Exchanges and regulators must brace for increased volumes as ATSes and crossing networks pour in resources, but governments are likely to remain protective.
Alternative trading systems and crossing networks for equities are ramping up their presence in Asia this summer and while the exchanges are not likely to feel the searing heat of competition just yet, they would be wise to heed these harbingers of fragmentation.
Traditional exchanges in the Asia-Pacific region, like those in the US, will eventually face competition for order flow and liquidity from ECNs, alternative trading systems and dark pools, says William Cline, managing partner of global capital markets consultancy Acai Solutions.
However, “the governments here like to keep control of their markets and take a much more involved role than you would see in Europe or the US,” says William Fyfe, senior vice president at Fimat Hong Kong. “It’s more a regulatory problem than anything else.”
Asian exchanges are primarily focused on keeping a level playing field for retail and domestic investors, and their technology platforms would have problems coping with the increased order flow that comes from allowing direct market access. “A lot of the exchanges are looking to upgrade their systems at the moment,” Fyfe says. Exchanges have to be responsive to market participant demands to trade electronically, anonymously, immediately and with certainty, he says.
“If exchanges are not responsive to these requirements, I think they will find themselves increasingly disintermediated by direct links between market participants and new alternative networks,” Acai’s Cline says.
That process is beginning in earnest. Asia Pacific’s first electronic communication network, the AXE ECN, is set to launch in Australia in July, while block crossing network Liquidnet plans to go live in five countries. Meanwhile, Instinet, which has been in Japan for five years, finally saw its usage grow last year and plans to expand to more countries, and ITG recently expanded its Posit product suite offering in Australia.
“A lot of this demand is driven by hedge fund and other institutional trading,” says Raj Aggarwal, Sullivan Professor of international business and finance and dean of the college of business administration at the University of Akron in Ohio. “However, some governments in Asia are likely to be more protective and will let their national stock exchanges keep their monopolies longer.” They also fear that uncontrolled capital flows may hurt local economies.
AXE in Australia
Operated by the New Zealand Exchange (NZX) and set to launch in Australia, AXE is a joint exchange and broker venture. NZX owns 50 percent, while Citi, Commonwealth Securities, Goldman Sachs JBWere, Macquarie Securities and Merrill Lynch each hold a 10 percent stake.
“We’ve got all our technology just about in place and two hosted sites for our trading system,” says Greg Yanco, CEO of the AXE ECN. AXE uses the GlobalVision platform from London-based Trayport, the same system the NZX is currently implementing for its equity market.
AXE gives firms an alternative to the restrictive rules and high fees of the Australian Securities Exchange, says Yanco. ASX rules make it difficult for firms to match orders internally and changing those rules would not only require approval from Australia’s securities commission, but would cost the exchange revenues from order flow. “They would need motivation to do that.”
ASX rules mandate a 10-second delay before matching an order to see whether there’s price improvement, he says. Matching orders on AXE eliminates that time lag and the chance that the market has moved in the meantime. AXE also has a fixed price model, while the ASX’s fee structure is based on the number of transactions, Yanco says. “If you grow the business, the cheaper we become, because we don’t keep charging,” he says.
The ECN also plans to offer a bulletin board that lets traders at different firms find counterparties for off-exchange trading. At press time, the AXE ECN was still awaiting final regulatory approvals, expected to come in July.
Also in Australia, ITG is already operating a continuous matching system, BlockAlert, which will be rolling out to the rest of Asia sometime next year, according to Gabe Butler, ITG’s Hong Kong sales director. ITG’s Posit is available in Australia, as well as in Hong Kong and Japan, matching trades once a day. ITG has more than 100 people in Asia, and trading in 12 markets. The company saw a 40 percent increase in Asian staff during the first half of this year, Butler says. “We probably will have another substantial amount of hiring to do in the next 12 months—a lot in technology,” he says.
“We’re keeping a close eye on China,” Butler says. “If the QFII (qualified foreign institutional investor) regulations ever shift and allow a lower threshold for entry, we definitely want to be telegraphing that way in advance. We’re already looking to that market for pre- and post-trade analytics products.” ITG offers pre- and post-trade products for India, and is working on getting direct access to that market as well, he says. Currently, it offers direct market access (DMA) in Australia, Hong Kong, Japan, Korea, Singapore and Taiwan, and provides other trading services for Indonesia, Malaysia, New Zealand, the Philippines, Thailand, and China’s foreign currency-denominated B shares market. ITG uses its algorithmic trading product on its own desk, and plans to roll it out to Asian clients over the next 12 months.
Cranking Up Volume
“As other markets become DMA-capable, we’re going to try to be aggressive in rolling out algorithms there as well,” he says. It takes time for local regulators to get comfortable with the new systems and for local brokerages to adapt to the new technology, he says. In addition, the exchanges themselves have to get ready for the increased traffic. “Once you allow DMA, the amount of order flow usually explodes dramatically—and the regulatory challenges go up,” Butler says.
Liquidnet has received regulatory approval in Japan. Approvals from Australia, Hong Kong and Singapore are expected shortly, and a fifth country, South Korea, doesn’t require approval as long as Liquidnet deals only with offshore institutions. Liquidnet officials hope to have a presence in most Asian markets. The major exceptions are China, India and Taiwan. India doesn’t allow off-exchange crossings, and China puts significant limitations on foreign investors. Taiwan recently started requiring that trades be pre-funded in cash, which makes it difficult to carry out automated crossings.
Liquidnnet allows buy-side firms to expose their order books—anonymously—to other member firms. This allows cheaper and faster execution of large orders, according to David Klinger, managing director for Liquidnet Asia. “Most traders would say that the best way to trade is by accessing natural liquidity,” Klinger says. “If you’re a buyer of the stock and you find a natural seller, you meet in the middle and there’s less price impact. It’s a far better way to trade.”
Over 100 clients already say they plan to use the system, Klinger says. Of those, about 60 are firms based in Asia, many of them international firms that already use Liquidnet in other jurisdictions where they do business.
Instinet, which was recently acquired by Japanese brokerage Nomura Holdings, has about a 3 percent share of trading volume at the Tokyo Stock Exchange and a 1 percent share of the Stock Exchange of Hong Kong. In addition, a few big brokerages in Japan, such as Credit Suisse and UBS, also match customer orders internally.
With an office in Japan since 1995, Instinet received its proprietary trading system license in 2002, allowing it to operate an electronic trade matching platform. Members can use one of two systems: a continuous block crossing platform that allows real-time block crossing around the clock, and JapanCrossing, which has three crosses during the day. “In Japan, you’re just starting to get the dark liquidity pools,” says Nick McDonald, Instinet’s head of equities in Tokyo. UBS and Credit Suisse were among the leaders in setting up the dark pools, he says, and Instinet recently signed a deal with Credit Suisse to link their dark pools in Japan and provide their clients access to both.
Instinet is working on rolling out an automated link to the Stock Exchange of Hong Kong—currently, there is a manual reporting system that has hindered growth. After the automated reporting system goes into place, “we’ll crank up our volume,” McDonald says. Instinet is also applying for Singapore Stock Exchange membership.