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June 2011

Wednesday, June 22, 2011

A foray into Beijing

Posted by Giles Nelson

Beijing was the last stop on my three city Asian tour and, from a personal perspective, the most exciting one as I’d never visited mainland China before.

China’s seemingly inexorable economic rise has been well documented. In the last 20 years, China’s GDP growth has averaged over 9%. As I travelled from the airport into Beijing’s central business district I saw few older buildings. Virtually everything, including the roads, looked as if it had been built in the last 10 years.

The Chinese stock market is big. In terms of the total number of dollars traded, the combined size of the two stock exchanges, Shanghai and Shenzhen, is approximately double that traded in the next biggest Asian market, Japan. The increase in stock trading has been very rapid. Trading volumes on Shanghai and Shenzhen have risen by approximately 20 fold in the past 5 years, although there has been significant volatility in this rise. 

The domestic algorithmic trading market is nascent. Currently, intra-day trading in company shares is not allowed. It is the recently established futures markets therefore where algorithmic and high-frequency trading are taking place. No figures exist on the proportion of trading done algorithmically in China currently, but I’m going to estimate it at 5%.

I was in Beijing to participate in the first capital markets event Progress has held there. Although Shanghai is the finance capital of China, we chose to hold the event in Beijing to follow up on previous work we'd done there. In the end, we had about 60 people along from domestic sell-side and buy-side firms attending which was a great result considering the relatively low profile Progress has at present in this market. There was optimism and an expectation that algorithmic trading had a bright future in China. 

I believe it's a practical certainty that the Chinese market will adopt algorithmic and high frequency trading. In every developed market a high, or very high, proportion of trading is done algorithmically and, although different regulations and dynamics make each market unique, nothing except an outright ban will prevent widespread adoption in every market in time. Liberalisation in China is occurring. For example, stock index futures are now traded, exchanges are supporting FIX, short-selling has been trialled and it is now easier for Chinese investors to access foreign markets. Also, earlier this year, the Brazilian exchange, BM&FBovespa, and the Shanghai exchange signed an agreement which may result in company cross listings. Only some of these changes support electronic trading growth directly but all are evidence that the liberalisation necessary to support such growth is happening. Inhibitors remain: no intra-day stock trading, restrictions on foreign firms trading on Chinese markets thus preventing competition and knowledge transfer from developed markets, and tight controls on trading in Renminbi. The Chinese regulators will continue to move cautiously. 

The question is not if, but when. We expect to sign our first Chinese customers soon. China is becoming a very important blip on the radar. 

 

Friday, June 17, 2011

Still big room for growth in Japan

Posted by Giles Nelson

And from Mumbai on to Tokyo. In so many ways, a bigger contrast between cities is difficult to imagine. 

Japan has, of course, had a tough time of it recently. Not only has the recent earthquake and tsunami knocked Japan back, but also Japan has had a long period of relative economic stagnation, compared to other Asian economies.  Its development in algorithmic trading also sets it apart from other developed economies due to the relatively low proportion of trading which is done algorithmically.

There’s little consensus on what this proportion is however. In a recent report, Celent, the financial market analyst firm, reported that around 25% of trading was algorithmic in 2010. Figures from the Tokyo Stock Exchange (TSE) report that around 35% of orders submitted to the exchange are from co-location facilities – it is reasonable to assume that nearly all of these could be regarded as “algorithmic”. From my conversations with people in the days I was in Tokyo who worked at exchanges, sell-side firms and our customers and partners, I’m going to put the figure at between 40-50%. 

That means there’s a lot of room for growth when you consider that the proportion of securities traded in the US and Europe algorithmically, in one way or another, nears 100%. One inhibitor to growth has now been removed. In 2010, the TSE launched a new exchange platform, Arrowhead, which reduced latency from up to two seconds down to around 5 milliseconds. In other words, the TSE is now “fit for purpose” for algorithmic trading and, in particular, for high frequency trading. Previously, with latencies being so long, high frequency firms who, for example, wanted to market-make on the TSE, simply weren’t prepared to take the risk of the exposure and uncertainty that such high latencies bring. Since Arrowhead's launch in January 2010, and according to the TSE’s own figures, the total number of orders on the TSE has risen by a modest 25%, but the proportion of orders submitted from co-location facilities has more than doubled. 

Progress exhibited and spoke at Tradetech Japan and we were joined on our stand by our partner, Tosho Computer Systems, that we’re working with on a service in Japan which we will be launching later this year. They’ll be more news on that nearer the time. Attendance wise, Tradetech was down on its peak in Japan in 2008, but up on previous years – a reflection of the renewed interest in trading technology generally.

Market surveillance was one of the key topics that came up in Tradetech Q&A and panel discussions. This is common across pretty much any market now, with the essential question being: how can markets be kept safe as markets get faster and more complex? Some say there should be restrictions and whilst circuit breakers, insistence on pre-trade risk checks and similar are important, over emphasis on “the dangers” can hold markets back. Progress’ view is that regulators and exchanges should all move towards real-time market surveillance. (Find more on this here and here).

There’s a lot of emphasis at the moment in European and US markets on OTC derivatives regulation and the move of trading in such instruments onto exchanges. Japan is relatively advanced in this regard with regulation requiring many domestic OTC derivatives to be cleared, a trend which is happening elsewhere in Asia too more quickly than in Europe and the US. 

Regionally, Japan is the biggest developed market in terms of share trading volume. Twice as big in dollar terms than the next biggest, Hong Kong. But Japan is itself dwarfed now by China and I’ll be writing about that next.

 

Wednesday, June 15, 2011

The rise of algo trading in Asia - first stop Mumbai

Posted by Giles Nelson

I’ve just completed a three city Asian tour, in Mumbai, Tokyo and Beijing. The purpose was to promote Progress’s business in capital markets, in particular both Apama and our Responsive Process Management suite. I’m going to give my impressions on those markets – first up is Mumbai and the Indian market for electronic trading.

Before I start with India though, I’d like to share an interesting piece of academic work I came across. We do hear a lot about the rise of Asia economically, particularly the “big two” of India and China.  Many predict that China will become the world’s biggest economy in the next 10 years and that India’s population will exceed China’s by mid century. Both economies are predicted to grow between 8-10% in 2011. The predicted long-term shift in relative economic fortunes is nicely illustrated by some work done at the London School of Economics in 2010, a graphic from which is shown below.

  Screen shot 2011-06-15 at 15.57.25
© Danny Quah, London School of Economics, October 2010

 

Professor Danny Quah calculated the “the average location of economic activity across geographies on Earth”. Put another way, this shows the “economic centre of gravity” and shows its mid-Atlantic position in 1980 and its predicted position in the middle of Asia by 2040. The economic power shift is on.

Back to my trip, and my first stop in Mumbai, commercial and financial capital of India. I wrote on the growth of electronification and algorithmic trading in India last July. Since then the market has progressed. Progress has acquired its first clients in capital markets in India using Apama for trading and the market itself has evolved and liberalised. Last year I criticised the policy of the biggest stock exchange, the National SE, for its “algo approval process”. I thought this was a poorly structured attempt to protect the markets from “rogue algos” and would stymie development. I'm pleased to say that the NSE has now relaxed this policy (the latest version of which can be found here). A further significant development has been that now both equity exchanges, the NSE and the Bombay SE, allow smart order routing from co-location facilities at each exchange to one  another. This was previously not allowed by the NSE. There is also evidence that the adoption of algorithmic trading is changing the way the market works – manual arbitragers are heading towards extinction and arbitrage opportunities in general are becoming more difficult to find – evidence that information flow between markets is becoming more efficient. 

Together with CNBC, Progress held a well attended event for the industry in Mumbai. The highlight was a panel session which had the deputy CEO of the BSE, a senior member of the Indian securities regulator and a practitioner from a buy-side firm participating. There was a consensus that the continued development of algo trading was welcome in India – bringing technological innovation, putting pressure on costs, bringing liquidity and more competition. There is some caution, particularly when it comes to the unfettered use of algos.  Reference was made to recent talk in the US and Europe about introducing algo “inspection” to provide justification for caution. As I’ve said previously, algo inspection is inherently flawed – it is far better for markets to be protected through good pre-trade risk checks and real-time market surveillance (as discussed at length recently on this blog). The panel acknowledged that real-time surveillance was key for markets to operate well.

Despite the Indian market progressing, there are still challenges. There is obvious enmity between the two stock exchanges that should lessen if and when the organisation behind the Multi Commodity Exchange (MCX) receives an equity trading license, something which is expected soon. The granting of such a license and the introduction of more competition into the market can only be a positive move. Trading costs for equities in India are still high. There are two equity clearers, each owned by the two exchanges which do not interoperate and foreign financial institutions need a license from the regulator to trade and an Indian local legal entity – a process which inhibits foreign firms entering the market and thus reduces competitive pressure on domestic firms.

In my view one change that India will see in the coming years is significant broker consolidation. Currently there are around 3000 brokers in the Indian market. Many of these are small and, in my opinion, will not survive in a market where access to technology will be needed to compete. Many will therefore go out of business or be forced to merge.

The market for algo trading in India is growing. Although it hasn’t reached a tipping point yet, it has all the promise to be one of the most important markets in Asia.

Next stop was Tokyo for Tradetech Japan 2011. I’ll talk about that tomorrow.

 

 

Tuesday, June 14, 2011

Keeping the Train on Track

Posted by Dan Hubscher

It has been said that regulators are struggling to keep up with high frequency and algorithmic trading because they have outdated methodology and technology. This battle has been likened to trying to chase a Ferrari on a bicycle.

But what happens when the regulators are constantly changing the rules, and the Ferraris are turning in the wrong direction at high speed? I liken this to regulators trying to switch tracks while your HFT train is barrelling along at 100 mph. If you do not protect yourself from high speed changes, you might find yourself thrown off the tracks.  

The ability to respond to both regulatory change and split-second market anomalies can make the difference between emerging from the global financial crisis as a leader or as the firm that has to manage the aftermath of a messy derailment.

Imminent, sweeping regulatory reforms are not the only issues that firms have to grapple with.  Market structure changes underway in both the USA and Europe, from exchange mergers to regulatory “fine tuning” such as market maker quoting rules, circuit breakers, and limit up/down rules are already completely changing the game - and the playing field - and firms have to adapt to them. Cross-asset, cross-border trading is proliferating and creating new opportunities for arbitrage trading strategies that can throw a cross-asset "splash crash" into the mix.

Or, as Tabb Group told Advanced Trading: "strategies that go beyond speed, and emphasize 'cross-asset, cross-regional multi-temporal, asymmetric versus symmetric trades, even enhanced front-to-back automation'" are on the way. This means that real-time visibility - for spotting trading abuses, market anomalies and operational errors - is necessary on a global, cross-asset, 24/7 basis to remain in regulatory compliance and mitigate reputational damage.  

Also, when regulations change you need the flexibility to change your systems to match and manage them; flexibility is key. Financial firms are constantly on the move, changing trading strategies and products to stay competitive. New regulations can throw new strategies out of compliance - the tracks keep changing.

And what about looming regulations beyond today’s mandates?   The rush to real-time trade reporting of swaps, for example, is causing some consternation among market participants because it may impede trade flow, according to Operational Risk and Regulation.  Real-time reporting is intended to help in the fight to avoid market abuse and as an early warning system to detect systemic risk. But T0 may be overkill, especially if monitoring and surveillance tools are in place.

In the Risk article, Frederic Ponzo, managing partner at technology consultants GreySpark Partners, said: "The real benefit of real-time surveillance is with identification of fraudulent activities, market manipulation and errors."

 And if you could put compliance in control by building surveillance detection and workflows on your own terms, so much the better. Because every firm is unique, brokers need to customize their case management systems for efficient incident investigations, rapidly and continuously, in addition to customizing real-time abuse detection and market monitoring scenarios. 

By gaining visibility to potentially abusive and erroneous trading activities, with the flexibility to adapt to new trading patterns and regulations, firms can protect themselves and their clients from market risks and not run afoul of shifting market regulations.  They can quickly pinpoint threats and tailor responses without disruption, maintaining regulatory compliance now and into the future - effectively changing tracks at 100mph or more. 

-Dan

 

Monday, June 13, 2011

Tickets Please: Technology to Keep You on the Train

Posted by Dan Hubscher

The ticket to preventing and deterring rogue trading could well be technology.  Although most financial services firms have some form of surveillance and monitoring technology in place, it isn't good enough to keep them from getting kicked off the regulation train.

Financial services firms risk running afoul of new regulations because their technology is not the "right" technology anymore. The burning question now is – what will be the “right” technology be, in an unpredictable future?

Detecting, preventing and deterring market abuse can only be effective when it permeates financial services activities from pre-trade to settlement. The number of different places that trading activity occurs is constantly increasing. Trading can be done at the office, or via cell phone. Or a trader can begin to work a deal at the office, go for lunch and finish it via instant messaging with his broker.

Surveillance is necessary in order to provide transparency in trading activity, whether it is via formal trading platforms, using an instant messenger platform, e-mails, Twitter or other social media sites, or even old-fashioned phone conversations. Compliance officers need to have full visibility in order to spot and prevent abusive trading activity - and that vision has to encompass it all; every message, every trade, every conversation, every Tweet has to be recorded, taped and downloaded into a database for on-the-spot or future scrutiny.

The technology of yesterday will not be able to cope with the audit trail of today. Plus those audit trails need to occur in real-time, not just looking back over history. This means that current methods, employing historical analysis of already-old data just won't do. Analysis has to be done both in real-time and historically in order to make sense. It has to span asset classes including cash equities, interest rates, swaps, commodities, OTC derivatives - cleared or not. Silos can no longer exist in terms of monitoring; trading today is truly democratic, crossing borders, asset classes and currencies.

New market abuses seemingly proliferate by the day. Some are really the old ones - only done faster (like front running), but there are fresh ones too. Just last week the SEC suspended trading in 17 OTC microcap stocks because of doubts over the publicly available information on the companies.  Here, investigators from different offices and working groups used “a coordinated, proactive approach to detecting and deterring fraud.”

Packaged applications cannot handle new rules or monitor new types of market abuses. Add flash crashes, mini flash crashes, cross-asset crashes (we call these "splash crashes") to the mix and a picture starts to reveal itself. In this picture there are Chief Compliance and Technology Officers handing the regulatory conductors their tickets to prove that they have the right technology, and then getting kicked off the train because they have the wrong tickets.

Flexible, extensible surveillance and monitoring technology is the top-up fare needed to stay on the train. If you can see every move your traders make today, you can take control. If you can see every move your traders make down the line, you will stay in control.  A real-time platform that can handle the massive, increasing volumes of transactions and events in today's electronic marketplaces, and handle the rules of tomorrow’s, is imperative to staying on top of rapidly changing regulations. 

-Dan

 

Friday, June 10, 2011

PLUS Stock Exchange Making Progress Around Regulation

Posted by Richard Bentley

Richard BentleyChanges in financial regulation will inevitably increase the importance of market surveillance for exchanges as well as the regulators. Having asked our experts their opinions on how the changes in approach will affect the market in general, we are now looking at the impact on exchanges themselves, and how they can best prepare to serve their customers and remain compliant through this time of change.

In the last of our short videos, James Godwin and Tony Harrop from PLUS Stock Exchange tell us about how the Progress Apama solution is supporting PLUS Stock Exchange. In particular, we ask, how important is it to have market surveillance technology that can be flexible as new regulations are implemented?

Here they are the other 3 videos that were part of this 4 part series:

 

Thursday, June 09, 2011

All Change: When to Prepare for New Regulations

Posted by Dan Hubscher

As financial institutions bemoan the uncertainty still hovering over Dodd-Frank implementation and possible delays, there are steps that they can take to prepare for them even before the ink dries. Otherwise compliance can cause major disruptions to their business operations.

Brokers, in particular, cannot afford to wait to protect themselves and their clients from market risks, and from running afoul of shifting market regulations. Attracting new clients - and retaining existing clients - will depend increasingly upon whether a broker has measures in place to protect a client's interests.

Dipping an unprotected toe into a market where a flash crash can happen at any moment can be frightening. This is not scaremongering, it is the market today; insider trading and market manipulation can happen within the best of trading firms.  And algorithms allowed to run without proper controls can take a company's balance sheet from black to red, or worse. The debate around the notion of regulators reviewing algos before they go to market (see Larry Tabb’s article and resulting commentary here) is a clear indication of nervous market sentiment (no Twitter trading analytics required). 

Regulators are laying miles of new tracks (rules) for high-speed and heavy freight trains running through the electronic trading frontier, and they are preparing to make sure the trains stay on the tracks. Trade monitoring, auditing, and abuse prevention requirements abound throughout the proposed rules, including recent efforts to detect market manipulation. But there is little reason for financial firms to wait for strict definitions of what “sufficient” measures are in a market that continuously gives us examples of what to detect, prevent, and deter.  

By gaining real-time visibility to potentially abusive and erroneous trading activities, brokers can quickly pinpoint threats.   But brokers need to constantly adapt detection scenarios to new threats; and they also need to tailor their responses and modify them without disrupting their trading operations.  Responsiveness is more than lightning-quick reflexes.  Flexibility is also key; and is what will transform regulatory compliance into competitive advantage now and into the future.

Despite complaints, media interest and suggestions to the contrary, algorithms and high frequency trading are not going away. When problems such as crashes or abuse occur it is partly because regulators have not yet had the chance to get a uniform, industry-wide grip on how long-standing underlying market practices manifest in the new, high-speed environment, and how compliance departments should monitor them.

HFT is not necessarily the culprit; market structure must also be questioned.   High frequency trading shops often act as de-facto market makers. During the flash crash some HFT’s algorithms sensed a problem and pulled out.  If HFT's have replaced traditional market makers, why have the market making obligations not carried over?  And should they?  Now we must ask who - if anyone - should have an obligation to stay in the game when things go wrong, and the eventual answer will change market participants’ business models.

Human beings continue to possess attributes that computers cannot. But the human intelligence to slow things down in times of stress, or provide real liquidity in a two-sided market - not just volume - is a decision that can be automated. This is necessary, in fact, because humans can't step in fast enough in today's hyper-speed markets. Therefore, financial organizations have no choice but to use technology and applications that ensure compliance, though not at the expense of efficient trading operations. This kind of technology enables firms to be compliant in new ways, including transparency and reporting.

The ability to detect abuse and operational errors in real time, along with the flexibility to modify scenarios in response to new conditions, while staying ahead as regulations change, differentiates a broker competitively. The buy side wants safety in the marketplace, and it is up to the sell side to make sure their buy side customers feel secure.

New regulations bring new headaches to organisations as they have to add or change both applications and operations to comply. Having the ability to sense threats, and to respond in real-time, is just the compliance “price of entry” to the market today.  Being able to comply with new mandates quickly is the differentiator, and there will be no shortage of surprises in store as the regulatory trains rumble towards an unknown destination. 

-Dan

 

 

Friday, June 03, 2011

Using technology to prepare for regulatory change: how can market surveillance technologies help?

Posted by Richard Bentley

Richard BentleyBecoming and remaining compliant is a key consideration for brokers and exchanges, especially in a time of regulatory change. It frequently makes the top of the list in surveys on their primary concerns, which is unsurprising given the current confusion surrounding financial regulation.

In this video our experts comment on how technology can be used to help the trading community prepare for upcoming changes to specific regulations, and the overall regulatory approach. We speak to:

These experts give their views on how market surveillance and monitoring tools might be able to help market participants as they prepare for change.

Wednesday, June 01, 2011

All Aboard: New Regulations Take Many Tracks

Posted by Dan Hubscher

The regulatory trains in Europe and the US have left their respective stations and are headed down the tracks, but they will change tracks many times along the route before reaching their destination. Thick tomes of proposed operating rules have to be interpreted even as interested financial services parties line up to persuade regulators to change tracks (in order to accommodate their particular demands). Passengers should be prepared for delays.

The significant regulatory rethink in Europe on two levels - derivatives and MiFID II, combined with the slow-drip interpretation of US Dodd-Frank rules are leading to a thick “London Fog” on both sides of the pond.  While some market participants are wanting to act but experiencing confusion and misunderstanding, others are quite clear in their approach to the unknown – wait and see.  From banks to brokers and funds to financial advisors, everyone is looking for clarity.

What we know so far is that both regions want to move as much OTC trading as possible onto clearing platforms; and both support setting position limits by trader type to try and spot speculative activity. The US and the UK support splitting banking activities from speculative, or proprietary, trading. The US, UK and EU all seem agreed that hedge funds should at least be registered. All are under short deadlines to implement new rules.  Some deadlines from the Dodd-Frank Act are slipping, while others remain intact.  And MiFID II’s draft publication is scheduled for July.

There is an additional kink in the UK's track, where there is an impression of a regulatory void now that the Financial Services Authority is being broken up

While the US and Europe hurry to regulate the rest of the world has to scurry to catch up. Until the G20's plans are in place in late 2012 there is a lack of harmony - a global regulatory framework that is full of holes and pitfalls. Regulatory arbitrage is a hot topic and has already begun with the shift of trading personnel to more lightly regulated areas. Transparency is not well served by disparate regulatory frameworks.

The ultimate goal for regulators has to be visibility; the ability to see across geographies, asset classes, exchanges and market participants. Cross border trading is a reality and problems can happen - as we’ve seen - so regulators do need to cooperate, just as we are already seeing with the US and UK.

Market participants cannot really afford to wait for regulatory harmony, however, nor can they wait for local regulatory clarity to satisfy their own need for visibility. Hot button issues such high frequency trading, algorithmic trading, dark pools and flash crashes (or splash crashes) may all be clarified in due course. But likely some issues will remain open for a long time to come.  Regardless, firms need to move forward now, carefully of course, in order to move smoothly into compliance.

Despite all the noise to do with algo and high frequency trading, the changes that regulators and exchanges are making are to try and better contain HFT issues, not to take HFT away.   How trading is conducted and governed may change, but liquidity, reduced spreads, and lowered trading costs need to stay.

Using surveillance and monitoring technology alongside HFT will not entirely prevent flash crashes or fat fingers, but it will go a long way toward helping you to protect yourself when these things happen. If you can sense problems and protect yourself when something untoward occurs, you won't get caught in a 'deer in the headlights' moment. 

Don't be the guy standing on the track when the train comes along. The 'deer in the headlights' will not win against the barrelling train. Be the guy (or the deer) who heard the whistle and got safely out of the way. 

-Dan