May 31, 2011 / 3:38 AM / 8 years ago

Analysis: Asian markets shed high frequency trading inhibitions

SINGAPORE/HONG KONG (Reuters) - After years of resistance, the lucrative practice of high frequency trading is growing across Asia, driven by market demand, stock exchange consolidation and greater acceptance among regulators.

The move by regional exchanges to open up to computer-driven trading has led to increasing numbers of algorithmic and high frequency traders setting up shop across Asian markets, using complex, automated strategies to execute trades within the space of 10 millionths of a second.

Client demand and a growing desire by exchanges to stay current has influenced Asian regulators to allow the practice, which has been openly embraced in the United States and Europe.

Also driving the change of sentiment is consolidation between U.S. and European bourses that could leave Asian markets on the sidelines if they don’t adapt to current trends.

“The regulators have started to be more pro-active in terms of trying to meet the requirements of firms interested in HFT (high frequency trading),” said Anshuman Jaswal, an analyst at Celent in Bangalore.

Still, concerns linger that a “flash crash” could wreck havoc across Asian markets, like the one that hit U.S. exchanges in May 2010.

Then, the Dow Jones industrial average .DJI plummeted almost 700 points in just minutes, wiping out $1 trillion in market value in a move industry players blamed on high-frequency trading powered by ultra-fast computers and complex algorithms.

Experts say that type of crash couldn’t happen in Asia because the markets are not as interconnected as in the West, many exchanges have limits on how far stocks can fall in a session and high-frequency trading has, for the most part, been frowned upon until now by regulators.

Japan is the only market that comes close right now to the HFT seen in western markets. The Tokyo Stock Exchange launched its “Arrowhead” trading system in January 2010 in a bid to lower latency and drive trading volumes. That has pushed the proportion of trades classified as high frequency to around 30 percent and helped the TSE fend off competition from alternative trading venues cropping up in Japan.

“Japan’s experience has made it clear to exchanges across Asia Pacific that investment in technology and having infrastructure that can deal with the unexpected are critical to performance and profitability,” said Ross Whittaker, a product manager at Credit Suisse’s advanced execution services unit in Tokyo. That argument clearly resonates with Singapore Exchange (SGXL.SI), which has just invested S$250 million ($201 million) in its new trading engine, Reach, which it says will be the fastest in the world when it launches in August. Experts are doubtful whether the exchange has a high enough turnover of stocks to become a major HFT player immediately but is expected to start seeing a growing proportion of high-speed trades in the coming years.

DOMINO EFFECT

While most markets in Asia are nowhere near as interconnected as in the West, there has been steady growth in the number of derivatives that can be traded in different markets, such as the Japan Nikkei 225 futures offered on the Singapore Exchange as well as the Tokyo and Osaka markets. The potential for contagion from a market crash was shown in June last year when a mistrade on the Osaka Securities Exchange sent futures in Singapore plummeting. “We are looking at a possible domino effect across Asia if something goes wrong, so this is certainly something regulators would be worried about,” said Celent’s Jaswal. “The regulators might be able to prepare for a repeat of the flash crash or a fat-finger trade, but the big risk is some kind of crash due to HFT that hasn’t been seen before.”

Dealing properly with that kind of issue will need co-ordination between regulators, something that has always been elusive in Asia.

“What you don’t have is a common regulatory framework, a common regulator across Asia-Pacific, they’re still relatively siloed and doing their own thing to a large degree,” Lee Porter, Asia-Pacific managing director of Liquidnet, a trading platform for asset managers, said in a recent presentation.

“I think and can see there will be regulatory harmonization along the way I’d just like to see it happen a little bit quicker.” That will become essential if the growth in the region’s markets continues at its current pace. “Barring any regulatory impediments and assuming continued technological enhancement and convergence to technological best practice, then you would expect the rest of the world to look more and more like the U.S. going forward,” said Trevor Hill, deputy head of Japanese equities at UBS in Tokyo.

CATCH UP

High frequency trading now accounts for as much at 70 percent of turnover in U.S. equity markets, where have HFT systems are dealing with up to 2.3 million messages per second in some cases.

“Whatever is happening in the U.S. and EMEA we can prepare ourselves that it will happen in Asia within four to five years,” said Josephine Kim, head of Southeast Asia execution sales at Bank of America Merrill Lynch in Singapore. “We’re getting a lot more interest from Asian clients, many of whom are setting up new offices in Singapore and hiring people to do HFT just within the Asian markets.”

One such example is Getco, one of the world’s biggest market-making and high frequency trading firms, which started trading on the SGX late last year.

A STEP TOWARD HFT

The rising popularity of algorithmic trading in Asia’s emerging markets wouldn’t have been possible a few years ago, when regulatory suspicion of automated trading techniques meant exchanges and authorities shied away from giving brokers direct access to the stock market.

Now markets such as Indonesia and Malaysia are seeing a growing legion of algorithmic traders setting up shop. While these markets are not deep or fast enough to support full-blown HFT, the growth of computerized trading is a step on the path toward it.

“Three years ago people were really afraid of this stuff, but now we’ve worked and interacted well with the regulators and no one is calling for a witch hunt,” said Quentin Limouzi, head of electronic and algorithmic trading services for Asia at BNP Paribas in Singapore. A popular strategy among his clients is known as GRAB — tailored for markets like Indonesia that tend to trade in a ping-pong style for much of a session. An algorithm is programed so the moment a large order finally comes through the computer will place a trade immediately so the investor can exploit the sudden change in price.

Editing by Matt Driskill

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