Large Institutions Push Growth in Japanese Automated Trading

- Updated October 11, 2014

This article originally appeared in Securities Industry News (paid subscription required). A much-anticipated rise in algorithmic and electronic trading is taking hold in Japan. It is confirmed in a recent report by Connecticut-based research firm Greenwich Associates and is being led by Japan’s largest securities firms. Growth in these activities is expected to continue at a rapid pace, within the context of global competition and pressures to increase efficiency and reduce costs. “Looking out over the next 12 months, these influential institutions expect to be doing 12 percent of their equity trading business through algorithmic strategies,” said John Feng, a consultant with Greenwich Associates. “When you add in non-algorithmic trades, overall self-directed single-stock electronic execution is expected to reach 18 percent of these large institutions’ total volume by mid-2007.” Greenwich’s reports said that in 2006, electronic trades in Japan’s largest securities firms increased 10 percent, although there was no increase in the nation as a whole. That is expected to change this year as smaller brokerages and securities firms adopt algorithmic and other electronic trading approaches. Greenwich sees electronic trading rising to 13 percent of total trading volume this year, from 8 percent in 2006. Brad Bailey, senior analyst at Aite Group of Boston, said that as foreign investors move into the market, Japanese firms need to improve execution speeds while reducing costs–qualities that hedge funds and other international investors are looking for as they make their way into Asian capital markets. “Investment banks are very interested in rolling out algorithmic trade,” Bailey said. “Nomura [Securities] and Nikko [Cordial] are already starting to offer those to their clients.” Importing Skills To get up to speed, Japanese firms have started looking for help from abroad, Bailey noted. In the highest-profile move, Nomura Holdings on Feb. 2 closed its $1.2 billion purchase of New York-based agency brokerage Instinet from private equity firm Silver Lake Partners. That brings Nomura access to 1,500 institutions worldwide and a range of algorithmic strategies for markets around the globe. Los Gatos, Calif.-based Vhayu Technologies entered the Japanese market through a deal with Nomura last year for managing a streaming feed of tick data into the firm’s algorithmic trading platform from the Tokyo Stock Exchange (TSE). Nikko Cordial, Japan’s third-largest securities firm, has also started offering the service. Interest in algorithmic strategies is not generated only by investors from outside Japan, Bailey said. Competition is increasing at home as individual investors are more actively directing their own investments. In retail brokerage, Bailey added, “the last two years have looked a lot like the day-trading boom in 1999 and 2000 in the U.S.” “Algorithmic trading is sort of the buzzword of the moment,” said Neil Katkov, Asia analyst for Boston-based research firm Celent. “The sell side is actively trying to promote it to all their buy-side customers. The buy side is keenly interested.” A recent example of domestic demand, Katkov said, is the FIX protocol conference held in Japan last October. The FIX standard for buy- to sell-side communications is a virtual prerequisite for automated strategies, Katkov said. Sizable attendance showed that “interest in FIX and algorithmic trading is huge,” he said. Remaining Challenges Still, there are obstacles to overcome. “You have to remember that we’re recovering from 15 years of recession, practically,” said the Celent analyst, when the financial industry underinvested in technology. That was manifest in operational and capacity problems in 2005 and 2006 at TSE. The exchange, which is now investing in new platforms and upgrades, was hindered not only by limits on the volume of trade, but also by slow processing speeds that were not conducive to algorithmic trading, Katkov said. TSE’s new trading system, expected to be up by 2009, “is going to be faster by 100 times,” said exchange spokesperson Mitsuo Miwa. “Speed is one of the most important things in creating” the next-generation system. FIX, however, will not be part of the package. “They’re developing a proprietary system–going proprietary is something Japan often does,” said Katkov. That will require brokers using algorithms to add an extra step to their process to make their FIX messaging compatible. Even so, the new system will be a big improvement, Katkov said. The rapid adoption of technology on the sell side, however, is not reflected on the buy side, according to Katkov. Certain assets, including pension and insurance-backed assets, are required by law to go through specific custodial intermediaries. “As a result, these firms have little competitive pressure,” Katkov noted, adding that the adoption of electronic trading technologies on the buy side tends to be driven by Japanese subsidiaries of foreign institutions. Observers are looking for the same trend to extend to other Asian markets. “People are running algorithms where they can in Asia,” said Bailey. “The big issue is liquidity. When you look at the rise of electronic trading, and especially algorithmic trading, markets need to have a certain amount of liquidity.” Where they see opportunity, notably in Hong Kong and Singapore, Western hedge funds and investment managers are already starting to use the technology, Bailey said.

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