so they can take away many of the language and technology hurdles." However, he also noted that there are no rebate models in Asia. "Exchanges see the need for rebates, but are not ready to try it. Any rebates go to the prime broker anyway and not the member firm, so fee structures will be very important to facilitate algo trading."
However, van Put has found Asians very eager to learn and use technology. One software firm apparently supplies 200 young traders in China, who are using algos to execute both in local markets and globally, even the US. At the Chinese University of Hong Kong van Put is setting up a dealing room to allow students to trade on different markets in Asia, the US or Europe. "They're learning to program new hedge fund strategies," he said. This makes me confident that Asia will adapt quickly." He notes that there are many more quants with a PhD who can now be successful compared to twenty years ago. "Traders are like formula one drivers, who are half engineers. You need a high speed, low latency car, but you also need drivers who understand the technology and can contribute to a balanced market," concluded van Put.
The Long Arm of the Law
The Western webinar focused very much on the torrent of legislation that could radically change the markets. "There's a lot going on," said Lance Zinman, partner and head of financial services in Chicago at law firm Katten Muchin Rosenman LLP. "It's mostly on the equity side, with at least 5 federal acts that could impact prop trading, two primary regulatory bodies, the CFTC and SEC, and many self regulatory organizations. As a result, there is potential for overlapping and/or inconsistent regulation." He described how currently the SEC is looking at the elimination of flash orders, a ban on naked sponsored access, rules regarding undisplayed liquidity and dark pools, and short selling in falling markets, and requirements for large trader reporting to improve transparency. Most interesting of all he found the SEC 'concept release' that asks many questions about high frequency trading including co-location services, market latencies and undisplayed liquidity. "The overall theme is whether long term investors are harmed by short term or high frequency trading," Zinman concluded.
He contrasted the SEC actions with those of the CFTC responsible for futures and derivatives. "The CFTC has not appeared to be as concerned with high frequency trading," said Zinman. "They currently are focused much more on position limits and OTC clearing. They will also look at co-location and are similarly concerned about the fairness of the futures markets."
It looks like the pendulum is swinging back towards tighter controls. "Regulatory responses might impose a minimum duration on orders, prohibition or restriction of pinging orders, affirmative or negative trading obligations, and registration requirements for proprietary trading firms," said Zinman. He went on to explain how in equities, many prop firms became broker dealers to get leverage or direct access to a national securities exchange.
Then with portfolio margining and sponsored access they found they could get the leverage without the regulatory burdens applicable to broker-dealers. Now the SEC is saying regulated brokers must impose pre-trade risk checks on all sponsored access participants, so we may see an increase in broker-dealer registrations to avoid this extra layer of pre-trade risk. On the futures side, prop firms generally were not registered with the CFTC, although many were members of various futures exchanges in order to obtain preferential rates.
"Clearly the regulators feel the need to deal with some issues like flash orders or certain facets of undisplayed liquidity," said Zinman, "but we hope they will only nibble around the edges and not look for fundamental market reform."
"We are still studying the SEC concept release," said Wecker at Lime Brokerage, "but believe that some proposals could impact the market negatively and reduce liquidity. It's critical however that technology tools are provided in a non-discriminatory manner. We need to ensure the SEC takes time to make a well informed decision and is not overly politicized by people who don't really understand how the market works."
However, on one point Wecker is very positive. "The clear focus of the SEC has been to put in place the necessary preorder validations to protect the market from runaway or errant behaviour," he said. "One reason we think it will go through is we've proven that such inline validation can be done in a few microseconds. So it's good for the health of the market."
High Frequency Trading US/Europe
Meanwhile, Martin Cornish partner and head of financial services in London for Katten Muchin Rosenman Cornish LLP described how the European regulators are taking stock of fragmentation of markets and exchanges and the resulting increased volume of high frequency trading strategies. "The Committee of European Securities Regulators has come out with a consultation paper," said Cornish, "conceptually similar to the SEC release Lance mentioned, but much shorter, only 7 pages. It calls for evidence, amongst other things, on high frequency trading, sponsored access, co-location services, market fee structures, tick size regimes and indications of interest. It's not clear where they're headed, but I would be surprised if we don't see something emerge on sponsored access with conclusions similar to those reached already by the SEC."
Cornish emphasized that supervisors in Europe want to be sure that regulated firms are not putting themselves at risk since prop trading firms can be a direct members of European exchanges without being a regulated entity. They're worried about fat finger errors and the sheer volume of orders overrunning broker systems and unregulated firms potentially having an adverse impact on regulated firm and/or exchanges."
The Future Lies Ahead
Caught between the long shadow of impending regulation and the bright future of Asian youth, the webinars ended on a very positive note.
Wecker at Lime Brokerage saw the technology arms race as still in its relative infancy. "Increasing cross asset trading will continue to make this field quite exciting," he said.
Over the next two years, Caudell at Interactive Data expected latency to continue to go down and volumes to increase, if not double, every year. "Algo efficiency will continue to be key," he said, "but the playing field will level. There will be a greater focus on the algos themselves and complex technology rather than raw speed."
Meanwhile to the East, a rising generation is enthusiastically embracing the technology. "We've been surprised at how progressive Indian firms are with huge demand for tools to deliver both simple, locally focused strategies and wide-reaching global strategies in commodities across multiple markets," said Lamb at RTS. "Even in the West commodity markets are still seen as specialized and underdeveloped. Asian traders could bring futures, cash and finance all into the equation bridging the different components in the commodity food chain."
Pak at Chi-X was equally optimistic. "Not just Chi-X, but the entire connectivity and infrastructure around trading is falling into place, he said. "Japan has unexpectedly become a front-runner, with what they're doing around licensing trading platforms and enabling anonymous clearing. If we can demonstrate high frequency liquidity is additive to the market then we'll see viral expansion in the coming years."
Lamb however doubted we would see consolidation of market centres in Asia as in the US or or Europe. "So technology providers will be pushed to provide more distributed applications to work effectively across the markets, very much smarter as well as faster."
Nevertheless, Pak sees the opportunities for alpha in these markets as tremendous. "New technology will affect both volumes and spread," he said, "which we saw after the TSE switched over to Arrowhead technology: up 20% overall in volume and spreads came down as well. We expect continued growth when we enter the market in the summer. The regulators are very open-minded. They see the growth in Europe and the US and want it for their own markets." Nevertheless, Pak still thinks it could be a slower, step by step approach.
It sounded as though Wecker is right: we are only just beginning.