Smart Order Routing

Wednesday, August 29, 2012

FX Aggregation: Defusing eCommerce Aggravation

Posted by Ben Ernest-Jones

We know that finding real liquidity AND the best pricing for FX market aggregation is something many firms struggle with every day – but that doesn’t need to be the case.

For those wondering how they can defuse their own eCommerce aggravation, check out our new video below. In it, we discuss the value of using flexible, proven aggregation and smart order routing technology to level the playing field.

 

 Interested in learning more? Contact a member of our team to learn about how Progress Apama’s FX Aggregation solution can help your business. We look forward to hearing from you.

Thursday, July 19, 2012

Scooping FX Bubbles Out of a Boiling Pot

Posted by Ben Ernest-Jones

Foreign exchange trading appears to be moving from a beneath-the-radar, bank-dominated activity into the international trading limelight. There has been an explosion of new trading platforms and a wave of newer participants lately, partly thanks to new transparency afforded by Dodd-Frank and partly because of the relentless hunt for alpha. Increasingly automated, FX is also becoming the next go-to asset class for high frequency and algorithmic trading.

It wasn't always that way. As TABB Group's Larry Tabb said in an article in Wall Street & Technology: "FX has always been different. Be it that currency is a bank’s core product, be it that banks control the payments infrastructure, or be it that banks are critical in implementing Central Banks’ monetary policy, the banks have historically dominated FX."

Because FX is mainly traded via single dealer platforms, multi-dealer platforms such as FXall, and interdealer marketplaces, it is fragmented in a different way from equities.  Traditional trading platforms along with a couple of the sturdier newcomers like multi-dealer platforms FXall (which Thomson Reuters is buying) andCurrenex have been the dominant destinations for electronic trading of FX.

But now that the SEC and CFTC have clarified that forex contracts will be determined to be swaps, they will become part of the centrally cleared instrument pool. This means a whole new layer of banks, brokers, and venues are already popping their heads up. FX will soon emulate the expansion, consolidation, and then contraction of destinations experienced by the equities markets. 

There will be more opportunities for market participants to trade, hedge, arbitrage and manage risk. Algorithmic strategies will dominate, attracting more and more destination venues - and then fragmentation will be the mantra. So how are traders going to position themselves to scoop the profitable FX bubbles out? It is not as easy as you would think. In many cases, what appears to be an increase in liquidity is actually an increase in “phantom” orders, as institutions advertise the same underlying liquidity across an increasing number of locations. Trading algorithms will need to be smarter, and tuned over time to counteract this as the landscape changes.

Bank traders are looking for ways to handle the new world order of FX. Because their clients want to be able to trade forwards, swaps, spot and even options on the same system, banks are having to do the once-unthinkable: merge their forwards desks with their spot desks.

In the old days of voice trading, forwards and spot traders ran completely separate books and dealt with (mostly) different customers. Today clients are asking to hedge forwards and spot on the same system at the same time. Some want to trade using forward-to-spot conversions against aggregated spot prices from several platforms and some want to use aggregated forward rates directly. Some want a blending of both. The opportunities for banks are plentiful, if they can harmonize FX products, trading and hedging across trading systems successfully.

Many bank clients have seen what has happened in the equities markets; with high frequency trading and algorithmic strategies becoming problematic and largely vilified. When the world’s largest interdealer brokersaid recently that it would tackle “disruptive” practices by high-frequency traders on its foreign exchange platform it became clear that some of the lesser-loved equities issues were already creeping into FX markets.

The Wall Street Journal says that there are already fears of an FX "boom" reminiscent of the equities venue explosion in 2001. "Some market insiders fear the trend for highly specialized new systems aimed at separate pockets of clients could end up splitting the liquidity that underpins this $4 trillion-a-day market, making it harder to trade," said the paper. Pigeon-holing traders, whether it be by class of trader, asset class or by delivery date, only creates more fragmentation. This could equate to lower volumes (like equities), more volatility (like equities) and an increase in manipulative practices (like equities). Regulators will no doubt be watching, and new rules will be implemented even faster than has happened in equities.

In a discussion at the FX Week USA event in NYC recently one FX trading platform provider said that you need a full market ecology to provide proper efficiency. This means having all market participants operate in the same liquidity pool.  In the end the unique self-regulating properties of the FX markets mean that the market will shift towards what is best for the market - because it can. Preparation for this inevitability will determine who survives. 

Monday, July 02, 2012

Turning Metals into a Goldmine

Posted by Ben Ernest-Jones

"Every man now worships gold, all other reverence being done away," said Roman poet Sextus Propertius sometime around 15 BC.

Metals are hot. The Hong Kong Exchange's extravagant £1.39 billion bid to win the London Metal Exchange (LME) shows just how hot. HKE bought LME, which accounts for 80% of trade in nonferrous metals such as copper and aluminum, in a bidding frenzy against NYSE Euronext, CME and ICE.

From gold and silver to copper and nickel, it seems everyone is interested in buying and trading metals. Once the domain of producers and specialty traders such as Glencore and Marc Rich, investors globally are clamouring for access to this non-traditional asset class.

There is a natural cyclicality to asset classes; they wax and wane in popularity depending upon the opportunities to make money by trading them. Lately, investors have lost heart in stock markets and volumes are plummeting. Commodities such as oil and agriculturals lost their shine when demand in China and other emerging nations dwindled.

With returns shrinking in equities and fixed income market plays, it is no wonder that investors are interested in asset classes outside the traditional. Foreign exchange markets have been extremely active in recent years, for example, and with the current uncertainty over European debt problems demand for "safe haven" currencies is high. Precious metals often fall under that safe haven umbrella, which is presumably why interest has soared of late.

The correlation between gold and currencies such as the US dollar and the Japan yen is well documented, as gold and other metals are often used as a hedge against inflation or against a weak currency. There is also a strong correlation between gold and oil prices, and gold and the stock market historically. So there are plenty of opportunities to use metals for cross-asset-class trading, particularly in high frequency or black box strategies which monitor for anomalies in these correlations.

Luckily, pressure from investors is giving banks and brokers the incentive to break down the barriers to trading metals. Some brokers are adding metals to their foreign exchange trading platforms. We’re seeing an increase in the number of banks that are converting metals futures -  from CME, NYMEX, LME, etc. - into spot prices to stream to clients for trading. It looks like the beginning of a trend.

It is only a matter of time before banks and brokers are aggregating FX, metals, oil, stocks and bond markets for their clients - all onto one trading platform. Then we may finally see true cross-asset class and cross-geography trading. In the meantime metals trading may be the next goldmine for banks.

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.

 

 

Wednesday, January 26, 2011

US and UK to Lose Ground as Algorithms and HFT Emigrate

Posted by John Bates

High frequency and algorithmic trading will blossom in emerging markets such as Brazil and India, possibly signalling the end of US and UK dominance in financial markets.

Even as regulators in the US and Europe debate over how to regulate algorithmic and high frequency trading (HFT), firms in emerging markets such as Brazil and India are embracing the trading practices. US and UK proprietary trading firms and hedge funds are opening offices in emerging markets centers, partly to take advantage of these budding opportunities. But there is more than greener pastures calling them; stricter regulations in the US and UK may force large banks and hedge funds to trade in - or move to - more lightly regulated regimes. This mass regulatory arbitrage emigration could signal the end of US and UK dominance in financial markets.

Brazil is attracting HFT like bees to honey. The world’s tenth largest economy, Brazil's exchange, BM&FBovespa, trades everything from cash stocks to commodity futures. The exchange has recently undertaken steps to further automate trading in an effort to capitalise on investor interest and gain more business from outside the country. Almost 90% of trading is now done electronically and about 10% on the floor. Demand for connectivity and trading access to the Brazilian market is increasing; exchanges are helping to upgrade Brazilian exchange platforms and bridge the gap between Brazilian markets and non-Brazilian traders (and vice versa). Technology vendors are building ticker plants for real-time, low latency market data as well as adding connectivity and algorithmic trading capabilities. And brokers are clamouring to join up with, or buy, Brazilian brokerage firms to help smooth the path for non-Brazilian customers - which by law must have local representation.

Algorithmic trading in India is also taking off. Spending on software for algorithmic trading is going to be easily worth $100 million in two years. The market share of algo trade will rise from 15 per cent at present to 50 per cent in the next three years. The number of trades on the NSE (National Stock Exchange) are 10 times that of the London Stock Exchange. Both NSE and BSE (Bombay Stock Exchange) are offering co-location facility; smart order routing and mobile trading has now been allowed, too. Also, commodity exchanges are catching up on algo trading. It is being put to use in foreign exchange derivatives too. That’s an enormous reason to do algorithmic trading. Smart order routing will force inefficiency out of the market, reduce price discrepancies between the two main equity exchanges and increase competition. (NSE’s process of validating every algo was putting a significant brake on its growth. The process is unsustainable and will be short-lived.)

Turkey’s main bourse, the Istanbul Stock Exchange, was the latest to open up to HFT and algo trading, according to the FT. Mexico is opening up, as are Asia Pacific markets in Japan, Australia, Singapore and Hong Kong. Bulge bracket banks, large hedge funds, and buy-side firms are all gearing up for the next onslaught of HFT in these areas, which may take business away from the more regulated markets.

Few of these markets are as heavily regulated as the US and Europe for this kind of trading. But regulated or not, any market that embraces HFT and algos has an obligation to make sure that they will not cause new issues such as flash crashes. Mandatory pre-trade risk and market surveillance should be there within the regulators and the exchanges. Regulators have had a rear-view mirror approach when it comes to understanding market software. They do not have the capability to know what is happening on a real time basis. The technology that SEC, the US stock market regulator, was using was two decades old. Regulators have to catch up here. All parties in the trading cycle should take more responsibility to ensure appropriate risk control and surveillance. Then perhaps algo trading can be fluid, with risk managed across borders. And the dominant players will go with the flow, retaining their HFT crowns.

 

Monday, December 13, 2010

Calming 'Regulation Anxiety'

Posted by Dan Hubscher

There is a new kind of emotional disorder going around the financial markets - the previously unnamed fear of something ominous now that new financial rules have been laid down. Let's call it regulation anxiety.

Regulation anxiety has led to all sorts of new types of behavior in banks such as laying off proprietary trading staff, hiring ex-SEC lawyers, and laying on extra lobbyists to besiege Capitol Hill. The syndrome is so widespread that it has finally attacked the foreign exchange market - the market that performed the best during the financial crisis despite a lack of almost any regulation. And although the FX market 'ain't broke' it will undoubtedly get 'fixed' under new rules. It is these fixes that are causing panic attacks in the FX industry.

A survey of FX professionals at the Bloomberg FX10 conference in October showed marked anxiety over the impact of regulation and also possible changes to market structure.  More than 80 percent of those polled said they were concerned about the impact of recent regulations on their businesses.  They were also against structural reform and at odds as to which industry model is best for the future.  According to Bloomberg, the majority of the respondents were opposed to an exchange-traded model or a clearing house model, with only 19% believing the FX markets should have both clearing houses and exchange-traded requirements.

FX is a unique asset class in many respects; being (to date) almost totally free from regulation and benefiting from high liquidity on a global scale. Traders - wholesale, institutional and retail - are attracted by the ease and convenience of online currency buying and trading. The statistics bear this out with an average turnover of around $1.5 trillion per day – a clear indication of the strength of the market.

FX liquidity and volatility is growing day by day and trading foreign exchange in fast-moving, highly volatile times carries a high level of risk. As such it may not be suitable for all types of investors, institutions and buy-side firms. As a result, sell-side organizations that are serving the quickly-growing needs of hedge funds, proprietary traders, and other firms that take on these risks take on their own additional risk. There is a need to manage their own increased risk intelligently without erasing their competitive advantages.  

At the same time increased automated order volumes from the buy-side represent revenue opportunities for sell-side firms. But attracting that order flow away from competitors requires unique services, aggressive pricing and the ability to find the best prices in a highly fragmented market - not to mention the speed and scale needed to keep up in a high-risk environment.

There are solutions available which enable sell side institutions worldwide to rebuild their FX eCommerce platforms in line with the requirements of the most challenging customers and prospects. This is with a view to automate and customize their trading operations to become more competitive. There are now technologies that combine FX trading venue connectivity with a bird’s eye view of the market in real time; aggregating fragmented liquidity and including smart order routing algorithms, enabling every element of an eCommerce platform to automatically find and leverage the best prices.  

And, a very few include a rich development framework for both business users and IT. The flexibility for the business user allows traders to create and rapidly deploy proprietary FX and cross-asset trading strategies that help them competitively engage with clients.

There have been numerous recent examples of banks looking to take advantage of these solutions. For example, Royal Bank of Canada (RBC) recently deployed a new FX Aggregation solution to support its foreign exchange dealing operations. The Progress Apama FX Aggregation Solution Accelerator  is completely customizable and has been modified for RBC to meet its specific requirements. RBC's new system has significantly increased the efficiency in which its traders obtain the best FX prices for their clients.

RBC is the latest in a growing list of global and regional banks, which have deployed this type of platform as a foundation for eCommerce. Other organizations that have deployed FX solutions driven by technologies from Progress Software (namely its Apama product) recently include BBVA, UniCredit and ANZ, who can now access multiple sources of liquidity and dramatically improve their ability to handle increased trade volume.

The best way to deal with anxiety is to address the root cause. In this case, regulation. Regulation is coming, change is coming. Since the FX world is now facing looming regulations with dramatic impact, you’re going to need to adapt your business models and supporting applications quickly in order to survive – for instance by building flexible rules within your FX trading systems to identify and manage risks, whatever they may turn out to be.  If you do, you’ll be ahead of the pack and will be able to create competitive advantage.

-Dan

Thursday, November 04, 2010

A postcard to Jeremy Grant

Posted by Giles Nelson

Jeremy Grant, editor of FT Trading Room at the Financial Times, recently asked for explanations "on a postcard" about why speed is a force for good in financial markets, or put another way, to explain what the benefits are of high frequency trading. I've just come back from Mexico where I was addressing the Association of Mexican Brokers and during my visit I thought I'd write that postcard. So here it is:

 

Dear Jeremy

I saw your request for postcards recently, and as I'm travelling I thought I'd drop you one. There's not a lot I like doing more than explaining the benefits of so-called "high frequency trading".

I would suggest that you think of high frequency trading, or HFT, as being just the latest stage in the evolution of electronic trading. And this, as you know, has evolved very rapidly over the last decade because of cheaper and faster computers and networks. It's led to many innovations and benefits: electronic crossing networks, algorithmic trading, online retail trading, smaller order sizes, the overall increase in trading volume, more price transparency, greater trader productivity, more accessible liquidity, spreads between buy and sell prices tightening, broker commissions reducing, competition between exchanges and so smaller exchange fees - none of these things would have happened without electronic trading. MiFiD couldn't have happened; it simply wouldn't have been financially viable for the many alternative European equity-trading venues to launch without cheap access to networks and computers. Without these we would still have greedy, monopolistic exchanges with high transaction prices.

HFT is just the latest step in a technology driven evolution. You can't just look at it in isolation.

"Ah", you exclaim, "but high frequency trading is a step too far. Trades happening far faster than the blink of an eye. Surely that can't be right?"

So what if trades happen quickly? Things "going too fast" is a common concern. In 19th century Britain, people were worried about trains going faster than 30mph. They thought that passengers would suffocate or that as the train reached a corner it would simply come off the rails! And to those that say trading happens too quickly, at what speed should it occur? If not micro or milliseconds, should it be a second, a minute, an hour? Who's going to decide? Any choice is entirely arbitrary anyway; time is infinitely divisible.

There are plenty of things that happen too fast for humans to comprehend - human nerve impulses travel at more than 100m per second, yet we function successfully. Why? Because we have the monitoring systems in place that ensure the information from the nerves is processed correctly. Put a finger on a hot coal and it will be retracted immediately - quicker than we can consciously think. And if a 200mph train goes through a red light then warning bells will ring and the train will be automatically stopped.

And so to the main point. Trading speed, per se, is not the problem. But, yes, problems there are. Markets, particularly in Europe and the US are now very complex. These markets are fast moving, multi-exchange, with different, but closely interlinked asset classes. It is this complexity we find difficult to understand. Speed is only one facet of this. We imagine that an armageddon incident could occur because we know that the markets are not being monitored properly. Regulators freely admit this - Mary Schapiro recently said that the SEC was up to two decades behind in its use of technology to monitor markets. And because we know that the people in charge don't know what's going on, we get scared.

It doesn't have to be like this. The same technological advances that led to the evolution of HFT can be used to ensure that the markets work safely, by ensuring that limits are not exceeded, that an algorithm "going crazy" can't bring down an exchange, that a drunken trader can't move the oil price and that traders are dissuaded from intentionally trying to abuse the markets.

Doing things faster is a human instinct. Faster, higher, stronger. The jet engine, the TGV, the motorway. Would we really go back to a world without these?

Thursday, July 22, 2010

India – big potential for algorithmic trading

Posted by Giles Nelson

I spent last week in India, a country that, by any standards, is growing fast.  Its population has doubled in the last 40 years to 1.2B and economic growth has averaged more than 7% per year since 1997.  It’s projected to grow at more than 8% in 2010. By some measures, India has the 4th biggest economy in the world. 

Progress has a significant presence in India. In fact, people-wise, it’s the biggest territory for Progress outside the US with over 350 people. Hyderabad is home to a big development centre and Mumbai (Bombay) has sales, marketing and a professional services team.

The primary purpose of my visit was to support an event Progress organised in Mumbai on Thursday of last week on the subject of algorithmic trading. It was also our first real launch of Progress and Apama, our Complex Event Processing (CEP) platform, into the Indian capital markets. We had a great turnout, with over 100 people turning up. I spoke about what we did in capital markets and then participated in a panel session where I was joined by the CTO of the National Stock Exchange, the biggest in India, a senior director of SEBI, the regulator, and representatives from Nomura and Citigroup. A lively debate ensued.

The use of algorithmic trading is still fairly nascent in India, but I believe it has a big future. I’ll explain why soon, but I’d like first to give some background on the Indian electronic trading market, particularly the equities market, which is the largest.
 

The market
India has several, competing markets for equities, futures and options, commodities and foreign exchange too.  In equities, the biggest turnover markets are run by the National Stock Exchange (NSE) and the Bombay Stock Exchange (BSE), with market shares (in the number of trades) of 74% and 26% respectively. Two more equity exchanges are planning to go live soon – the Delhi Stock Exchange is planning to relaunch and MCX is also currently awaiting a licence to launch. This multi-market model, only recently adopted in Europe for example, has been in place in India for many years.

It was only two years ago that direct market access (DMA) to exchanges was allowed. Although official figures don’t exist, the consensus opinion is that about 5% of volume in equities is traded algorithmically and between 15% and 25% in futures and options. Regulation in India is strong - no exchange allows naked access and the BSE described to me some of the strongest pre-trade risk controls I’ve come across - collateral checks on every order before they are matched. The NSE has throttling controls which imposes a limit on the number of orders a member organisation can submit per second. Members can be suspended from trading intra-day if this is exceeded. The NSE also forces organisations who want to use algorithms to go through an approval process. I’ll say more about this later. Controversially, the NSE will not allow multi-exchange algorithmic strategies so cross-exchange arbitrage and smart-order routing cannot take place. Lastly, a securities transaction tax (STT) is levied on all securities sales.

So, with the above restrictions, why do I think that the Indian market for algorithmic trading has massive potential?
 

The potential
The Indian market is very big. Surprisingly so to many people. Taking figures from the World Federation of Stock Exchanges (thus I’m not counting trading on alternative equity venues such as European multi-lateral trading facilities), the Indian market, in dollar value, may still be relatively modest – it’s the 10th largest. However, when you look at the number of trades, India’s the 3rd largest market, only beaten by the US and China. The NSE, for example, processes 10 times the number of trades as the London Stock Exchange. So why isn’t more traded in dollar terms? That’s because trade sizes on Indian exchanges are very small. The median figure worldwide is about $10K per trade. The figure in India is about $500 per trade, a 20th of the size. In summary, surely the task of taming the complexity of this number of trades and the orders that go with them is ideal for algorithmic trading to give an edge? To compare to another emerging, “BRIC”, economy, that of Brazil, where the number of firms using Apama has gone from zero to over 20 in as many months, the dollar market size is fairly similar but the number of equity trades in India is 33 times more. The potential in India is therefore enormous.

India is already there in other ways. All exchanges are offering co-location facilities for their members and debate has already moved on to that common in more developed markets on whether this gives certain firms an unfair advantage or not and whether co-location provision should be regulated.

 

The challenges
There are some difficulties. The STT is seen by some as an inhibitor. However, its effect is offset somewhat by the fact that securities traded on exchange are not subject to capital gains tax. 

The NSE process for approving algorithms is more controversial. Firms that want to algorithmically trade must show to the NSE that certain risk safeguards are in place and “demonstrate” the algorithm to the exchange. As the biggest exchange, the NSE wields considerable power and thus its decision to vet algorithms puts a brake on market development. I believe this process to be unsustainable for the following reasons:

  1. As the market develops there will simply be too many algorithms for the NSE to deal with in any reasonable timeframe. Yes, India is a low-cost economy, but you need highly trained people to be able to analyse algorithmic trading systems. You can’t simply throw more people at this. Firms will want to change the way algorithms work on a regular basis. They can’t do this, with this process in place.
  2. It raises intellectual property issues. Brokers will increasingly object to revealing parts of their algorithms and their clients, who may want to run their alpha seeking algorithms on a broker-supplied co-location facility, will most definitely object. 
  3. It puts the NSE in an invidious position. Eventually an algo will “pass” the process and then go wrong, perhaps adversely affecting the whole market. The NSE will have to take some of the blame.
  4.  Competition will force the NSE’s hand. The BSE is trying to aggressively take back market share and other exchanges are launching which will not have these restrictions.

It strikes me that the NSE should spend its efforts into ensuring that it protects itself better. Perhaps a reasonable comparison is a Web site protecting itself from hacking and denial of service attacks. If they can do it, so can an exchange. And it would offer much better protection for the exchange and the market in general.
 

In conclusion
I’m convinced of the growth potential in India for algo trading. The market is large, the user base is still relatively small and many of the regulatory and technical prerequisites are in place. There are some inhibitors, outlined above, but I don’t think they’ll hold the market back significantly. And finally, why should India not adopt algo trading when so many other, and diverse, markets have?

Progress has its first customers already in India. I look forward to many more.