In North America and Europe, high-frequency trading (HFT) has been put under the microscope. Flash crashes—the most recent of which befell the British pound on October 7—price volatility, heaps of cancelled orders, and the belief that the financial markets are rigged, notably outlined in Michael Lewis’ Flash Boys, has led regulators to reexamine the potential (some might say “theoretical”) benefits of the practice: added liquidity, tighter spreads, and decreased costs.
But one region of the world that has been quick to embrace HFT in order to bring in foreign expertise and liquidity is Asia. To varying degrees, Japan, Singapore, Australia and Hong Kong have seen their exchanges build out their trading platforms and networks to entice low-latency traders to try out their markets. While it’s too early to judge the long-term success or failure of these efforts, there’s clearly an appetite for this type of trading in this region.
Another market that is poised to join this group is India. For those unfamiliar with India’s marketplace, the second-most populous country in the world has two stock exchanges: the Bombay Stock Exchange (BSE) and the National Stock Exchange (NSE).
The topic of HFT brings about its own drama. India’s regulator, the Securities Board and Exchange of India (Sebi), hopes to address those concerns. As such, any conversation about the merits of HFT will first have to begin with how best to regulate algorithmic trading and co-location.
HFT and Algo Differentiation
“You have to be really skilled to enter this market as well as have an appetite for the risk. But in India, HFT has grown, especially as some of the global players have opened offices there for proprietary trading. A lot of the increase in volume is coming onshore.” Hani Shalabi, Credit Suisse
Earlier in the year, the Indian regulator issued a discussion paper, Strengthening of the Regulatory Framework for Algorithmic Trading & Co-location.
The nine-page report lists seven measures designed to address concerns relating to market quality, market integrity and fairness due to the increased usage of algo trading and co-location in the Indian securities market. By the end of August, Sebi had collected feedback from the industry, including from broker-dealers, investors and intermediaries, among others.
Sebi chief Upendra Kumar (UK) Sinha recently said the regulator would consult all stakeholders—including the Reserve Bank of India (RBI) and technology providers—before making a final decision on implementing new rules targeted specifically at HFT.
There is a concern among HFT proponents that some of the measures proposed will be detrimental to the overall trading landscape in India. According to data provided by Sebi, algorithmic trading and HFT strategies account for about 40 percent of the country’s trades. However, that estimate lumps HFT and algo trading together. While all high-frequency trading strategies are conducted using algorithmic platforms, not all algorithmic trading constitutes HFT. Even in the US, regulators have given up on trying to define an exact latency that constitutes HFT, but there still needs to be some differentiation between HFT and simple algorithmic trading, notes one asset management firm’s risk manager.
“It can be difficult to distinguish and define algo trading and HFT, and in markets like India, these are things the regulator is grappling with,” says the source.
[Editor’s note: As Waters went to press, it was reported by Mint, an Indian business newspaper, that Sebi will start a second round of consultation—following the August consultation paper—and it will drop some of its earlier proposals, though details of what will be removed were not released as of deadline.]
In the paper, Sebi states that algo trading and HFT drew regulatory attention due to price volatility, market noise, costs imposed on other market users, and it often presented limited opportunities for regulatory intervention. The regulator is examining several measures to “allay the fear and concern” of unfair and inequitable access to the trading systems of the exchanges.
Potential measures to curb high-frequency trading include a minimum resting time for orders; frequent batch auctions; random speed bumps or delays in order-processing or matching; randomization of orders received during a given period; maximum order message-to-trade ratio requirements; separate queues for co-located and non–co-located orders; and a review of tick-by-tick data feeds.
One big concern, though, is that Sebi has not clearly identified the specific problem it is trying to solve. Without proper clarification, implementing those measures without addressing a specific problem could be detrimental, adding complexity to the overall market structure in India.
Rather than target HFT specifically, Pamela Casey, business development manager at trading-platform provider Fidessa, says cracking down on specific cases would deter any intentional misconduct.
“This then leaves more options on how to ensure a fair and competitive marketplace,” she says. “Continuous market supervision or guidelines and enforcement of pre-trade checks and market-abuse monitoring have been proven successful in other markets and could also prove useful here. If I was to use an analogy of a motorway, if speed bumps were placed instead of speed cameras, what effect would this have on the flow of traffic?”
Sylvain Thieullent, CEO of Horizon Software, says he recognizes the need for Indian regulators to put some safeguards in place, given that investors on the securities exchange are still largely retail. As a result, the country does not want its securities exchanges to become “a big casino,” as is the case with China, he says.
But Thieullent says the concern is that the measures that Sebi has proposed will likely make a complicated situation even more complex and confusing. “As a vendor, we think India and Korea are some of the most challenging countries in terms of compliance,” he says. “Regulators in India have always been allowed to review the code of algorithmic firms, which causes intellectual property issues, given that the written code is confidential.” This is an issue also being debated in the US with the Commodity Futures Trading Commission’s (CFTC’s) recent source-code provision of Regulation Automated Trading (AT), which stipulates that trading firms have to turn over their source codes to a repository, as opposed to handing over the code after being served a subpoena.
Despite the discussion paper being closed for feedback, Sebi is still consulting with industry bodies and market participants on the proposals as the body looks to get more clarity on the specific issues it intends to solve. And people are happy that they’re taking their time—at least for right now—but the concern of unintended consequences looms.
As an example, one of Sebi’s proposals is to implement a minimum-resting time for orders of 500 milliseconds; the idea is to eliminate “fleeting orders,” or orders that are put in and then cancelled within a short amount of time. But Sebi also noted that no other regulator currently mandates the resting-time mechanism.
Back in March 2013, the Australian Securities and Investment Commission (ASIC) asked for feedback on implementing a similar measure to address concerns market operators and participants had over the effect of HFT and dark-pool trading. However, ASIC later decided against it, saying that such an implementation would only affect about 1 percent of order amendments and 2.26 percent of order deletions. In total, that represented approximately 1.25 percent of all order flows, including executed orders on the Australian market. So they concluded that the reward of such a bold move would not be worth the added market complexity.
“The proposed minimum resting time rule would affect only a small portion of HFT operators. In ASIC Report 331, it is estimated that HFT accounts for 46 percent of orders and 32 percent of trades in the Australian equities market, with around 25 percent to 35 percent of small fleeting orders attributable to high-frequency traders,” according to Capital Markets Consulting, which was commissioned by the Financial Services Council of Australia to conduct research on the impact of technology on capital markets.
The risk manager says implementing a minimum resting time for orders would definitely hurt HFT players, but the source also questions the need for that kind of speed in the first place. “It is such a small time period that the normal institutional investor wouldn’t have a problem with this. But 500 milliseconds is like an eternity to HFT traders. What are you doing that requires that kind of speed and why would you be cancelling orders in half a minute?” he says.
Another proposed measure is the random speed bumps or delays in order processing and/or matching, similar to what IEX in the US has implemented. IEX introduced a two-way 350 microsecond delay on communications from its members and its trading system.
Sebi said in its discussion paper that this type of mechanism could discourage latency-sensitive strategies, which would drastically affect HFT but would not deter non-algo order flow. The intent behind it is to “nullify the latency advantage of the co-located players to a large extent,” it said.
As for randomization of order matching for co-located orders and non–co-located orders, Hani Shalabi, head of advanced execution services for Credit Suisse in Asia-Pacific, says implementing such measures may result in shifting the problem rather than resolving it.
While Sebi mulls over whether it should implement some, if any, of the proposed measures, there is no doubt that any of these measures would affect liquidity in India’s market—the question is, whether the impact would be positive or negative.
Shalabi says it is likely that at least some of the proposals will be implemented, since Sebi put out the discussion paper. “The industry understands that Sebi is under pressure to implement measures to solve what it perceives to be a problem. These proposals, if implemented, may impact volumes and, hence, liquidity,” he says.
Meanwhile, Casey says she would be surprised if any of the specific mechanisms are implemented in the near-term. “This would deter HFT activity and could, in their current form, have an unintended impact on liquidity in the market,” she says. Instead, she wagers there will be more analysis into specific, suspect cases and activities in the marketplace.
After all, by significantly curtailing HFT, many market participants would have to change their strategies and also conduct a review on their relevance in the new market structure. “This would be costly in my view and may lead to unintended impact on liquidity. Cost and complexity will deter liquidity providers,” she adds.
The Liquidity Issue
Whether in Asia, North America or Europe, the HFT battle often comes down to the question of liquidity. Access to liquidity in Asia has always been complicated because the region is both fragmented—each country has its own market structures/rules and the differentiation isn’t always that clear—and homogenous, as most markets have only one or two exchanges. Other than Japan and China, markets in Asia are really small, says Shalabi. US markets trade around $250 billion a day while markets in Asia trade only about a third of that. “Trying to trade a $50 million block in India is very hard; you would exhaust liquidity and end up pushing up prices. So the more liquidity you have, the better,” he says.
This is a big reason why countries like Japan, Singapore and Australia have tried to entice HFT firms, which boosts volumes, adds Casey.
“The main benefit of HFT would be the creation of more liquidity,” she says. “If it is hard to buy and sell, then institutional investors will see the risk of being stuck with positions longer than they want. This is definitely not the only factor in question for encouraging institutional investment, but anything that helps tighten spreads and improve liquidity is important.”
Shalabi says HFT in Asia has plateaued for a while now, whereas in India, it has grown. “You have to be really skilled to enter this market as well as have an appetite for the risk,” he says. “But in India, HFT has grown, especially as some of the global players have opened offices there for proprietary trading. A lot of the increase in volume is coming onshore.”
Lee Porter, head of Liquidnet Asia-Pacific, says there are six elements that need to be present for HFT to flourish in any market. These are: low-cost market access; very low-latency market access; a robust choice of large-cap liquid stocks; relatively low spreads; volatility; and a functional short market. Without these present, it would be too expensive or too risky a market for HFT shops to participate and they would move to markets that meet those conditions.
“If you look across Southeast Asia, rarely do all of these boxes get ticked,” he says. “Also, the regulators have to wrestle with whether they want to create and support a market for investors—institutional and retail—and issuers, or pander to traders in the pursuit of volume and revenue.”
Shalabi adds that HFT in Japan peaked in 2009, but has declined since then and now plateaued. He does not see it increasing in Hong Kong or Australia, either. So is it best to let the market work itself out, before adding new, stringent rules?
There are still many questions to be answered. Although the Indian regulator is engaging with the industry on its proposed measures, all eyes are on its next move.
- The Securities and Exchange Board of India (Sebi) is mulling implementing measures to address concerns around HFT.
- Some industry participants have criticized Sebi for not specifying the exact problem it is trying to solve, and they believe that implementing any of the proposed measures would adversely affect liquidity in India.
- For all the talk of HFT, the practice has seemed to have plateaued in Asia, so is it best to let the market work itself out before adding in any new rules that could bring about unintended consequences and complexity.
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