* High-frequency trader interest in emerging markets grows
* HFT in dollar/Mexico peso, Turkey lira/yen seen
* Decline in transaction size a reasonable proxy for HFT
* Big problem for emerging market currencies is liquidity
By Gertrude Chavez-Dreyfuss
NEW YORK, June 13 (Reuters) - AienTech is not your typical hedge fund.
There are no set work hours and its 11 employees, most of whom dress casually in T-shirts, jeans and flip-flops, come and go as they please.
Its Manhattan office looks more like a mini-sports club than a trading floor, with a Ping-Pong table, a couple of board games and a separate massage and sleep area.
But its laid-back appearance belies its lofty ambitions to lead the pack in rapid-fire, computer-generated global currency trading.
AienTech is building more sophisticated machines than its larger high frequency competitors, and it aims to generate about $100 billion in volume per day within a year. It also plans to navigate the murky waters of emerging market currencies, a sector in which many see a huge upside potential.
Ugur Arslan, AienTech's founder and managing director, is a 33-year-old, soft-spoken Turkish engineer who likes to build complex machines from the ground up. His new high frequency trading fund will begin to trade the most liquid emerging market currencies over the next few months, he said.
"As emerging markets improve both their technology and infrastructure, the increased number of participants will produce opportunities that will spike interest for high frequency firms," said Arslan, whose fund will also trade other assets such as commodities and futures.
"There is already a trend among high frequency firms to move onto new emerging markets where competition is not that fierce yet."
These high-octane players, who run a bunch of super-fast computers designed to execute trades in milliseconds, have reportedly bumped up volumes in currencies such as the Mexican peso, Turkish lira and South African rand. ^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^ For links to more of Reuters' multi-media package on high frequency trading see: To see Reuters Insiders series: HFT Transforms FX Market, please click on the following link: link.reuters.com/wew99r HFT: For interview with Aien founder and Managing Director Ugur Arslan see: reut.rs/lkthCf HFT: Algo Trading Brings 'Seismic Change' to FX Market-Citi link.reuters.com/qaw99r HFT: Bank-Only FX Trade Platform May Change Market-FX link.reuters.com/deq99r HFT: New Network Pushes Limits of Physics-Spread Network CEO link.reuters.com/meq99r HFT: Speed Trading Triples Forex Options Business, Says CME link.reuters.com/jeq99r HFT: Telcos Spend Millions to Gain Milliseconds link.reuters.com/teq99r HFT-ANALYSIS-Trading currencies in fast lane [ID:nN10219700] ^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^
The average daily volume of the U.S. dollar/Mexican peso MXN= pair in the North American spot market, for instance, rose about 17 percent year-on-year in October 2010, according to the latest report by the Foreign Exchange Committee. The monthly volume was up more than 8 percent in the same period.
Market participants said a good chunk of that volume could be attributed to high-frequency traders, although it would be difficult to distinguish the actual trades coming from their systems since they are lumped together with other non-high frequency programs.
Liquidity in these currencies, however, remains limited, which has prevented high frequency traders from dominating these markets the way they have done in equities. High frequency trading typically takes place in the deepest and most liquid segments of a market.
DECLINING TRANSACTION SIZE
Analysts say one can only infer a high frequency trade has taken place due to the size of the transaction, which has declined over the years.
This is also consistent with the growing trend seen in the settlement of these currencies. Jonathan Butterfield, director of communications for the CLS Group in London, a global settlement system, said there has been a drop in the average value of trades being settled.
"A little over 80 percent of the trades at CLS are one million dollars or less. Generally, that's a reasonable proxy for high frequency trading," Butterfield said.
In addition, CLS has seen a surge in the settlement volume of three of the most heavily traded emerging market currencies, suggesting more and more of these units have become automated, although not all are high frequency transactions.
The average daily volume for the U.S. dollar/South African rand pair, for one, topped $30 billion in 2010, from about $20 billion the previous year, CLS data shows.
Chip Lowry, chief operating officer at multi-bank platform Currenex in Boston, said CLS is critical to the success of high frequency traders in emerging market currencies.
"When currencies enter CLS as a settlement mechanism, we typically see volumes go up. If we see volumes go up because there is less settlement risk, then prime brokers would start loosening the lines for high frequency funds, and then we would see a natural increase in trade," said Lowry.
Prime brokers, usually investment banks and securities firms, typically allow clients like hedge funds and high frequency firms to use their credit facilities to access financial markets.
Another indication of high frequency trading is the contraction in bid-ask spreads in a currency pair, which suggests an increasing amount of trade.
Data from Thomson Reuters, an execution venue where most emerging market currencies trade, shows that the bid-ask spread in the dollar/Mexican peso pair has dwindled to about 25 pips from as wide as 390 six months ago.
Another currency pair reportedly popular among high frequency players is the Japanese yen/Turkish lira. Its bid-ask spread has narrowed to about 15 pips, from around 135 in December last year.
But investing in emerging market currencies remains hampered by a lack of liquidity
"When you look at the liquidity profiles in developed markets, you can see trades flowing throughout the day," said Paul Aston, head of quantitative solutions at Morgan Stanley in New York, "When you look at emerging markets, there are periods when there is zero liquidity."
This has resulted in what analysts call a "gap" in the market, or a sharp increase or decrease on a price chart when there is no trading volume between the moves. In major currency pairs, gaps are rare due to the depth of liquidity.
David Rutter, chief executive officer at ICAP Electronic Broking in New Jersey, which owns electronic trading platform EBS, further stressed the need for a "high-beta" market such as futures to back up positions in emerging market currencies.
"For the real high frequency traders, it's important to have both a spot and futures market," Rutter said.
"Take the case of the U.S. dollar/Mexican peso. It's very popular among high frequency traders because you have the spot market, on the one hand, and a liquid futures market, on the other, and you can get in and out into the other," he added.
Overall though, most market observers agree increased liquidity in emerging market currencies will come because the interest among traders is growing.
Declining profits in trading major currency pairs are also prompting high frequency players to seek returns in other foreign exchange crosses.
"Their profit margins are tough to begin with because they're doing small lots. And it's only going to get tougher," said Sang Lee, a partner at research firm Aite in Boston. "So they're constantly looking for opportunities to move well beyond the currency pairs they're trading now."
The prospect is especially bright for the Chinese renminbi, which still trades within a band against the U.S. dollar.
The Chinese government launched spot trading in the renminbi in Hong Kong last year, called CNH, which has sparked some interest among high frequency traders. Currently, all CNH trades, at least those done on EBS, are done manually.
"The goal is to make the Chinese yuan one of the most liquid currencies in the world," said Richard Olsen, founder of OANDA, a currency trading platform. "You cannot have the world's largest trading partner have an illiquid currency." (Editing by Leslie Adler)