AsiaEtrader Issue 6 | Volume 1
The Electronic Trading Resource for Asia
SGX-LSE interoperability Cashmere futures at MongoliaX Aussie off-market trading Collateral crunch
Hedge funds migrate to Asia MCX-SX arrives in India
Opposites don’t attract
AsiaEtrader Issue 6 | Volume 1
I 2013 Q2
The Electronic Trading Resource for Asia
SGX-LSE interoperability Cashmere futures at MongoliaX Aussie off-market trading Collateral crunch
Here we are in Spring, and with it renewal and hopefully improving capital markets. It has already brought new perspectives on algorithmic trading from regulators in Australia and Hong Kong, generally regarding as favourable and Hedge funds migrate to Asia MCX-SX arrives in India
spelling out what the local regulators
expect to be a level playing field.
Editor-in-Chief Stephen Edge firstname.lastname@example.org
Both markets, interestingly, are polar opposites with one having cutting edge
Managing Editor Dan Barnes email@example.com
technology and competition and the other
Contributing Writers Stephen Price firstname.lastname@example.org
lacking both. Despite the tough environment, hedge funds are moving to Asia while local Asian brokers are seeking growth from beyond the region.
Roger Aitken email@example.com
On competition, India now has three national exchanges vying for liquidity,
Frederic Stephan firstname.lastname@example.org
the same number of venues as Japan. The former has the smallest tick sizes
Cover Design Nadia P. email@example.com
in Asia and a fast growing derivatives segment and the latter the largest tick sizes and a tiny futures market, relative to its GDP. Mongolia, that land-locked
Graphic Design Matteo Rosin firstname.lastname@example.org
nation, has one of the smallest capital markets in the world but is writing
Mariel Closa email@example.com
laws and overhauling regulations to open its markets to anyone willing to
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trade. China is its next door neighbour and largest trading partner, who’s new regulatory chief thinks that pooled assets are akin to shadow banking
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keeps the door closed. Asia is, in the famous words of Winston Churchill, “…a riddle, wrapped in a mystery, inside an enigma.” With this our sixth issue of the Asia Etrader we hope to offer some clues to the puzzle.
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Contents IN THE ZONE
Our quarterly round-up of industry news and developments across Asia last quarter. Page 4
COVER STORIES Fund migration – Agile hedge funds seeking investment – Hedge funds are coming to Asia though with less AUM than in the past. Find out how they are coping. Page 6
Many possible paths for new Indian Exchange – MCX-SX has the potential to challenge the NSE and BSE, but there are pitfalls along every avenue for growth.
DERIVATIVES FX Trading in India – The NSE and MCX-SX dominate FX trading in Asia but that could all change if restrictive rules aren’t lifted.
Eastern brokers look west – A new breed of sell-side are moving from the domestic to the international market successfully.
Asia Futures Trading Q1 2013 Recap – See how Asia’s derivatives exchanges faired this past quarter.
Volatility in Asia Q1 2013 – We compare volatility profiles of various benchmarks in Asia Page 20
OPINION POLL What markets are on your radar for 2013? – See how the industry voted between China, India and the emerging ASEAN countries.
BUY SIDE Collateral Management – The New Normal in Asia: We hear from a panel of industry experts on the latest developments in collateral management.
REGULATION Capitalizing on Compliance – Never has there been greater focus on compliance. Read how you can capitalize on it.
Saruul Ganbaatar – the deputy CEO at the Mongolian Stock Exchange spoke with Asia Etrader about the challenges of developing a young trading industry, algorithmic trading and the technology behind the exchange.
EQUITIES Playing Aussie pools – Australia is bringing clarity to off-market trading, writes Dan Barnes.
36 Asia’s Fragmentation Footprint Q1 2013 – A new Chi-X Aus CEO, a new exchange in India and big volume in Japan.
Asia Equity Trading Q1 2013 Recap. O ur quarterly review of turnover, average trade sizes, spread and market impact costs on Asia’s exchanges.
WORD ON THE STEET
What do you think of the Australian government’s decision to delay competitive clearing for 2 years? – 5 of your industry peers weighed in.
POST TRADE London to Singapore: From pillar to post-trade – C ould the two exchanges make a clearinghouse work?
TECHNOLOGY Pushed beyond the boundaries – Technological advances have led markets to trip over their own feet.
BACK PAGE 44 Dates – Exchange holidays and important industry events. Directory – A listing of Asia’s electronic trading industry participants.
IN THE ZONE
In the Zone... The first quarter of 2013 has come and gone, and with it the promise of better volumes and an uptick in business. It also brought with it a new exchange in India, clarity on algorithmic trading regulation in Hong Kong and Australia, partnerships, expanding market access and a myriad of other developments.
Australia The quarter got underway in Australia with ASX joining the Global Liquidity Alliance, a group composed of Cetip (Brazil), Clearstream (Frankfurt/Luxembourg), Iberclear (Spain) and Strate (South Africa) that was formed in response to the global collateral crunch. The members aim to exchange information, identify common needs and extend global collateral solutions. The following month, ASX announced the launch of ASX Net Global, a low latency network connecting to the ASX and ASX 24 trading platforms and the ASX Australian Liquidity Centre (ALC). In other exchange news, ASX Compliance ﬁned Merrill Lynch Australia A$40,000 (US$41,640) in March for transaction transgressions. Meanwhile, Chi-X announced two new trading participants in the quarter. In February, BTIG Australia Limited was admitted and PhillipCapital was admitted in March. In February, Wayne Swan, the country’s deputy prime minister and treasurer, accepted recommendations made by the Council of Financial Regulators on competition in cash equity market clearing and settlement. The Council recommended that any license application from a clearing facility seeking to compete in the market be deferred for two years. And in March, ASIC released a report and consultation paper arising from the work of two taskforces that examined dark liquidity and high-frequency trading. The taskforces found that negative perceptions about high-frequency trading were not justiﬁed, and that there was less trading by fundamental investors on lit exchange markets.
China In February, Hong Kong Exchanges and Clearing Limited (HKEx) launched its Mainland Market Data Hub (MMDH). HKEX’s Founding Members Programme, which allows participation in the early set-up of the market data hub, will launch by the third quarter of 2013 in Shanghai as part of its Orion Market Data
Platform. Orion is scheduled to be phased in the beginning of the second quarter of 2013.
Hong Kong Staying with Mainland-Hong Kong news, the planned mutual recognition of funds represents a new frontier for the evolution of renminbi (RMB) investment products and the development of the asset management business, said Securities and Futures Commission’s (SFC) Deputy Chief Executive Ofﬁcer Alexa Lam at a Hong Kong Securities and Investment Institute forum in January. Lam urged market participants to gear up for new opportunities arising from the initiative, which would build on the experience of the Renminbi Qualiﬁed Foreign Institutional Investors (RQFII) scheme. In March, the Securities and Futures Commission (SFC) welcomed the announcement from China of amendments to RQFII rules that increase the types of qualiﬁed investors and relax investment restrictions on RQFII funds. Also in March, the SFC published a consultation conclusions paper on the regulation of electronic trading. The new rules, which are largely unchanged following the consultation process and take effect 1 January, 2014, place a greater onus on responsible ofﬁcers, or executive ofﬁcers and the management of the intermediaries for compliance, testing
electronic systems, keeping records on the design, development, deployment and operation of their electronic trading systems and automated pre-trade controls and regular post-trade monitoring. The quarter saw several personnel changes of note. At HKEx, Mark Dickens retired in March as head of listing and was succeeded by David Graham, and it was announced that Head of Mainland Development Yang Qiumei will leave at the end of April, with her successor chosen but yet to be named. Meanwhile, Eurex tapped Markus Georgi as the new head of its Hong Kong ofﬁce, and Instinet announced Shaun Bramham will become its regional head for Asia-Paciﬁc seeing Glenn Lesko return to the US. HKMEx also welcomed several additions to the fold, with Taiwan Concord Capital Securities, Zhujiang International Futures, Industrial Securities, Yuanta Futures and Marigold joining as broking members. HKMEx increased the minimum ﬁneness for physical delivery for its US dollar gold futures contracts to 999.9 from 995, applicable to all gold delivery months from April. The exchange signed up to FFastFill’s SEALS and Eclipse software the preceding month to enhance its connectivity and order processing. Turning to incidents of misconduct, Du Jun, former managing director of Morgan Stanley Asia, was barred from the industry for life for insider trading, and Joyce Hsu Ming Mei, a former licensed representative of Merrill Lynch (Asia Paciﬁc) was handed the same ban following her conviction and imprisonment for theft. The SFC also reprimanded Manulife Asset Management (Hong Kong) and ﬁned it HK$24mn for serious deﬁciencies in the way the Manulife Global Fund was distributed between 2007 and 2012.
India While much fanfare preceded the launch of MCX-SX, the country’s newest exchange made little market share or volume headway, and introduced incentives to increase liquidity.
IN THE ZON E
Backed by MCX and Financial Technologies, the exchange aims to latch on to India’s growth trajectory and lure retail investors. MCX-SX competitor the BSE announced mid March that it is deepening its alliance with Eurex. The exchange has signed up to Eurex’s technology roadmap and plans to replace its derivatives market platform in 2013, before replacing its cash market platform. Also in March, PhillipCapital began Direct Market Access to the National Stock Exchange.
Meanwhile, KRX and the Philippine Securities and Exchange Commission signed a contract to export KRX’s Market Surveillance System to the Philippine markets.
Japan The Tokyo Commodity Exchange announced 31 March that the monthly volume of customer trades originating overseas reached a new all-time record high. The TSE reported that on 12 March, 2013, the trading volume of equity options reached 74,573 contracts, the highest level since 13 January, 2011. In less positive news, the Osaka Securities Exchange suffered a system failure on 4 March that forced the share market to suspend trading for about four hours. Japan Exchange Group (JPX) and India’s NSE signed a letter of intent in January on preparing for the launch of S&P CNX Nifty Index futures on the Osaka Securities Exchange. MarketPrizm, a leading provider of ultra-low latency market data and managed infrastructure services, announced it is providing highperformance market data to SBI Japannext via its MarketPrizm API feed handler technology. Turning to regulation, the Financial Services Agency announced that it plans to make permanent a ban on so-called “naked” short selling that was implemented after the global ﬁnancial crisis in 2008. And TOCOM ﬁned Yamazen Shoji 19 million yen (US$195,000), and suspended it for 15 business days for violating market rules.
Korea Eurex Exchange announced in February that the country’s Financial Services Commission (FSC) has allowed it to offer its full suite of products in South Korea in a move that strengthens ties between the Korean and German ﬁnancial markets. On 18 March, Korea Exchange (KRX) added US treasury bills, notes and bonds to its margin instruments in the derivatives market. KRX previously allowed only cash, substitute securities and certain foreign currencies for margin deposits. And two important agreements were inked in the quarter. KRX and Korea National Oil Corporation signed an MOU on mutual cooperation to promote KRX’s Electronic Petroleum Spot Market, and Singapore Exchange (SGX) and KRX signed an MOU on joint collaboration in
the development of OTC ﬁnancial derivatives clearing capabilities.
Malaysia The Malaysian capital market registered record performance in 2012 with its overall size reaching RM2.5 trillion (US$817.7 billion), a 16.4% increase from RM2.1 trillion in 2011. All market segments saw double-digit yearon-year growth of between 14.1% to 22.6%. The large amount of funds raised through the issuance of corporate bonds and initial public offerings (IPO) in 2012 cemented the country’s ranking as the world’s biggest sukuk market, the ﬁfth largest IPO destination globally and the fourth most active in Asia for corporate bond issuances. Meanwhile, Bursa Malaysia (BMB) revamped its rules, with the changes, including improved investor protection and the streamlining of standards, taking effect 2 May, 2013.
The city-state began the quarter on a high with SGX FTSE China A50 Index Futures achieving new records in January with average daily volume of 97,984 contracts and a month-end open interest of 307,491 contracts. From 25 February, SGX broadened its clearing services for OTC customers to include swaps and futures contracts. SGX deepened its derivatives offering by signing a licensing agreement with global index provider MSCI for 14 new regional and country indices. Also in the quarter, BNP Paribas Securities Services SCA joined SGX as a securities market clearing member, and KGI Capital (Singapore) joined as a clearing and trading member of its derivatives market.
Taiwan In early February, the Taiwan Futures Exchange (TAIFEX) and Eurex announced they had agreed on a strategic alliance to cooperate on trading and clearing derivatives based on the TAIEX. The partners plan to list TAIEX options and futures as daily expiring futures on Eurex Exchange in the fourth quarter of 2013.
Philippines GFI Group announced in February the opening of its ofﬁce in Manila, which will focus on the brokering of Philippine Government and corporate ﬁxed income products in the domestic market. In other developments, NYSE Euronext announced it had created a new subsidiary, NYSE Philippines, which will operate as a regional technology hub based in Manila. In March, SGX and Philippine Dealing System Holdings signed an MOU on the development of ﬁxed income access between Singapore and Philippines. Included in the MOU is development of trading platforms to support cross-border ﬁxed income trading. SGX also signed an MOU with the Philippine Stock Exchange (PSE) on the development of Philippines-linked derivatives products. As part of the MOU, SGX and PSE will jointly explore the development and promotion of Philippines futures and options. The ﬁrst planned product launch, a Philippines index future based on the MSCI Philippines index, is scheduled for the fourth quarter.
Thailand As of March 18, the Thailand Futures Exchange (TFEX) increased to 50 from 30 the underlyings for stock futures. The additional underlyings are constituents of the SET100 Index that have market capitalization of more than THB10 billion (US$342 million). Also in March, it was reported that the Agricultural Futures Exchange of Thailand (AFET) had signed an MOU with SMX for the exchange of knowledge and experience on regulatory matters, the creation and revision of futures contracts’ terms and conditions and the co-development of new technologies.
COV ER STO RY 1
Fund migration: Agile hedge funds seeking investment Outsourced trading desks and hosted technology are helping new hedge funds launch in rough seas, reports Dan Barnes
infrastructure for your business to run on,” says Ed Gouldstone, hedge fund product management at technology provider, Linedata. In Q4 2012 research ﬁrm Eurekahedge saw the number of closures for global funds reach around 275, the third highest quarterly closure rate in the last ﬁve years behind Q42011 and Q4 2008, both quarters in which the number of closures exceed the number of launches and latter being the quarter which opened with the collapse of Lehman Brothers. The frustration is that Asia-Paciﬁc funds have seen the greatest returns to date this year, with emerging markets focussed funds up some 3.97% for the year according to the Mizuho-Eurekahedge Emerging Markets Index, with Asian funds more broadly returning over 4% and Japanfocussed funds seeing returns of over 7%. Nevertheless a number of funds have seen launches delayed as they struggle to put funding and infrastructure into place, with the new regulatory regimes adding complexity to the process. “Asset raising is the number one issue right now,” says Mark Wightman, head of alternative and institutional asset management strategy for Asia Paciﬁc, at system supplier SunGard. “A lot of the launches coming up are in the region of US$10-25 million. Very small. I can count on one hand the launches that will be US$150 million+. By contrast, in London there is a belief that you need US$250 million to be viable given the costs of hire in London.”
Weight of wealth
FRA NC IS SO, HEAD O F DEA LING DE SK, BNP P ARIBA S FINAM S HONG KONG
ew Asian hedge funds are looking for ﬂexible operating models as they struggle to ﬁnd backing in the tough economic environment. Despite the boost in performance seen in the ﬁrst quarter of 2013, smaller and medium-sized funds have found that bank’s liquidity issues are making many funds a non-starter. Even well-known fund managers are seeing their launches pushed back as money is found to put behind the traders. “If you are looking to attract big ticket investment you need to demonstrate that you are not just a good investment strategy but a safe operational bet for the investor. Part of that is demonstrating that you have got good operational processes, good systems and a good solid
As funding has diminished, costs in Asia have grown dramatically, in no small part due to regulation. In August 2012, Singapore introduced the fund management company (FMC) guidelines which introduced rules requiring independent custody and valuation of investor assets, as well as requirements for FMCs to undergo independent annual audits by external auditors and having an adequate risk management framework commensurate with the type and size of investments managed by the FMCs. Hong Kong has had a strict regulatory environment for some time. These rigorous policies have engendered trust between investors and funds but in the short term they have had a negative impact. The extraterritoriality of regulation from other regions is also biting. “Firms are looking at trading across multiple markets; many funds based in Hong Kong and Singapore are trading across the region, so they have an additional burden in complying with regimes across all of those markets,” says Gouldstone. “A lot is being made of reporting requirements. AIFM and Dodd-Frank will place an additional burden upon funds even if they are based in Asia. Whether it is registering with the SEC and ﬁling a Form PF or the CFTC and Form PQR, these obligations are real worries for the COOs of hedge funds over here.” “[These rules] are positive for creating a more professional market, but to comply does increase ﬁrms’ costs,” says Wightman. “Anyone
COVER STORY 1
“A lot of the launches coming up are in the region of US$10-25 million.”
launching with US$10-25 million today has to achieve their escape velocity with asset performance to get them through the US$100 million barrier where you start to break even. Bringing that back to reality, there are regulatory costs, standard set up fees for tax advice, audit and ofﬁces, and after that technology is your biggest barrier to look at.”
A head of steam Taken on face value a hedge fund’s technology can be pretty straightforward. An execution or order management system (EMS/OMS) is typically used to deal with the execution side, often from vendors like ezecastle, Bloomberg and TradingScreen. Costs for execution platforms tend to be relatively light as the fees will be paid by brokers, or some funds may use a single bank platform, such as BARX, Autobahn or REDIPlus to allow direct execution. Smaller funds tend to have one platform as they launch operations, and then add others as they scale, to complete operational workﬂows. “A large number of the hedge fund community are not heavy traders and are not
using electronic trading,” says Gouldstone. “However many are coming around to the idea that they need to. You can ﬁt an electronic trading workﬂow within your ﬁrm and connect a compliance check, produce an audit of your trade history and it gives you straight-through processing as well. It requires not only the trading systems but the connectivity with the brokers and venues.” The main system that fund managers need on day one is some sort of portfolio management and risk solution to capture all the trades on a real-time basis, which will hook into the EMS/OMS platform. If they have derivatives as part of their portfolio it will typically let them look at risk intraday. But sourcing, managing and maintaining kit is an unwanted burden for many. “Fund managers want to get on with the business of managing money. If they can outsource technology and infrastructure, or even used managed services, if they can get one operations guy not three, it is certainly a conversation they are willing to have,” says Wightman. “Another point is to host or not to host; do we put everything in the cloud?”
COVER STORY 1
There has been an obvious shift towards hosting systems in the cloud he asserts. Whilst some funds remain nervous about the security of a cloud-based environment, the majority will be at least be talking about the cloud as an option. “It ﬁts nicely into today’s environment which is outsource-centric,” says Wightman.
Outsourced trading Middle- to back-ofﬁce functionality is often outsourced at smaller funds with low trading volumes, where issues such as reconciliation are not so time sensitive, but now their front ofﬁce trading can also be outsourced to centralised service provider, via BNP Paribas Asset Management’s Hong Kong dealing desk. “For hedge funds which are starting up, whether long-short or macro funds, we can help with the process by taking on their dealing activities,” explains Francis So, head of dealing desk at BNP Paribas Finams Hong Kong. “The focus for fund managers is producing alpha from their stock picking ability, not in their trading capacity and that is where we can help these entrants.”
“There is a structured approach that we are taking across the region,” says Carl James, global head of ﬁxed income and FX Dealing at BNP Paribas Finams. “Hong Kong, Singapore and Australia is where we are focused at present. This is a reasonably new concept that more and more people are looking at, moving up the value chain from the middle and back ofﬁce.” The perception that outsourcing may weaken control over operations is one of the greatest challenges to be overcome, however the right level of due diligence and communication can ensure the outsourced functions simply act as extensions of the fund. “The outsourcing part doesn’t mean the fund manager loses control over their brokers; they retain that relationship so we are acting as their internalised centralised dealing desk,” says So. “There is no advice, for us it is a case of understanding their needs, understanding how aggressive they want to be in buying or selling a stock, and understanding their benchmarks.”
“Firms are looking at trading across multiple markets; many funds based in Hong Kong and Singapore are trading across the region...”
Outlook: Good The start of the year has seen a revival in the fortunes of the markets, and investment
COVER STORY 1
ﬂows typically return within two months of positive hedge fund results, according to EurekaHedge analysis. Volumes have picked up, with Japan seeing the strongest growth although some of this has been due to retail trading and government initiatives. Australia’s market has seen a constant ﬂow of orders from SuperAnnuation funds, which are now looking further aﬁeld and could add liquidity to other markets in the region. There are issues in the region that are a cause concern for hedge funds managers. Alternative venues are still nascent in the region and need to see more volume and clearer regulation if they are to be accessible by equity funds. The level of proprietary trading taking place within broker crossing networks was cited by one hedge fund COO as being too high to risk exposure to. A recent study by the Australian Securities and Investments Commission (ASIC) found that eight ﬁrms in the Australian market were conducting principal trading via their crossing networks during Q3 2012, with principal trading making up 38% of the value traded on those networks over that period.
New rules clamping down on electronic trading will cut back on other ﬁrms’ involvement in markets. The head of IT at a London-based hedge fund said, “A lot of the HFT rules that are coming in will negatively affect latency arbitrageurs who are categorised by super-high intraday leverage, a lot of them based in Chicago and typically going home ﬂat overnight, often holding direct membership of exchanges. A lot of the HFT rules will punish them.” Taken as a proportion of global funds, the amount headquartered in Hong Kong, Singapore and Australia has not changed since 2009, but the proportion of global AUM assigned to funds in the region has fallen from 8% to 6% over the same period. Firms in Asia are ﬁghting for a smaller part of the pie. Asian funds will need to take on the operational best practices and infrastructure that is found in London or New York, to keep themselves lean. As people move to Asia from those markets or come back to Asia with experience of those markets the use of these practises are growing; as outsourcing gains favour, funds will ﬁnd it easier to achieve escape velocity.
“If a fund manager can outsource technology and infrastructure, or even used managed services...it is certainly a conversation they are willing to have.”
COVER STORY 2
Many possible paths for new Indian Exchange MCX-SX has the potential to challenge the NSE and BSE, but there are pitfalls along every avenue for growth, writes Stephen Price.
he battle lines have been drawn in India, home to Asia’s oldest and newest exchanges. On 11 February 2013, the new MCX-SX stock market was launched, backed by the well-established Multi-Commodity Exchange (MCX) and Financial Technologies. It has entered the market with ﬁnancial incentives for liquidity providers as it enters combat with the incumbent Bombay Stock Exchange (BSE) and National Stock Exchange (NSE). India’s trading environment is undergoing a period of change which may help the new exchange. Sidelined retail investors are expected to return to the market, in part incentivised by recent cuts in the Securities Transaction Tax, and the government is trying to wean the populace off gold and property and expand equity investment.
MCX-SX is betting it has the technological and product wherewithal to cut a slice off NSE’s close to 80% market share of the cash segment and over 90% market share of derivatives trading, and take on BSE. As happened in 1993, when NSE was recognised as an exchange and squared off with BSE, founded in 1875, the battle is expected to once again bring down trading costs, boost product innovation, improve execution, and advance network expansion. Brokers, however, are cautious. “Even if MCX-SX doesn’t grow the market, it could just gain market share, as happened in Australia [when Chi-X Australia launched],” said Prakhar Sharma, India analyst at broker CLSA. “The regional exchanges are not really meaningful; so it will be a ﬁght between the three of them.”
“The regional exchanges are not really meaningful; so it will be a fight between the three of them.” - Prakhar Sharma, India analyst at broker CLSA
COVER STORY 2
And even if the scheme boosts participation, the quality and longevity of liquidity could fall short of expectations. “The scheme might artiﬁcially boost the numbers as brokers might use it to run various arbitrage strategies to make that incentive,” said Nithin Kamath, founder and CEO of Bangalore-based discount brokerage Zerodha. “The important aspect of this though is to check the retail client participation, and in the near term it doesn’t look like it will pick up. I don’t think incentives alone will attract retail participation.”
Retail investor key Nithin Kamath
founder and CEO Zerodha
chairman, Estee Advisors Private
A narrow window of opportunity After an unsurprisingly lackluster opening, on February 19 MCX-SX announced a Liquidity Enhancement Scheme that took effect March 6 and runs to June. The exchange says the incentives offset some 64% of the Securities Transaction Tax for equities, and 37% of that for futures. Inducements include Rs 21 lakh (approximately US$38,800) per month for market markers reaching 90% of their obligation in a month for 20 securities, rising to Rs 50 lakh (US$92,379) for 40 securities. The exchange says the incentives offset some 64% of the Securities Transaction Tax for equities, and 37% of that for futures. This is a good start but not a long term strategy notes Sandeep Tyagi, chairman of investment management company and MCX-SX member, Estee Advisors Private. “The incentive system can only facilitate trading; it cannot create trading in a sustainable way,” he says. “The markets will trade, or will have volume if there are people who want to buy or sell for the longer term. For them to do it with minimum cost and minimum friction they need people who will take that risk on for the shortterm, and that’s what trading incentives facilitate. But whether people who want to buy and sell for the long term will come to this market or not, that only depends on whether they believe it’s longterm viable.” Similar short-lived programs have been rolled out in the past, with the blessing of the Securities and Exchange Board of India (SEBI) – BSE reinvigorated its derivatives segment after rolling out such a scheme in 2011 – but though long-term inducements for market making are
“The incentive system can only facilitate trading; it cannot create trading in a sustainable way...” - Sandeep tyagi chairman, Estee Advisors Private
currently unlikely, the regulator has relaxed its stance on liquidity-boosting measures. “Liquidity enhancement windows have been offered to new and old exchanges. To some extent it helped them in the beginning, but it wasn’t sustainable,” says Sharma. “The regulator allows a window to offer a liquidity enhancement scheme, which technically is a discounted product. In that period, people move a lot of trades to this window. But generally when things neutralize, they tend to be imbalanced. The liquidity enhancement scheme beneﬁts the entity offering it, even in the long run, but the beneﬁt deteriorates once the scheme ends.”
The government and Securities and Exchange Board of India (SEBI), the market regulator intend to increase India’s investor base by encouraging participation in the equity market with programs such as the Rajiv Gandhi Equity Savings Scheme, which offers small investors tax beneﬁts on equity investments, and educational campaigns. Although the country’s savings rate declined to an eight-year low of 30.8% in the preceding ﬁscal year, according to Central Statistical Organisation statistics, and is forecast to slip further this ﬁscal year, it remains comparatively high with other countries. Investors, however, prefer gold and property to equities. “Households save a lot. There is potential to move traditional savings into equity-linked assets, but that will also need the support of equity markets that perform well, or companies delivering on earnings growth,” said Sharma. “Inﬂation and interest rates have remained high for a long time; so there is always this assumption of 7%-8% interest that you could earn on low-risk investments. And if the gold price rises, preference for it increases.” Although the government initiatives have the potential to encourage greater investment, any increase is unlikely to synchronise with the MCX incentive programmes. “The government has launched equity schemes that help retail investors come into the market, but a lot of these programs take time to come into play,” said Parshant Mittal, executive director of boutique ﬁrm Way2Wealth Illuminati Securities. “A lot of the retail guys are sitting out because they’ve been burnt, though they will come back slowly.” But an increase in retail investors “may not necessarily translate into a structural rise in equity trading volume,” said Sharma. “The people buying long-term may not be frequent traders.” And the obstacles to widening participation are formidable, says Tyagi.
COV ER STO RY 2
“There are two contrary challenges in India,” he asserts. “One is broadening our base of investors, and even taxpayers. Secondly, the economy in many places has been set up in such a way as it’s an informal structure and the growth that happens in these places doesn’t easily lend itself to creating wealth in declared forms.” He continues, “I think growth in equity investing will come as salaried employment increases and businesses grow, as people start having savings and disposable income. Like every other economy, after improving consumption, the ﬁrst investment tends to be automobile, and then housing. I’m sure that the group of people who have gone through those stages of consumption, basic mobility, residence, is growing consistently. All the data is there in terms of middle class savings rate and excess capital.” A further incentive for investors comes in the form of reductions in the Securities Transaction Tax, which Finance Minister P. Chidambaram unveiled at the end of February in the 201314 budget. The tax on equity futures will be reduced to 0.01% from 0.017%, and for mutual fund/exchange-traded fund redemptions it will be decreased to 0.001% from 0.25%, while the levy on mutual fund and exchange-traded fund sales and purchases will be cut to 0.001% from 0.1%. “The government may reduce the Securities Transaction Tax, which might bring in more action, but liquidity growth on a third exchange in the current scenario looks tough,” said Kamath. “That said, the potential that India holds, especially with the sheer number of prospective investors, demands to have multiple exchanges. The tipping point will probably be the markets hitting a new all-time high.” After dropping from Rs 110,121 crore (US$20.35bn) in FY2010-11 (ﬁscal year ends March 31), to Rs 43,738 crore (US$8.08bn) in FY2011-12, foreign institutional investor equity investment has picked up in FY2012-13, reaching Rs 130,284 crore (US$24bn) as of February 28, 2013, according to SEBI. That indicates renewed conﬁdence in India’s markets. Meanwhile, market turnover for NSE and BSE’s cash segments combined for the eight months ending December 31, 2012, was Rs 2,383,854 crore (US$440.4bn), compared with Rs 3,478,391 crore (US$642.7bn) in FY2011-12, Rs 4,682,437 crore (US$865.1bn)
“The scheme might artificially boost the numbers as brokers might use it to run various arbitrage strategies to make that incentive...” - Nithin Kamath founder and C EO Zerodha
in FY2010-11, and Rs 5,516,833 crore (US$1.019tn) in FY2009-10. Foreign and retail investors look like possible stepping stones for growth, but the limited life of its incentive program mean MCX-SX could have a narrow window of opportunity for gaining liquidity.
Innovate or die? In principle for investors, increased competition between the exchanges could reap several beneﬁts. “At the product level, innovation is quite important, particularly in terms of types of orders. For example, some of the big areas one needs to think about is how is margining done, because today margining is done by product, by segment,” says Tyagi. “There is no offsetting between various venues of liquidity, so there is no real structure that recognizes risk mitigation across trading venues and across products. That’s ﬁne if regulation was only meant to support long investors because they don’t have risk-mitigating strategies in place that work in that way. However, there is a separate function in the market for people who do make markets, and there the beneﬁt and cost of doing business
can be dramatically affected if one were to recognise risk mitigation across trading venues and products.” “Reduced costs are good for brokers like us, but would probably not be the only incentive,” said Kamath. “If the exchange as promised can develop the bond-trading segment, try to get investors in from tier-two and tier-three cities, etc, that would help the community as a whole.” The relative share of bond issues as a mode of resource mobilisation compared with IPOs, FPOs and rights issues grew rapidly from 0% in 2008 to 73.5% in 2012, according to SEBI’s 2011-12 Annual Report. But observers say MCX-SX’s room for manoeuvre is constrained, for example the products that can be traded are very limited; partly because of regulation, and partly because of investor appetite. While market participants have an appetite for a developed debt market, it may offer limited beneﬁts to MCX-SX, at least in the near term. Mittal says, “There is some debt trading, in NSE, but it’s nowhere what you’d see in other exchanges; you really don’t see that here.” “On the debt side we don’t have too much proﬁtable business available, because the margins that investors make on debt are very low. And that’s why they can’t share too much with the brokers,” said Sharma. “If an investor doesn’t get much, and a broker doesn’t get much, the exchange also doesn’t get much. For all the exchanges, debt is almost a zerorevenue business.” “India is still primarily viewed as a private equity, or a public equity destination,” said Tyagi. “Corporate debt markets are still quite underdeveloped. The objective is to only attract longterm investors; so we put considerable hurdles up for short-term trading and exiting. However, long-term investors need to exit easily if required. So relaxing trading rules would paradoxically help attract long-term investors. Also, the Inﬂation Protected Bonds announced in the budget will be a welcome product for people who worry about continued high inﬂation.” Add the stellar track records of backers MCX and Financial Technologies to the equation of India’s growth trajectory, potential product innovation, latent retail investors, and liquidity incentives, there is a huge amount of potential for MCX-SX, which could make its humble beginnings to look less like a portend of failure, and more like a bout of teething troubles. But it certainly will not have an easy path to success.
1,000; November 3, 1999
100; 1 April 1979
10,000; March 31, 2010
free float market capitalisation weighted index
free float market capitalisation weighted index
free float market capitalisation weighted index
Oil and gas
Sector weighting (%)
INDEX COMPONENTS ACC Ambuja Cements Asian Paints Axis Bank Bajaj Auto Bank of Baroda Bharat Heavy Electricals Bharat Petroleum Corporation Bharti Airtel Cairn India Cipla Coal India DLF Dr. Reddyâ€™s Laboratories GAIL Grasim Industries HCL Technologies HDFC Bank Hero MotoCorp Hindalco Industries Hindustan Unilever Housing Development Finance Corporation ITC ICICI Bank Infosys Infrastructure Development Finance Co. Jaiprakash Associates Jindal Steel & Power Kotak Mahindra Bank Larsen & Toubro Lupin Mahindra & Mahindra Maruti Suzuki India NTPC Oil & Natural Gas Corporation Power Grid Corporation of India Punjab National Bank Ranbaxy Laboratories Reliance Industries Reliance Infrastructure Sesa Goa Siemens State Bank of India Sun Pharmaceutical Industries Tata Consultancy Services Tata Motors Tata Power Tata Steel UltraTech Cement Wipro
Bajaj Auto Bharat Heavy Electricals Bharti Airtel Cipla Coal India DLF GAIL HDFC Bank Hero Motocorp Hindalco Industries Hindustan Unilever Housing Development Finance Corporation ICICI Bank Infosys ITC Jindal Steel & Power Larsen & Toubro Mahindra & Mahindra Maruti Suzuki NTPC Oil and Natural Gas Corporation Reliance Industries State Bank Of India Sterlite Industries Sun Pharmaceutical Tata Consultancy Services Tata Motors Tata Power Tata Steel Wipro
ACC Ambuja Cements Asian Paints Bajaj Auto Ltd. Bharat Petroleum Bharti Airtel BHEL Cairn India Cipla Coal India Dr. Reddyâ€™s Laboratories Gail HCL Technologies HDFC Bank HDFC Hero Motocorp Hindalco Industries Hindustan Unilever ICICI Bank Infosys ITC Jaiprakash Associates Jindal Steel & Power Larsen & Toubro Lupin Mahindra & Mahindra Maruti Suzuki India Ntpc Oil and Natural Gas Corporation Power Grid Reliance Industries Sun Pharmaceuticals Tata Consultancy Services Tata Motors Tata Power Tata Steel Titan Industries United Spirits Wipro Zee Entertainment
FX Trading in India
ndian exchanges will not beneﬁt from the growing volumes of spot and derivatives trading in the rupee, if restrictive rules are not changed, according to market commentators. The Indian rupee has increased in importance in the global foreign currency markets over the past decade. According to the BIS (Bank of International Settlement)’s 2010 Triennial Central Bank Survey, the rupee grew from less than 0.2% of the world forex turnover in 1998 to about 0.9% of the world forex turnover in April 2010. The survey estimates the aggregate daily INR market, off-shore and on-shore included, at about USD 37.3 billion. It ranks the rupee as the 15th most traded currency in the world and among the top few emerging market currencies along with the Russian Rouble and the Chinese Remnimbi. But trading is not restricted to Indian markets. The Intercontinental Exchange (ICE), the second-largest US exchange company by market capitalisation, announced plans of launching a new cash-settled currency futures contract based on the Indian rupee/US dollar exchange rate from 22 January 2013. This
announcement was soon followed by the CME Group, the world’s largest currency futures franchise, announcing plans to list futures contracts on the rupee, from 28 January2013. “With the rapid rise in growth economies like India, there has been an increase in demand for ﬂexible, capital-efﬁcient tools that market participants can access to participate in and act on emerging opportunities,” said Derek Sammann, senior managing director, Interest Rates and FX Products at the CME Group, in a press statement. The addition of the Indian rupee futures contracts recognises the signiﬁcant and increasing commercial importance of the country, said ICE Futures US vice president Ray McKenzie in a press release. He added, “In particular, interest in emerging market nondeliverable forward currencies from a range of market participants, including Commodity Trading Advisors (CTAs) and funds, has been growing in recent years.” Anindya Banerjee, analyst at the currency derivatives research desk at Kotak Securities states that interest in Indian rupee futures in
the offshore market is bound to increase further especially given the Indian rupee volatility. “Media reports have indicated that offshore markets have seen an increase in activity, including Singapore which has had a very active over-the-counter (OTC) USD-INR nondeliverable forward (NDF) market for some time. The Dubai Gold and Commodities Exchange (DGCX), which is an international exchange to trade rupee contracts, has also seen high volumes.” In the DGCX, which commenced trading in Indian rupee futures in 2007, the Indian rupee futures dominated currency trading in 2012, registering a growth of 171% from the previous year to reach 8.6 million contracts. The growth in the offshore rupee market, warn some experts, might impact domestic volumes. While foreign ﬁnancial institutions that are currently not allowed to invest in the Indian OTC and exchange-traded markets, are expected to move to the US exchanges, even large Indian companies, it is suggested, might opt for these overseas exchanges to hedge their currency risks while beneﬁting from lower taxes and transaction charges.
“...the Indian foreign exchange market will continue to grow in the months and years to come as the regulators allow the banks and their customers to adopt global best practices.” - Jonathan Woodward, head of FXall Asia-Pacific
Noted economist, Ajay Shah of India’s National Institute for Public Finance and Policy (NIPFP), observes in his blog that while there has been nearly 24 times growth in the last twelve years, domestic policy mistakes could lead to a decline of the onshore market. A few issues he highlights are capital controls preventing foreign investors from participating on the onshore market and the decision by the Competition Commission of India (CCI) to intervene towards the middle of 2011 to force the National Stock Exchange (NSE) to charge transaction fees for currency derivatives trading. NSE had launched currency derivatives trading in August 2008, charging no fees to investors. MCX Stock Exchange (MCX-SX), which launched later, too was forced to charge zero fees and had complained to the CCI which had found NSE guilty of following an unfair pricing policy and abusing its dominant market position in currency futures. Following CCI’s order, both NSE and MCX-SX have been charging a transaction fees. Aakriti Mathur, consultant at NIPFP states that the launch of rupee futures on ICE and CME will
have a negative impact on Indian exchanges as long as it is harder to do business within India, “With innovative products, no barriers to entry for participants, more efﬁcient systems of taxation and lower transaction costs, these exchanges are going to be formidable competitors. If reforms are not undertaken in the onshore market, then we will rapidly lose business from the onshore market, for example, from large domestic ﬁrms.” Banerjee of Kotak Securities however believes that onshore markets will not be negatively impacted. “The initial administrative and operational costs for trading in CME and ICE will be quite high for Indian entities. Maybe volumes from DGCX might move to CME but I do not see onshore trade moving offshore. Both onshore and offshore volumes will continue growing.” Currency derivatives volumes in India have been growing steadily and are estimated to be around US$8 billion. This includes both futures and options with the former accounting for more than 90% of derivatives trading volumes. There are four currency pairs – INR/USD, INR/JPY,
INR/EUR and INR/GBP. The maximum growth is in the INR-USD segment. These instruments are traded on the NSE, MCX-SX and United Stock Exchange (USE). The USE has only around a 5% market share, while the rest of the market is nearly equally divided between NSE and MCX-SX. The current size of the onshore OTC market is estimated to be around US$ 35billion. Industry experts state that the growth of the OTC market has been impacted by onerous restrictions placed by the Reserve Bank of India (RBI). Banerjee of Kotak Securities explains, “After the 2008 crisis, regulators started focusing on risk management in the OTC market. Hence a lot of volumes shifted to exchanges.” In December 2011, the RBI announced a series of measures to moderate the excessively volatile conditions present in the foreign exchange market which had led to a sharp depreciation of the rupee against the dollar. Banks were prevented from re-booking forward contracts after cancelling them, so they cut their net open positions that they could not carry over and were left with much smaller ‘open position’ limits, while corporates could not dynamically hedge and this led to volume reduction, explains Agam Gupta, managing director in the FX and rates division at Standard Chartered, India. “The market became more illiquid and choppy,” he says. “Currency futures volumes in the meanwhile have gone up. Here, corporates can trade up to a limit without underlying documents. Exchanges have become avenues for corporates to express their position freely unlike in the OTC market where regulations are very strong.” These restrictions may not be here to stay; Gupta states that the market is becoming more stable – underlying capital ﬂows have increased and the sentiment towards the INR has stabilised, which both help. Others are equally optimistic about the future. Jonathan Woodward, head of AsiaPaciﬁc of electronic trading platform FXall which has been operating in India since 2006, observes that the Indian forex market is well developed as compared to other emerging markets. “We have seen a tremendous evolution of forex trading in India recently and believe that the Indian foreign exchange market will continue to grow in the months and years to come as the regulators allow the banks and their customers to adopt global best practices,” he says.
Eastern brokers look west As Asia’s capital markets mature, local clients’ interest in mature markets overseas is growing. Brokers must tread carefully to avoid the mistakes of the past writes Roger Aitken.
Teyu Che Chern
CEO Phillip Futures Pte Ltd
managing director, Guosen Securities HK
managing director Trading Technologies Asia
he US recovery and Europe’s ongoing crisis each offer opportunities for investors with the right strategy, and Asian brokers are cognisant of the potential that western markets hold. “Asian-based brokers see the penetration to the West as a ﬁnal challenge to overcome and a sort of a pinnacle of achievement,” says Roger Chiman, managing director, head of institutional business at Guosen Securities HK, a whollyowned subsidiary of Chinese ﬁnancial services ﬁrm Guosen Securities. “Their motivations are grounded upon a degree of respect they have for the more mature markets. And, they know full well that that their successful penetration will mean their eventual graduation onto the world stage.” Nevertheless, many Asian brokers today are relatively small compared to the Japanese brokers who had nearly a generation head start over their Asian counterparts. As such the next wave of expansion – if and when it does come – will likely be very different to the last. Indeed, Japanese forays into the US and Europe across the last 30 years may serve as a warning to any would be new Asian entrants. In the 1980s -90s fabulous prices were paid to acquire supposedly gilt-edged assets including a number of investment ﬁrms and even part of the Rockerfeller Plaza in New York. While
sellers did well some Japanese buyers suffered massive losses. More recently Japanese broker Nomura saw rocketing growth through the acquisition of agency broker Instinet in February 2007 and Lehman Brothers’ non-European operations in 2008, however its timing was terrible. The global ﬁnancial crisis saw trading volumes decline, impacting revenues and making maintenance of the two businesses, which were reliant on order ﬂow, untenable. Chiman says, “I suspect that having seen the dismal results of those that have gone before them, Asian brokers will tend to take a more conservative and piecemeal approach towards entering the Western markets. Some will undertake it through mid-sized acquisitions whilst others will do it organically.”
“Asian-based brokers see the penetration to the West as a final challenge to overcome and a sort of a pinnacle of achievement.” - Roger Chiman, managing director,
Grasping the green shoots Not every ﬁrm has seen such volatility. Another Japanese ﬁrm with longstanding operations in the US and Europe, Daiwa Securities, has seen a small contraction of its operations in the west over recent years in the face of the global downturn, while expanding in the east to take advantage of improving economic conditions in Asia and Japan. In Europe, focussing on core business areas, such as M&A advisory, has delivered proﬁtable results for the last
Guosen Securities HK
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three quarters. The ﬁrm has around 200 M&A bankers across the continent following 2009’s acquisition of Close Brothers Corporate Finance, who are increasingly seeing interest from small- and medium-sized Asian ﬁrms looking at very targeted deals in the west. The economic recovery in the US holds an entirely different set of opportunities. On 14 January 2013 Phillip Futures, the Chicagobased full-service futures clearing entity of Singapore’s Phillip Capital, and Trading Technologies (TT), a global provider of derivatives trading software and solutions, announced a deal building on the parent ﬁrms’ existing Asia-centric distribution agreement and coinciding with the launch of Phillip Futures’ US-based trading network. It offers co-location access to CME Group’s (CME) data centre in Aurora, Illinois. TT’s platform has integrated with Phillip Futures’ back-ofﬁce and proprietary third-party applications. The ﬁrm is also in the middle of a registration process to trade retail foreign exchange product. Phillip, one of the largest futures brokers in Singapore with more than US$18 billion in global assets under management, expanded TT’s X_TRADER platform to a growing US customer base, while offering Asia-based customers the ability to trade futures products in the US. The network offers the ﬁrms’ mutual customers low-latency access to TT-supported markets traded through the CME Globex platform including interest rate, equity index, FX, metals and energy products. Teyu Che Chern, CEO of Phillip Futures Pte Ltd. commenting says: “We do see growth in US markets and compared to 2008 we’ve see tremendous growth of our business going into the US side at between 100%-200%”. The ﬁrm, which was recently ranked in the top 50 (34th) amongst other CME member ﬁrms has seen customer segregated funds approach a ﬁgure on that close to US$200m. Che Chern commenting on the future says: “We are still optimistic. As Asia further opens its doors, there will be more new customers trading into the US markets.”
The start of something big Robbie McDonnell, managing director for Trading Technologies in Asia Paciﬁc, reﬂecting on the Phillip deal, says, “It’s a very distinctive move and I don’t think it will be the last such foray into the US or Europe. And, I deﬁnitely see this as the beginning of a trend. I’m aware of a number of Asian banks with strong balance sheets
“...as the Asia market opens up there will be more new customers trading into the US markets.” - Teyu C he C hern, C EO of Phillip Futures Pte
wanting to expand from their traditional areas/ regions into the US and European markets. They deﬁnitely have an appetite given that the nature of trading is now entirely global.” According to McDonnell, TT is currently in discussions with “some of the biggest banks in Asia looking to expand their operations and to take exchange memberships.” McDonnell cautions however that the bigger deals are “unlikely to happen overnight.” It is not only historical lessons that will lead Asian ﬁrms to act with caution. Chiman observes that “signiﬁcant barriers” to entry exist that include differing cultures, politics, legal and organisational issues. “First and foremost, Asian brokers need to ascertain who is it they wish to become as they gradually enter into the global arena,” he says. “Do they hold on to their national culture, which has provided them with signiﬁcant advantages, or do they relinquish it to embrace a more multicultural organisation as a prelude to their engaging in foreign markets?” For ﬁrms that have a clear sense of direction and growth strategy, technology is making the expansion of operations relatively simple. Asian institutions going down an expansionary route can exploit ‘Points-of-Presence’ (POPs) in the ground in overseas territories or opt to be colocated in data centres where an exchange’s matching engine resides. They will also start to build their own branding in the US and Europe and get all their risk management controls tested and in place before commencing trading business. McDonnell adds, “Some of our customers and particularly the bigger Singaporean banks
are in the process of getting memberships of the larger exchanges – CME included. Many of them are already members of LIFFE and Eurex. And, Australian banks too with strong balance sheets are making moves into what they see are potential weakening within the futures commission merchant (FCM) and the clearing space in the US and Europe.” Part of the draw will be the ability for ﬁrms to exploit alpha opportunities between locally traded derivatives products and those traded outside of Asia. Che Chern notes, “Those [exchanges] that offer an arbitrage opportunity between similar Asian products and those tradable on western markets will see increasing activity. As long as there is a value proposition, clients and traders will take the plunge and switch to similar products on different exchanges.” Take COMEX gold contracts versus many of the gold contracts offered on Asian exchanges. “There’s a natural arbitrage between the two. Perhaps traders are using COMEX prices as indicative prices or for market making on the Asia side,” he adds. “Customers could be trying to arbitrage between some of the Asian markets such as MCEX. As some Asian contracts like gold, copper and energy are similar to those in the US, customers may want to hedge out their exposure into the US markets where there are similar products like gold, copper and energy.” Whilst previously the copper market used to be dominated by LME copper he says “increasingly there is a signiﬁcant shift from traders migrating to COMEX copper instead of hedging into LME copper.” Having been in Singapore since 1975, Phillip is positioning itself as a “gateway” for clients who want to access the Asian region. “Equally we want to be a gateway for Asian investors seeking to tap overseas markets and it is a platform strategy to meet the needs of the new Asian customers. With a local presence in most of Asian countries we aim to add value for those who want indepth knowledge.” The gates to the west are open for Asian ﬁrms wishing to expand; however economic uncertainty and a wealth of experience mean that new paths should be trodden carefully. Chiman says, “This is an eventual trend that will accelerate, although the Chinese investment banks will need to build up their competencies on this front ﬁrst before expanding beyond their traditional comfort zones.”
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National Stock Exchange of India
US Dollar/Indian Rupee
Shanghai Futures Exchange
US Dollar/ Indian Rupee
Zhengzhou Commodity Exchange
Dalian Commodity Exchange
Dalian Commodity Exchange
Zhengzhou Commodity Exchange
Pure Terephthalic Acid (PTA)
Zhengzhou Commodity Exchange
Dalian Commodity Exchange
Dalian Commodity Exchange
Dalian Commodity Exchange
Linear Low Density Polyethylene (LLDPE)
Shanghai Futures Exchange
Shanghai Futures Exchange
Multi Commodity Exchange
Australian Securities Exchange
3 Year Treasury Bond
Multi Commodity Exchange
Multi Commodity Exchange
Shanghai Futures Exchange
Zhengzhou Commodity Exchange
Cotton No. 1
United Stock Exchange
US Dollar/ Indian Rupee
Australian Securities Exchange
90 Day Bank Bills
Shanghai Futures Exchange
Multi Commodity Exchange
Multi Commodity Exchange
Multi Commodity Exchange
Tokyo Financial Exchange
Euro/ Japanese Yen
Dalian Commodity Exchange
No. 1 Soybeans
Tokyo Financial Exchange
US Dollar/ Japanese Yen
Australian Securities Exchange
10 Year Bond
Dalian Commodity Exchange
Multi Commodity Exchange
Dalian Commodity Exchange
Hard Coking Coal
Multi Commodity Exchange
Tokyo Commodity Exchange
Tokyo Financial Exchange
Australian Dollar/ Japanese Yen
Multi Commodity Exchange
Multi Commodity Exchange
Tokyo Stock Exchange
10 Year JGB
Multi Commodity Exchange
Zhengzhou Commodity Exchange
Multi Commodity Exchange
Crude Plam Oil
Zhengzhou Commodity Exchange
Strong Gluten Wheat
Shanghai Futures Exchange
Shanghai Futures Exchange
Dalian Commodity Exchange
Polyvinyl Chloride (PVC)
Zhengzhou Commodity Exchange
National Commodity & Derivatives Exchange
Ref Soya Oil
Zhengzhou Commodity Exchange
Source: Exchange Websites
TOP 50 Futures Contracts by Volume in Asia for Q1 2013
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Osaka Securities Exchange China Financial Futures Exchange National Stock Exchange India Korea Exchange Singapore Exchange Osaka Securities Exchange Singapore Exchange Tokyo Stock Exchange TAIFEX Hong Kong Exchanges Hong Kong Exchanges Singapore Exchange Singapore Exchange TAIFEX Australian Exchange Thailand Futures Exchange Bursa Malaysia
Q1 2013 Vol
Q1 2012 Vol
Nikkei 225 mini CSI300 S&P Nifty KOSPI 200 Nikkei 225 Nikkei 225 FTSE China A50 TOPIX TAIEX HSI HHI MSCI Taiwan SGX CNX Nifty mini-TAIEX SPI 200 SET 50 KLCI
55,572,590 45,108,953 14,450,372 12,924,531 10,344,036 7,369,366 5,730,185 5 196 028 4,957,917 4,871,620 4,549,577 4,152,412 3,696,200 2,950,999 2,691,873 1,251,724 606,097
31,190,649 20 477 024 24 978 605 15 629 281
24,381,941 24,631,929 -10,528,233 -2,704,750
4 869 035
2 212 224
2 546 060 907,770 510 630
145,813 343,954 95,467
Top 5 Gainers Exchange
Zhengzhou Commodity Exchange Shanghai Futures Exchange Dalian Commodity Exchange Dalian Commodity Exchange National Stock Exchange of India
Flat Glass Steel Rebar Soy Meal Coke US Dollar/Indian Rupee
133,514,406 127,611,078 97,077,860 54,562,478 47,060,812
Top 5 Agriculture Futures Exchange
Dalian Commodity Exchange Dalian Commodity Exchange Dalian Commodity Exchange Dalian Commodity Exchange Dalian Commodity Exchange
Soy Meal Palm Oil Soy Oil No. 1 Soybeans Corn
129,822,100 36,350,396 34,450,640 5,667,566 5,117,900
Top 5 Commodity Futures Exchange
Zhengzhou Commodity Exchange Dalian Commodity Exchange Zhengzhou Commodity Exchange Zhengzhou Commodity Exchange Dalian Commodity Exchange
Flat Glass Coke Pure Terephthalic Acid (PTA) White Sugar Linear Low Density Polyethylene (LLDPE)
133,514,406 54,802,014 46,138,102 43,885,802 33,331,672
Top 5 Currency Futures Exchange
National Stock Exchange of India MCX-SX Korea Exchange United Stock Exchange Tokyo Financial Exchange
US Dollar/Indian Rupee US Dollar/ Indian Rupee US Dollar US Dollar/ Indian Rupee Euro/ Japanese Yen
185,477,685 139,150,948 13,250,538 8,065,989 5,704,755
Top 5 Metal Futures Exchange
Shanghai Futures Exchange Shanghai Futures Exchange Multi Commodity Exchange Shanghai Futures Exchange Shanghai Futures Exchange
Steel Rebar Copper Silver Micro Silver Zinc Futures
160,053,902 16,607,514 9,698,579 8,799,134 6,879,966
Source: Exchange Websites
Stock Index Futures
What market is on your radar for 2013?
dentifying trends and trying to stay ahead of them are typical of any competitive business. While there are hundreds or even thousands of trends that could be indentiﬁed in Asia’s electronic trading industry we wanted to see what market in developing APAC people were focusing on for 2013. We had expected China (21.43%) to rank ﬁrst but instead was second to India with 28.57% of the votes. Perhaps some realise that accessing the number two economy continues to be difﬁcult or that prospects have waned over the past year or so. Either way India and China at the top of the list weren’t much of a surprise and continue to be the focus for many industry participants. Where our opinion poll becomes interesting are the remaining selections. Surprisingly, the Philippines ranked third with 19.05% of votes.
There seems to be genuine interest of late in this market though still quite small trading just US$250 million per day. The Philippine Stock Exchange has made some investments in technology and is part of the ASEAN bloc. Next came Thailand another ASEAN member with 16.67% indicating this was a country of interest for electronic trading. The SET Group has recently upgraded its matching engine and post trade apparatus and was the third member of the ASEAN Trading Link. There has been a push for algorithmic trading and derivatives at the exchange over the last two years and it would seem people are keen to access this market. Notional traded on the cash segment has more than doubled year on year. Indonesia at 11.90% we thought was a bit low given that it is a sleeping giant in terms of demographics and the continued economic
growth over the last decade. Some of the international sell sides have set up businesses recently even offering block crossing and the usual algorithms found in developed Asia. The exchange still has a fair way to go in terms of technology however and notional traded while up 25% is just US$500 million per day. Big up side here. Lastly Malaysia came in at 2.38%. We were surprised by this low showing as Malaysia is pushing access through derivatives trading with Globex and investing in technology too. They were one of the founding members of the ASEAN Trading Link as well and have seen a spate of IPOs making this market a hot spot for capital raising. At the end of the day it would seem 50% are looking at China and India and 50% are focused on ASEAN in developing Asia.
Visit: http://www.AsiaEtrading.com/opinion-polls/ Vote on the latest Opinion Poll
Collateral Management – The New Normal in Asia With the profound changes the global financial crisis has brought to the trading industry, collateral management has moved from a support function to a fundamental business activity.
his article is based on a webcast hosted by AsiaEtrading.com that examined collateral management, which has been the subject of much scrutiny and debate in the wake of the ﬁnancial crisis. Security valuation, and the quality of pledged assets between counterparties and risk management have become increasingly important, and the interconnectedness of participants, and ease of capital movement in a world of sophisticated product engineering make this a timely topic for discussion.
New Regulations Changing Business Practice The discussion opened with a poll that asked audience members about the key collateral management challenges they have faced since Lehman. Sixty-seven percent answered regulation, which was followed by technology at 14%, and quality of collateral and bank guarantees at 10% each. Increased regulation has prompted ﬁrms to look at new ways of doing business. “In particular the regulatory response to the global ﬁnancial crisis in the form of the Dodd–Frank Wall Street Reform and Consumer Protection Act in the US and EMIR in Europe, and equivalent regulation,”
says Ted Allen, VP Collateral Management at Sungard. Recent developments Allen cites include jurisdictions moving towards the central clearing of OTC derivatives, which is having an impact on operational processes and cost of doing business. For example, collateral calls made at the product level currency reduce the scope for netting, and dealing with multiple exchanges and multiple currencies bifurcates risk. “There is a change in the business model and a much greater demand for ﬁnancial requirements,” says Allen. “Not only that, but you’ve got the latest proposals for the collateralization of non-cleared transactions, which would impose similar margins as the cleared side.” Because of growing streams of regulation, institutions are changing the way they are organized, says Allen. Regulation also tops the list for Kishore Ramakrishnan, Director Financial Services Advisory at Ernst & Young. He points to the margin requirements being imposed on bilateral transactions in the push towards central clearing. “You are going to have to face more margin calls in the Dodd-Frank era,” he says. “So call volumes are going to increase. And then you’ll also have to worry about real-time connectivity to the
clearing facility. From an operations perspective, the impact is felt very severely in terms of client documentation. How will you establish different reporting requirements as part of the collateral? How will you classify your clients? What additional documentation is required to facilitate the transfer of margin?” Further challenges Ramakrishnan cites include determining membership of the counterparty consolidated group for the purpose of margin rules, and assessing counterparty credit risk subject to different collateral requirements. Then there is a raft of implications for technology, staff and skills. For example, to facilitate portfolio visibility across divisions and asset classes, infrastructure is needed to enable a centralized view. “It’s clearly time for the industry to move from a silo-based approach to centralized collateral optimization,” says Ramakrishnan. “There is going to be Frank-prompted integration, where collateral management is no longer a back ofﬁce function; it’s obviously moving into the front ofﬁce.” For Kevin King, former EVP Head Risk Management Division HKEx, a major theme is the confusion that different standards produce. “You have conﬂicting issues that tie in through liquidity management, collateral management, segregation, and portability; and that all ties back into implications for collateral management,” he says. Systems need to be in place, not only for risk management, and to assess implied collateral requirements, says King, but for operational issues of assessing where collateral is and what form it takes, and whether it meets the standards of the different parties around the world. Moreover, market participants are looking at how collateral is being pledged operationally, and how quickly it can be moved. “It used to be silo in terms of product, and you dealt with your isolated collateral management within your ﬁrm,” he says. “Now you’re dealing with reporting transactions, you have to move beyond the silo approach.” And that involves coordinating between trading desks operationally, and treasury planning, which provides added support.
Approaches to Collateral Management Having established the regulatory backdrop to changes in collateral management, panelists turned to the effective strategies being deployed in collateral management processes and operations. Market participants need to look at what impacts changing requirements for collateral management will have on different aspects of the trade value chain, says Ramakrishnan. Important considerations are building a client classiﬁcation process, technological solutions ensuring proper feeds and data monitoring, and also client documentation, and moving to trade execution, making sure collateral feeds meet new regulations. “Here it gets tricky as depending on which regulator you face off, the requirements vary,” says Ramakrishnan. “For example, the requirements from Basel, IOSCO, and CFTC are different. Is there a one-way, or two-way margin requirement? If you look at Basel or IOSCO, both parties must post margin to each other; that’s essentially bilateral in nature. But if you look at CFTC’s proposal, it talks about a unilateral approach. Continuing through the settlement cycle, how will you support settlement of collateral to comply with the new or existing regulations? And how will you support your real time settlement reporting to multiple business lines, to multiple regulators, and multiple counterparties.” The reengineering of the whole trading process is a complex undertaking that market participants are tackling at various speeds. “The banks that are making the most of these regulatory changes are those that take a holistic view of operational processes across all of the business line,” says Allen. “Their clients are demanding statements showing single collateral calls, or single collateral statements, and exposure statements across listed products, across cleared OTC, bilateral OTC, and securities lending, and what other business lines they have. Clients want to see a single consolidated statement and to see how the collateral can be allocated to them. “Another strategy is providing other valueadded services, such as collateral optimization. So this means taking a look at the regulations and the portfolio of assets they can use and working out how best to allocate those assets in the most efﬁcient way.”
Automating the Post-trade Process Given the complexity of these changes, how important is it to automate the posttrade process? Leveraging existing assets and existing capabilities in the listed and bilateral area, and applying that to the new cleared-OTC area, is
one of the strategies Allen identiﬁes. He points to the expected increase in centrally cleared collateral calls as an area that requires technological investment. Secondly, there’s the liquidity side, especially the problem of managing the liquidity impact of increased requirements. Institutions are investing in the process of determining future exposures, and future initial margin requirements. Approaches vary between stock collateral and cash collateral, says Ramakrishnan, because CCPs handle them differently. “If you look at US CCPs vs European CCPs, in the US there’s a general tendency to accept collateral on an asset class basis vs. European CCPs, which try to manage this on a security by security basis identiﬁed on, for example, a CUSIP level,” he says. “There’s a tendency to apply for a different haircut. So it depends what kind of stock or instrument you are using to post collateral to the CCPs.” Ramakrishnan identiﬁes several technological issues when using cash collateral, including maintenance of cash accounts, calculation of interest on cash collateral, and opportunity cost, and default management, which would involve liquidating collateral.
The Liquidity Problem Liquidity is a pressing consideration, particularly for some illiquid OTC products. Before 2004, CPSS IOSCO industry standards didn’t include a speciﬁc category for liquidity risk, or for collateral management, says King. The increase of such standards establishes new CCP-applied criteria, but counterparties are at the same trying to understand what is expected from them. In terms of haircuts, a generic category for a broad range of securities is complicated by standards that require vigilance against stressed market conditions, says King, and avoidance of reciprocal risk when setting haircuts. Efﬁcient CCP management of what haircuts are is advantageous to the market. But CCPs would need to monitor every underlying security on an intra-day basis. Other challenges King highlights include concentration risk, and legal issues with respect to cross-border collateralization, as most OTC clearing deals with global counterparties that want to be able to pledge a broader range of collateral, and the effects of tighter collateral controls. Though there’s some latitude under Basel and EMIR, he says, setting stricter collateral controls means there’s less available collateral, which would price it out and reduce the amount of trading. King points to a report by the Bank of New York, which highlighted several consequences of stricter collateral controls. For example, if
cash or government securities are required as collateral, sovereign debt downgrades limit the amount of available securities for collateral. He also points to increasingly conservative margining standards and growing CCP default funds, that are increasing on the back of stricter stress testing, particularly under EMIR and ESMA.
Technical Innovation Turning to the technology and tools available to tackle the challenges of collateral management, we asked the webcast audience members to characterize the technology they employ in the collateral management process. Thirtyeight percent said they use old technology that needs upgrading, 23% said their technology is quite good but organized in silo-type structures, and another 23% said they connect to all parties in real time. The top three changes in how ﬁrms are investing in technology, says Allen, are in support of central OTC clearing, support of the initial margin demands that go along with that, and support of collateral optimization. Technology can help in dealing with the increased complexity, and volumes of collateral, says Allen. The aim is a single platform, or as few platforms as possible, that supports the whole collateral management process through facilitating the calculation and management of the call process, and management of collateral assets and inventory of available assets, all across multiple business lines. Secondly, technology can support collateral optimization. For example, a sophisticated algorithm can look at a client’s requirements all in one go, understand the different haircut rules, the different eligibility rules, the concentration rules, and so forth, and allocate collateral across all of those agreements, and do it in the most efﬁcient manner, says Allen. Moreover, technology can enable the constant rebalancing of the collateral portfolio. “There is an increased appetite to move from the current architecture to one that focuses on centralized collateral management,” says Ramakrishnan. And that involves higher STP rates. Whereas OTC desks, repo, stock lending and FX, sell by separate applications, in the future there will be a centralized view across products and multiple business lines. To conclude the discussion, we asked webcast audience members to characterize how much visibility they have into their ﬁrm’s capital adequacy. Fifty-ﬁve percent responded “next business day,” 27% responded “batch processing intra-day,” 9% responded “end of day,” and another 9% responded “real time across the entire ﬁrm.”
Capitalizing on Compliance In the wake of the Global Financial Crisis, the challenge posed by compliance has never been greater. The accelerating pace of regulatory reform, proliferation of technology and cross-border nature of Asia trading combine to make implementing best practices – and adhering to them – exceedingly difficult, while country specific requirements only add to the compliance burden.
his article is based on a webinar hosted by AsiaEtrading.com that focused on the real drivers of compliance in Asia, identiﬁed the key cross-border compliance challenges and highlighted the tools available to alleviate the cost burden of implementing best practices.
Key drivers of compliance Stephen Luk, Director of Investment Compliance at AIA, identiﬁes different factors driving compliance on the sell side and trading side. “From the sell side, particularly the fund and investment management industries, different jurisdictions all have different licensing requirements. Whenever you go to different countries to do cross selling you need to sort out that issue, for example to be accompanied by your colleagues in the local country,” he says. On the trading side, Luk sees central banks and regulators placing increasing emphasis on detecting and punishing ﬁnancial misconduct, employing surveillance with varying degrees of sophistication from country to country. “People are always looking to make money as easily as possible and they don’t always follow the rules when they go about it,” agrees Rex Gooch, VP of Product Strategy at SunGard, the maker of Protegent compliance solutions. “Markets are working hard to make sure they provide a level playing ﬁeld and trying to ﬁnd ways to identify those that aren’t playing by the rules.” Gooch sees technology driving the trend, with automated compliance solutions able to spot abnormal price moves and trading volumes
“Markets are working hard to make sure they provide a level playing field a n d try in g to fin d w a y s to id e n tify th o se that aren’t playing by the rules.”
ahead of price sensitive announcements and ﬂag any unusual patterns – enabling compliance personnel to investigate more deeply and detect possible foul play. “As the technology is becoming more sophisticated a lot of regulators have a higher expectation that ﬁrms will have these types of solutions in place to monitor their traders’ or their clients’ trading behaviors,” he says. International efforts to remove complexity and inject transparency into the post GFC ﬁnancial services industry – through regulations such as Basel III and the Dodd-Frank Act – have made compliance a headline issue. “Liquidity is a very big driver of regulatory compliance,” says Jayaradha Shankar, Steering Committee Member of the Professional Risk
RE G ULATIONS
“Asia is fertile ground for a lot of activities frowned upon by compliance authorities...”
Managers’ International Association. “A lot of Asian banks are worried about having enough liquid assets to meet a potential run on them. The funding markets in Asia are not well developed: we don’t have the debt instruments and a lot of capital is funded by equity.” Shankar identiﬁes capital as another key driver. “Though Asian banks and ﬁnancial institutions are comfortable in terms of capital adequacy, what’s going to happen two or three years down the line when balance sheets grow? Will they still maintain those high levels of capital adequacy?” she says.
Increasing surveillance Whatever trends are driving compliance, the impact is clear: a signiﬁcant rise in surveillance. Gooch puts that down to an increased level of enforcement activity. “Any time you have either emerging markets or maturing regulatory bodies the enforcement activity is going to go up and ﬁrms are going to start investing in technologies. That’s certainly what we’re seeing in Asia,” he says. Education is also a factor. Gooch cites a Capital Markets Cooperative Research Centre article that estimated 26% of price sensitive announcements in Asia Paciﬁc markets in Q1 2012 showed signs of leakage. “It’s interesting that people would think that’s a fair advantage and they can go ahead and trade on that information,” he says. “As education increases, and enforcement increases, those behaviors will change. As that happens ﬁrms will start to invest more in surveillance.” Firms are not only taking up surveillance solutions to auto-detect suspicious trades. A best practices compliance solution can delivery visibility into the complete trading lifecycle. “A lot of ﬁrms, particularly their compliance departments, are looking for tools to give them increased transparency and accessibility to their organizational data,” says Gooch. “What keeps compliance ofﬁcers up at night is the things they don’t know. And the only way to ﬁnd out about those is to have better access to data.” The compliance ofﬁcer’s need-to-know is also expanding into new arenas. “Social media is something that has made a lot of ﬁrms nervous,” says Gooch. “As investment professionals look to leverage social media to expand their sphere of inﬂuence, regulators have cautioned them. There hasn’t been a lot of enforcement but we expect to see that only increase.” Firms are responsible not only for monitoring their representatives’ social media feeds for recommendations that might be prohibited by regulations, but also for viewing and approving anything that might fall under advertising regulations before it is distributed. Compliance software is evolving to keep pace, providing the facility to register employees who want to leverage social media to give ﬁrms oversight – even employing automation to ﬂag posts where keywords are picked up by a lexicon, “similar to how a lot of ﬁrms use email surveillance,” says Gooch.
Trends in wealth management The wealth management business is booming in Asia, with the region becoming home to the largest number of high net worth individuals in 2011. Little wonder that compliance is an end-to-end focus for the industry.
“The time when you build your prospect list: that’s when your compliance starts, when your KYC kicks in,” Shankar says. Due diligence required before on-boarding a client includes identity and location veriﬁcation as well as checking a huge list of sanctions and watch lists that are issued by governments, ﬁnancial market regulators and law enforcement bodies across the globe. “The amount and scope of data that ﬁrms are required to capture has expanded signiﬁcantly over the last ﬁve years,” says Gooch. “We’re seeing lots of regulations that require ﬁrms know more about their customers: what their occupation is, what their investment time horizons are, risk tolerances – things which go beyond simply validating that a person is who they say they are.” Skimping on KYC compliance is not an option. “Asia is fertile ground for a lot of activities frowned upon by compliance authorities,” says Shankar, who chalks that up to peculiar legal conditions in many developing nations, a high number of cash transactions where there are no electronic records, as well as certain social and cultural norms. The increased focus on KYC is leading to more streamlined processes. Firms are becoming more consistent in their approach and revisiting the data more frequently. “In the past a lot of ﬁrms would just do their KYC up front as they onboard their customers, but now we’re seeing ﬁrms check those lists throughout their customer relationship to ensure the ﬁrm understands what kind of risk a customer can potentially bring to them,” says Gooch. Beyond KYC, “sales of tax related products really needs to be focused on because the source of funds – or the source of wealth creation and tax evasion – is gaining a lot of visibility in Asia in keeping with global trends,” says Shankar. Governments are targeting tax avoidance, with public opinion ﬁrmly behind them. “Governments are now actively involving wealth management entities in collecting tax revenue and client information on their behalf. Take FATCA, for example: a regulation associated with collecting tax revenue and client information for Americans who live abroad who have income offshore.”
Real time, real value For many ﬁrms, real time compliance monitoring comes top of the technology wish list, but Gooch has caveats for those looking to deploy it – especially if they deal in high frequency trading, which will be subjected to greater scrutiny because of the volume of potentially market moving transactions. “The question we always go back to ﬁrms with is ‘How do you want to handle that? Are you going to have somebody sitting there the whole time acting on these alerts?’ Because of the sheer volume you could bury a complaints department with things to look at if you’re not careful,” he says. Firms looking to address transaction issues in a real time with human interaction might be better to start with the OMS. “If you can ﬂag issues at the time those trades are entered, then you can address those prior, or you can head off some of your risk before the trades are even placed,” says Gooch. With OMS handling up front low volume trades, an automated system can be employed to deliver post-execution surveillance on high frequency trades. “It’s just a matter of calibrating how alerts are triggered and when they’re ﬂagged so that you’re only looking at the things you need to look at,” says Gooch. Whatever form the solution takes, the one inescapable fact is that compliance comes at a cost. For Luk, it’s money well spent. “Senior management all understand the importance of compliance. Research also shows that an ethical company in time shows a higher return and proﬁtability. So you need to ask what is the cost of non- compliance,” he says. “We can give examples of the big ﬁnes imposed by the regulator, but people understand that a good reputation means good compliance and that means good business. The important thing is that compliance is adding value.”
OPI W HO’S NION W &HO AN A LYSIS
Saruul Ganbaatar Saruul Ganbaatar, is the deputy CEO at the Mongolian Stock Exchange (MSE), one of the new bourses building out in Asia. Though the market capitalisation is very small the country’s law makers are implementing sweeping changes across all aspects of its capital markets. As one of best performing markets not only in Asia but around the world it has been garnering attention. With an abundance of mineral wealth on the doorstep of China, Mongolia’s exchange and nation could be rising stars in the near term. Mr Ganbaatar spoke with Asia Etrader about the Mongolia capital markets, the legal and regulatory change underway, algorithmic trading and their open door policy.
AE: How did you get started in capital markets Saruul Ganbaatar: I’ve always had this inherent interest in capital markets since high school. I was drawn to the action of the trading ﬂoor that you would typically see on television. Fortunately, I was in Chicago and had an opportunity to work at CBOE with various brokerage and proprietary trading ﬁrms who were trading options, gold, metals and energy and that is where I got started. Upon returning to Mongolia I was offered a position at the exchange where it was about to undergo a major transformation and I became the chief regulatory ofﬁcer and then the deputy CEO AE: What is the focus of the MSE, listing new companies or supporting the trading community? SG: We should look at it from both sides as our goal is to develop the Mongolia capital markets overall. Currently, the market capitalisation of our listed securities is just around US$1.6 billion so it’s very small and we do need new listings. Mongolia is known for its mineral wealth but ﬁrst there is a need for exploration, then production and these are activities are supported by investors. We are seeing early stage private equity investors and when they want to exit the market the Mongolia Stock Exchange
“Our goal is to develop the Mongolia capital markets overall.”
(MSE) wants to be there. There are more than 30 Mongolian companies who have gone overseas to raise money and our goal is to bring those companies back to list on the MSE in the form of a dual-listing. At the same time, we want to support trading and that’s one of the reasons why we partnered with the London Stock Exchange (LSE), to bring in their technology rather than reinventing the wheel. AE: How have trading volumes been growing? Why have they been growing? SG: Trading volumes have started growing really from 2011. The Government has done a tremendous job marketing the country to outside investors. And with that, trading volumes have been picking up and many of the companies appear to have been undervalued. For example, our index the MSE Top 20 rose over 134% in 2011
and 82% in 2012. We were the top performing exchange in 2011 and second in 2012. Those numbers speak for themselves. With the new legislation the government is tabling for the development of our capital markets it will allow for more participants to access our market. The legislation for custodian banks will allow for institutional money to come into the country. There are other regulations coming down the pipeline as well for the fund houses and broker dealers. All these forthcoming changes will only support trading on the MSE. AE: What is required to open an account and start trading Mongolia securities? SG: At the moment we have appointed four domestic clearing banks for cash side settlement. Currently, an investor will need to open three types of accounts one with a brokerage ﬁrm, one with a central securities depository (CSD) and one with a clearing bank. However, we are trying to simply the process by introducing a new securities law whereby a fund manager can open an account at the custodian or sub-custodian level. As it stands now it’s a bit complicated and cumbersome but we are pushing to simplify and standardise the process as soon as possible.
OPI NIONWH & AN O’S AWH LYSIS O
limits are breached trading is halted and enters an auction period which may last from two to ﬁve minutes.
“We want to support trading and that’s
AE: How much focus is there on risk and how is the MSE managing it? SG: We ask our brokerage ﬁrms to post collateral and contribute to a settlement guarantee fund in case one party defaults on a trade. The amount ﬁrms contribute is based on trading activity over a three-month period so brokers that do more trading will be required to contribute more. Collateral is based on cash only at this time but as the market evolves we will look at government
one of the reasons why we partnered with the London Stock Exchange.”
AE: What kind of exchange technology is the MSE using? SG: We partnered with the LSE and with that we are using their technology, Millennium IT, which is known for its ultra-low latency. We are using Millennium Exchange as the matching engine, Trader for the broker dealers, CSD and Surveillance that is supported by the LSE. The CSD service provides the risk piece, where trading limits are set based on collateral posted by the brokerage ﬁrms and are marked-tomarket intraday.
“The MSE Top 20 rose over 134% in 2011 and 82% in 2012.”
bonds and bank guarantees. As I mentioned the CSD monitors member risk and we can adjust limits based on the credit proﬁle
AE: Do you see commodity derivatives as an important part of the exchange’s product offering? SG: Currently, we have equities and bonds listed at the exchange and we see derivatives as the next step. But also exchange-traded funds (ETFs) which can be benchmarked from our index. We are working with FTSE to create an internationally recognised index where we can launch ETFs. We are not a Frontier market yet but we hope to be included in the near future, putting us on the radar of a new class of investors. Mongolia as you know is a mineral wealthy country and it deﬁnitely makes sense to launch a commodity exchange trading coal, gold, cashmere or other products which can be standardised and traded on the exchange. AE: How much focus is there on surveillance and how is the MSE managing it? SG: Surveillance is being conducted on a daily basis, with monitoring of trading activities for market manipulation. We also look for insider trading ahead of news, trying to move the market and have implemented both dynamic and static circuit breakers. Static uses previous day close data and dynamic is using tick by tick info. Once the
“We have appointed four domestic clearing banks for cash side settlement.” of the member increasing or decreasing leverage as needed. AE: How has regulating the market changed to support the industry? SG: It has begun to change dramatically. We want an optimum environment for foreign participants to come into the market. In this industry the goal is to have harmonised rules. Overall, when these participants come to the market you don’t want to have any surprises and this has been driving our changes in regulation. In the past, most investors would be surprised how different Mongolia regulations are versus other developed markets. With that in mind we brought in outside counsel to come up with best
W HO’S W HO
practices. From these recommendations Mongolian securities market laws have been completely overhauled. For example, for listings both the regulator and the exchange are given a time limit to review and approve or decline a company’s prospectus. It forces these parties to act diligently and in a timely manner. Also, we have increased the requirements of market participants; obligations for underwriting ﬁrms, broker-dealers, advisory and credit rating companies. Custodian banking never existed before; it is still a very new concept in Mongolia and also falls within our new securities overhaul. Though the law has yet to pass, global custodians are already speaking with local banks regarding custody business. In the foreseeable future ﬁrms can start settling not only local transactions but also cross-border transactions through the sub-custodian channel. We need to make sure that our market is served by qualiﬁed people who can manage the change and support the industry too. Our market used to require that you pre-funded your account before your trade, allowing for same day settlement T+0 but in order to bring in foreign participants we decide to shift to a T+3 model to allow them some time to channel assets through the custodians. We
broker’s server or directly to the exchange. There are independent software vendors (ISVs) working with the brokerage industry to help support customer trading in Mongolia either web-based, mobile or leased lines.
“We are not a Frontier market yet but we
AE: Where do to you see China’s role in the development of the MSE? SG: China is by far our largest trading partner but we would like to have as diverse as possible customer base accessing Mongolia from all over the world.
hope to be included in the near future.”
want these custodians to lend and borrow securities and allow market makers into the market supporting liquidity. A lot of changes are coming to Mongolia.
“It definitely makes sense to launch a
AE: How can one access the market from outside Mongolia? SG: With the Millennium IT platform we are in a position to offer remote trading at some point in the future. Trading is still done on the ﬂoor but we are working with the brokerage industry to offer them access from their ofﬁce. We expect these ﬁrms will be trading electronically sometime in April 2013 and should see our exchange trading ﬂoor disappear. The next step is to have broker clients accessing the exchange either via the
commodity exchange trading coal, gold, cashmere or other products.”
AE: Are you developing access from overseas? SG: The Millennium system uses FIX and FAST protocols for exchange messages so as long as your trading application is compatible with these protocols you will
“Brokers that do more trading will be required to contribute more [to the guarantee fund].”
be able to directly access the exchange matching engine. Of course you need to access in Mongolia. We are a long way away from offering data centre access abroad but we hope to achieve this one day. AE: What other aspects of Mongolia capital markets are being addressed? SG: We want transparency in our market. A couple of years ago company’s ﬁnancial statements were not available to the public.
WH O’S WH O
“Mongolian securities market laws have been completely overhauled.” Now we are making those listed companies as transparent as possible reporting to their shareholders as any international exchange would. From our side if an investor wants to come into our market they should have all readily available information like a ﬁnancial statement, material information disclosure, board member changes and information, insider trades. All these kinds of information send a message to potential investors that Mongolia listed companies are transparent and not hiding anything. It lends conﬁdence to the market. Change isn’t just about technology but how we do business. AE: What countries or exchange groups have been courting the MSE? SG: In addition to working with the London Stock Exchange we are very open to forging new partnerships and collaboration with other exchange groups. Our goal is to increase liquidity and entertain dual listing opportunities. We are happy to have conversations that will beneﬁt the Mongolian capital markets. We are open for business. AE: What is your opinion of algorithmic trading and high-frequency trading (HFT)? SG: It’s an interesting topic because the Mongolia Stock Exchange is probably one of the very few exchanges that does not support HFT at the moment. It is probably linked to the borrowing and lending of securities for market-making opportunities for participants or liquidity providers and possibly related to the trading fee structure we have. We are carefully reviewing whether algorithmic trading is beneﬁcial or not and looking at the pros and cons associated with HFT. We have the advantage of seeing the impact on other markets as to whether it is positive or not. It deﬁnitely creates more trading activity and opportunities and less pricing discrepancy as there are lots of liquidity providers out there, resulting in funds being able to trade large quantities without much market impact. We are deﬁnitely examining this type of trading and
“We want these custodians to lend and borrow securities and allow market makers into the market supporting liquidity.” if we believe it to be beneﬁcial to the market we will welcome it. We want markets to be efﬁcient and scalable and we certainly have the technology for it. AE: Any last words? SG: Our market is deﬁnitely changing and we want to create a market where anyone can step in and start trading. We are one of the smallest exchanges in the world but we are positioning ourselves to make a huge leap forward. Hopefully in ﬁve years time we can look back at what we have achieved and serve as a role model for other exchange groups.
Playing Aussie pools Dark pools are supposed to be dark, but not impenetrable; Australia is bringing some clarity to off-market trading, says Dan Barnes.
ver-the-counter (OTC) trading venues in Australia have been put on notice for harming market integrity by market regulator, the Australian Securities and Investments Commission (ASIC). A report it published on 18 March 2013 found that the total proportion of Australian trading taking place without pre-trade transparency has consistently been around 25-30% of total volume for several years; however the make-up of liquidity and the mechanisms which support it have changed. Noting that reported trading on crossing systems increased from 2.6% of total market turnover in Q3 2011 to 4% in the Q3 2012, ASIC poured water over the ﬁgures’ reliability stating that they “understate the volume of trading that is occurring on crossing systems… because the total volume of below block size dark trading is 14%, and it is unlikely that manual trading accounts for more than twice the volume of automated trading.” Any ﬁrm running a crossing system has to report the model a crossing system uses as it with ASIC before it launches. The report has to include details of how ﬁrms can get eligibility to access the system; whether it transmits orders to other crossing systems, and how transactions are executed. Any changes to the initial report have to be included in an aggregate basis in a monthly report including aggregate statistics on activity in system. However, ASIC reports that a number of unnamed crossing systems have made changes to the type of market participants, to connections with other market participants (which require reporting under Market integrity Rule 5.2.1), or the crossing type has changed between an ASX priority crossing and a national best bid-offer (NBBO) crossing. The latter two deﬁnitions can cause some confusion for market participants.
On and off-market Taken at face value, the daily and weekly reports issued by the two major venues do not appear to report the same ﬁgures due to differences between the inclusion of crosses as ‘on-market’ or ‘off-market’. “The concept of what is ‘on market’ has been used by ASX for many years,” explains Jason
Keady, director of market and operations at Chi-X Australia. “When you go into a market data vendor like Bloomberg or Reuters and you pull up on-market versus off-market for ASX the on-market turnover has always included trades from the ASX order book and what ASX call onmarket crossings. ASX has a unique Australian concept that is called ‘priority crossing’, which essentially allows a broker to get priority to cross a smaller trade and still be considered on-market. ASX has extended this to include Centrepoint priority crossing and NX. Chi-X has calculated its statistics on a similar basis to allow like for like comparison.” Looking at reports from the two exchanges offers different views of market share. Taking the week ending 15 March, Chi-X reports an ‘overall market share’ of 10.25%, for which it counts only those 298 securities that it trades ‘on-market’, which in its deﬁnition includes NBBO crosses. However for the same week, ASX reports that its rival had a 6.4% share of ‘on-market’ trading, having achieved a 93.6% share itself. In its report, the NBBO and other crosses are separated into the ‘off-market’ category. If the total market share is calculated by averaging ASX records of on- and off-market trading, Chi-X Australia has 11.45% total share for that week. If the same calculation is conducted for Chi-X’s records for on- and off-market data for the week it ﬁnds has 11.43% total share, which suggests it is simply an issue of presentation that creates the imbalance. Thomson Reuters’ data for the same period produces similar proportions; approximately 6% and 10% share Chi-X, depending upon the inclusion of on and off-market ﬁgures. The comparability of the data between the two exchanges will improve from 6 May 2013 when Chi-X plans to extend its universe of tradable securities to the 2100-odd equities and exchange traded funds available on ASX. It must be said that traders do not base decisions based upon the data that exchanges publish – one said that it is effectively “marketing material” and another noted that even “what appears on screen is taken with a pinch of salt.” Beyond a lack of standardisation in market share reporting, there are greater causes for concern about off-market trading for both regulators and market participants.
“We are concerned that in the Australian context dark pools could impact on the level of liquidity of ASX-listed companies”
What’s wrong with dark pools? ASIC identiﬁed several problems with the use or provision of Aussie dark pools. Firstly was the inclusion of proprietary trading in the mix; for eight ﬁrms that included prop trading in their dark pools in Q3, 38% of the order ﬂow had been proprietary. Secondly as high-frequency trading ﬁrms increase their activity on lit markets, fundamental investors look for ways to avoid them and so trade in the dark to a greater extent. That means that these long-term investors are contributing to less to price formation in the lit market and fewer lit orders contribute to widening spreads. There are also fears that market liquidity could be harmed by dark pools. “We are concerned that in the Australian context dark pools could impact on the level of liquidity of ASX-listed companies,” says by Gordon Noble, director of Investments and Economy at the Association of Superannuation Funds of Australia, the national industry body for pension funds. “While the top end of the market consists of companies that are heavily traded, among the bottom end of the market there are signiﬁcant issues around liquidity. ASFA’s interest in liquidity relates to the retirement system’s speciﬁc regulatory structure. Under choice of fund legislation, superannuation provider members have the right to move their superannuation account balance to another
fund within 30 days. Superannuation provider members can also enact investment choice within a fund.” The implication of ‘choice of fund’ legislation is that superannuation providers must actively monitor and manage the liquidity of investments. The Government’s legislation that has provided the Australian Prudential Regulation Authority (APRA) with prudential standards making power, will require that superannuation providers enhance their risk management practices, with a particular focus on stress testing portfolios for liquidity of investments at times of market stress. “The implication of parts of the market becoming illiquid, or less liquid, may be that superannuation providers would need to reduce the amount of investment that is allocated to these areas of the market,” notes Noble. “The reduction of superannuation capital could have a signiﬁcant impact on the ability of parts of the ASX market to grow over time. ASFA recommends that the Government should consider any changes to clearing and settlement on the basis of the impact on future market liquidity.”
Away from the mark Dark trading had originally been intended “to facilitate large orders and to manage their market impact,” according to ASIC, but increasingly smaller orders are being traded without pre-trade transparency including orders placed on behalf of retail clients. The number of trades on crossing systems has increasing from 8.1% of total market trades in the Q3 2011 to 10.7% in Q3 2012; while the average trade size of crossing system operators has fallen from AUS$2,400 to AUS$2,200 over the same period. Below block-size trades in the dark grew to 14% from 9% and block-sized dark trades fell from 14% of total turnover to 10%. To bring off-market trading back in line with its intended purposes, from 26 May 2013, Australian traders will only be able to trade in a dark pool if it delivers meaningful price improvement, and new rules will be implemented that allowed tiered block trades, with order sizes permitted at AUS$200,000, down from AUS$1 million at present.
In the ASIC report many off-market crossing networks were found to be misleading the regulators in its report on the sector, “Most crossing system operators have stated that they do not allow high-frequency trading in their crossing systems… Our data analysis suggests that the majority do in fact have user accounts with high-frequency trading characteristics,”. ASIC has launched a consultation on proposals to clear up market practices and restore integrity. It plans to increase transparency of order ﬂow types in dark pools, reduce tick sizes to allow greater liquidity for small size orders, demand that dark pools publish information on their trading processes and execution risks, and do not discriminate against users or allow conﬂicts of interest to impair service. Its Consultation Paper 202 will be open for comments until 10 May 2013.
“The number of trades on crossing systems has increasing from 8.1% of total market trades in the Q3 2011 to 10.7% in Q3 2012”
Fragmentation Footprint Q1 2013 Japan The ﬁrst quarter of 2013 marked the return of volatility to Japan (see page 20) brought on by political tensions with China and to some extent North Korea. With it, turnover in Japan grew quarter on quarter by 56% to US$1.6 trillion according to Thomson Reuters Equity Market Share Reporter. Some algorithm strategies of computer driven trading thrive on volatility as price discrepancies present themselves more often. One would think that average trade sizes would decrease with market share remaining constant across all venues but this wasn’t entirely observed in Japan last quarter. Market share at the PTSs, Chi-X Japan (CHIJ) and SBI Japannext (SBIJ), in fact retreated though both venues did post increased absolute turnover. Combined market share peaked at 6.87% in December to fall to 5.23% in February recovering to 5.54% in March. SBIJ was the biggest loser of the PTSs giving up just over 1% of overall trading. The PTSs in aggregate combined for a record US$31.2 billion of turnover in the month of March and US$84.6 billion for the quarter. Where did the PTS market share go? For the most part both the Osaka Exchange (OSE) and the Tokyo Stock Exchange (TSE) picked up more than 1% of market share each. In a volatile climate, it seems participants have a penchant for trading on the primary exchanges rather than the PTSs. We saw this during the earthquake in February of 2011 though the PTSs were still making a name for themselves. Looking at average trade sizes though reveals something further about Japan’s market structure. The TSE and OSE both saw average trade sizes increase in terms of dollar value though in terms of number of shares per order the TSE witnessed increasing then decreasing amounts. It’s hard to say why. Perhaps smaller orders buying an up market would see bigger notional trades of lesser share amounts. At the PTSs though, it is clear that SBIJ continued to see lower average trade sizes in terms of both USD and number of shares indicating that there is some sort of algorithmic arbitrage going on and/or their retail ﬂow from SBI Securities saw more volume in tandem with the market. CHIJ has achieved smaller trade sizes in less volatile times and has been trading within a band of around US$4400 and 622 shares per trade since August 2012. With the TOB rule amendments now 6 months old it doesn’t really look as if buy-sides are turning to the PTS for liquidity. We recognize client on-boarding and connectivity do take time but the loss of market share in an environment when volatility oriented strategies would proﬁt suggest the equity market still has quite a bit of upside in terms of multivenue arbitrage. From CHIJ’s and SBIJ’s March 2013 report the top 5 large cap stocks by market share were:
Top 5 Securities by Market Share
Market Share Avg PI
DAI NIP PRINT 7.00%
JX HOLDINGS 6.25%
NITTO DENKO 5.99%
The top 10 securities by market share in each venue are different suggesting minimal arbitrage between the two. Notably in both the above PTSs reports they indicate that price improvement has been declining at each venue over the past few months.
Australia Chi-X Australia (CHIA) continues to gain market share from the Australian Securities Exchange (ASX) reporting 11.34% on March 28, 2013. Our data supplied from Thomson Reuters’ Equity Market Share Reporter shows that CHIA achieved 7.25%. Why such a big difference? CHIA reports only on market trades versus the primary and we counted all trades except the auction which only the exchange participates in and constitutes as much as 25% of average daily value (ADV). However you want to read the data CHIA continues to be a growing force in Australia. For this fragmentation report we look at some of the characteristics of lit, dark and auction trading. Though CHIA doesn’t report dark market share it has been growing and makes up around 7-8% of its total turnover. Looking at the graphs it is clear that lit trading has a larger average trade size in both notional and per share than dark trading on both venues. While the primary has the bigger trade size its dark venue’s average trade size is approaching approximately the same proﬁle as CHIA’s lit venue suggesting arbitrage between ASX dark and CHIA lit is going on. However, breaking down the top 5 ﬁrms by value on Centre Point 4 out of 5 are sell side. From this we can infer that the average trade sizes are driven more from child slices from parent orders rather than arbitrage though Getco in the top 5 would indicate otherwise. Notable is the cyclical nature of the ASX auction trade size peaking during the end of the quarter and troughing one month later. This appears to be index rebalancing.
Looking closer at Centre Point it continues to draw liquidity trading A$3.25 billion in January (January data was only available at time of writing) according to the ASX Centre Point Report on 1,690,287 trades or A$1923 per trade. The report goes on to say that over A$8 million was saved in price improvement (24.6bps) and claims over A$120 million saved overall by trading Centre Point. Certainly enough to cover the cost of competition.
Centre Point Top 5 By Value Firm
Value (A$ Million)
AVG Trade Size A$ 1621
Centre Point Top 5 By Trades Firm
AVG Trade Size A$ 1621 543 1774 1801 2206
For the week ending March 28 CHIA reported Chi-X Australia Top 5 Securities By Market Share
Symbol A$ Million
Market Share Avg PI
Letâ€™s hope the new CHIA CEO, ex-Getco, can keep the momentum going.
India The highlight of the quarter was the commencement of the MCX-SX on February 11 bringing a third national venue to India. They claim the most number of approved members for a new exchange though ADV is just around US$250,000. It far too early to make any comparisons of course but we are looking forward to reporting to you fragmentation in India in the coming quarters. The average trade size of the National Stock Exchange of India is US$1375 and 455 shares. Volume grew at the NSE by 4.95% quarter over quarter to US$134.87 billion holding 82% market share. The BSE has an average trade size in Q1 2013 of US$544 and 329 shares.
The next chapter in Asia's fragmentation story The Asian markets witnessed a number of significant structural changes last year. Already this year the bar looks to be set higher in terms of fragmentation levels and the newly emerging competition for liquidity. Japan's Financial Services Agency (FSA) is working hard to make the country a more internationally friendly destination in order to attract liquidity. Following the relaxation of the 5% TOB rule last year, we have seen an increase in volume executed on PTSs. Since the start of the year Chi-X Japan and SBI Japannext have, on a number of occasions, reached record highs in their respective market share in the Nikkei 225 (chart 1).
However, equity volumes in Japan as a whole have remained buoyant so it's hard to tell if this activity is down to the more favourable regulatory regime, or just a rising tide lifting all boats. Fragmentation levels are now back to where they were six months ago (chart 2) but the FSA's recent decision to abolish the uptick rule may prove another turning point for fragmentation in Japan.
market share, enough to provide competitive pricing for market participants. In Australia, dark pools and HFT are very much on the table with the Australian Securities and Investments Commission (ASIC), in March of this year, proposing measures to address both of these areas. Once again, the regulator has shown good sense in respect of HFT, but quite rightly, given the continuously decreasing trade size (chart 3), remains concerned about the impact of dark pools.
Most importantly, ASIC's decision to bring more transparency to broker crossing networks can only help provide a clearer picture of the true size and shape of trading taking place in the dark. India's market participants welcomed the new MCX Stock Exchange (MCX-SX) which launched earlier this year. Initial fears that it would compete aggressively with the two main markets (BSE and NSE) proved unfounded. MCX-SX's daily reports have so far shown disappointing numbers in terms of market share. Members seem to be waiting for liquidity to pick up before they start trading actively but, as has been proved so often before, liquidity brings liquidity. At this stage it's still too early to judge the long-term impact the new exchange will have as direct competition is evident and arbitrage opportunities will present themselves in time. If, however, MCX-SX is successful, it could mark a new chapter in India's fragmentation story. Experience in other regions has shown us that a multi-market structure attracts both domestic and international firms willing to invest in the technology to trade across different venues. How might the existing regional equity exchanges benefit? The fact that a big, international and fully automated trading firm like Getco is starting its operations in India (whilst closing its offices in Hong Kong) suggests a high degree of confidence in the potential for significant growth in high-frequency trading.
Are multi-markets becoming a reality? If so, are we going to see a story similar to the one that has unfolded in Europe where two markets (a primary and an alternative) achieve 95%
It will be interesting to see how things develop as competition and regulation continue to play their respective parts in shaping the region's market structure.
Shares Q1 2013
Shares Q1 2012
584,078 703,014 23,155,330 7,263,943 94,042,608 119,990,441 5,679,985 173,456 110,407,145 6,198,345 1,692,153 5,906,658 258,202,957 87,613,471 11,841,769 9,728,500 53,121,345 893,209,673
875,723 26,008,344 9,692,760 78,545,481 97,083,555 4,653,293 191,935 98,052,156 9,452,421 1,889,344 7,580,021 297,043,210 99,749,484 9,677,462 22,394,322 78,607,535 933,304,562
Average Trade Size
Average Trade Size
% Change Q1 2013
Source: Thomson Reuters Equity Market
Q1 2012 (USD)
Average Trade Size
Q1 2013 (USD)
Average Trade Size
Q1 2012 (USD)
Value Share Trading Value Share Trading
Q1 2013 (USD)
36 EQUI TIES
Equity Trading Recap Share Reporter
W O RD ON T HE STREE T
WORD on the street What do you think of the Australian government’s decision to delay competitive clearing for 2 years? Ron Gould,
a well known industry consultant
he Council has written a report that is cautious, especially given the current state of the industry and the deluge of new rules and regulations with which they are currently having to deal. Adapting to all those new rules, including but not limited to Basel III, is taking a great deal of time effort and money, none of which are in huge supply. On that basis, calling for a two year delay is not unreasonable. But it is important to note that they did not reject the basic idea of competition in clearing.
CEO Optiver Asia
he positive news is that the government doesnít rule out competition for clearing. At the same time I understand that market participants need to allocate a lot of resources in order to adapt to all the regulatory changes. Adding another component to the already complex system might be a little bit too much to digest. As a ﬁrm believer of the positive effects of competition I would have preferred a bolder decision than a 2 year delay. For example when Chi-x came to Australia the ASX reduced trading fees and invested in upgrades in its technology in order to remain competitive. The downside of this current decision is that ASX keeps its monopoly on clearing and with that there is no pressure for the ASX to improve processes and pricing. The lack of competition means that the ASX receives a free AUD 15 million in revenues on the stated assumption that the clearing fees would decrease by approximately 30% with competition.
Rosemont Capital Pty Limited
he recent decision by the Australian Government to defer any decision around competition in the equities clearing and settlement space for at least two years is another blow to Australian market participants who will not enjoy product innovation, cheaper clearing and more efﬁcient trading venues that competition would bring. As much of Asia looks to Australia to see the affect of security market reform, new entrants and competition it also further harms Australia’s standing as a leading regional ﬁnancial centre. That notwithstanding, some of the arguments around having a single settlement and clearing venue are sound. Perhaps we should look at the not-for-proﬁt US Depository Trust and Clearing Corporation (DTCC) as a model which works very well.
CEO Capital Markets Cooperative Research Centre
ASIC is] simply not comfortable with innovation because they have no way of effectively evaluating it on an ex-ante basis and they have had a glimpse at some of the consequences if things go wrong (Flash crash, Knight Capital). As a result they would rather wait to see what happens in other markets; their public persona is that the market needs a rest from changes already affected like the introduction of Chi-X, and they donít see any loss in being second or third cab of the rank.
iven that ASX is likely to have competition from global clearing houses after two years, the smartest thing ASX could do is use the two year window to forge a strong partnership with a global clearing house which could offer genuine beneﬁts to Australian investors wanting to trade globally and global investors wanting to invest in Australia. I wouldn’t rule Singapore out of that equation as they are already forging links to Europe and USA.
London to Singapor: From pillar to post-trade A London-Singapore clearinghouse would simplify life for the sell-side, but are there enough reasons for SGX and LCH.Clearnet to make it happen?
hen rumours ﬁrst began circulating that the Singapore Exchange (SGX) was in talks to buy a stake in the UK and European clearing house operator LCH. Clearnet, the deal seemed to make sense. At face value it met the ambitions of the two parties, which have been thwarted on occasion. “Clearing as a concept has become a way of doing business,” says Muthukrishnan Ramaswami, president at SGX, who would not comment on the purchase of a stake in LCH. Clearnet. “The underlying risk mitigation hasn’t changed, but clearing has been put forward as a mechanism for resolving the unintended counterparty risk that is created when one tries to hedge against interest rate risk for example.” SGX has had mixed success in expanding internationally, as evidenced by one failed crossborder merger, successful partnerships with German exchange operator Deutsche Börse and the London Stock Exchange (LSE) to allow cross trading of products, plus a connection with Nordic-US exchange Nasdaq OMX for technology development. It is part owned by the Tokyo Stock Exchange and in turn owns a 5% stake in India’s second largest market, the Bombay Stock Exchange (BSE), adding to its international dimension. LCH.Clearnet has been knocking on Asia’s door for some time. It had been the posttrade underpinning for failed cross-border Asian equity market Chi-East, a joint venture between SGX and alternative trading venue operator Chi-X Global. It has existing clearing agreements with SGX in the FX space and under the LSE-SGX cross-trading agreement. It has been making noises about launching in Japan, a market in which it once had a partnership with the Tokyo Stock Exchange’s clearing house to clear interest rate swaps (IRSs), a joint venture it turned down on the basis of cost. It also has a license to clear derivatives in Australia.
With an integrated clearing house already in place with SGX Clear, it might appear questionable for a separate clearing house to be contemplated as a partner. Ramaswami says there are pros and cons to operating internal or external clearing. “The European approach has been having a horizontal layer that provides scale and the ability to clear for multiple trading venues; in the US stock market similarly many trading venues use DTCC as a clearing agent,” he observes. “A vertically integrated exchange gives more ﬂexibility in developing products end-to-end and not having to coordinate across institutions, but beyond that if you add up the two revenue streams I don’t think that they would be hugely different.” SGX and LCH appear to have a little of what the other wants. The question is whether they have enough.
Motivation How large a chunk SGX might buy of LCH and how it might do so has not been made public. Harsh Wardhan Modi, analyst at J.P. Morgan Securities Singapore said in an analyst note on 6 February that SGX may bid for its stake separately or through LSE. “The actual accretion/dilution for SGX will depend on actual price paid, amount of stake bought and extent of cooperation between SGX and LCH post deal,” he said. “The stake per se may not be the most important part of the deal, rather the arrangement that SGX and LCH come to in terms of expanding their relevant footprint will be more meaningful. Close to 50% of LCH’s annual revenues come from commodities and derivatives within the Pan-European space, hence it will provide SGX with an opportunity to grow in a new market. Also, this will be a stepping stone for SGX in intermediating overthe-counter (OTC) ﬂows in Western markets.”
LCH.Clearnet Group is 77.5% owned by its clients and 22.5% by exchanges but that is changing. The London Stock Exchange Group (LSEG) is expected to acquire a controlling 56% stake in the clearing house. Nasdaq is expanding its stake from 3.7% to 5%. These moves are not coinciding; both of these exchange operators harbour ambitions to provide international derivatives execution and clearing services. SGX shares these ambitions. The clearing of derivatives is big business, not only in and of itself, but because the derivatives trading process ties a trader to using a single clearing house and clearing via a central counterparty (CCP) is mandated for OTC derivatives under legislation being developed around the world, based upon a 2009 agreement by the G20 countries. Ramaswami says, “If you have the additional service of clearing then obviously you can generate returns that are commensurate with the added footprint of services that you provide.” Post-trade services allow SGX to expand by processing new OTC products such as iron ore swaps which are imperative in a market that is seeing increased consumption of commodities and power. “For every 100 tons of iron ore swaps around 10 tons are cleared and the other 90 are OTC trades,” says Ramaswami. “Our challenge is to expand our service so that we can service that 90% of the market, which today remains exposed to bilateral risks.” To clear through a CCP, the trader must post collateral with it to cover a margin calculated to mitigate any changes in the price of the traded contract, or of any trader defaulting. A CCP can net off the margin that has to be posted in favour of a trader, against the margin posted against the trader, and so a smaller sum of collateral is required when using that clearing house for all trades. The process has to begin all over again
if another clearing house is to be used and, as a consequence, other clearing houses are typically avoided.
“For every 100 tons of iron ore swaps around 10 tons are cleared and the
Keeping it in the family Major derivatives markets like Deutsche Börse Group’s Eurex, the CME and IntercontinentalExchange (ICE) all have pet clearing houses, ensuring that all of the revenues generated during the trade lifecycle stay within their four walls. Lacking a comprehensive clearing capability has meant NYSE Euronext, owner of the LIFFE derivatives trading platform, has been haemorrhaging post-trade revenues to LCH.Clearnet, its longstanding clearing house, despite having put it on notice back in May 2010, so that a comparable in-house clearing capability could be developed. A long notice period and a series of merger discussions with ﬁrms who have offered their own clearing operations (twelve months talking to Deutsche Börse in 2011-12, a takeover by ICE approved in December 2012 for US$8.2 billion) has meant that the in-house capability has not yet materialised. Those lost revenues may have been expensive indeed. SGX is not in the same boat as NYSE Euronext. It can clear cash securities and derivatives via SGX Clear. But it does need a way to grow and Singapore is not a big market whether measured geographically or by market capitalisation. “SGX is not able to just stick to locally based products as domestically it is very small compared to other markets,” observes Ken Ang, analyst at Singapore broker Philip Securities. In March 2013 the exchange saw multiple developments in its cross-border derivatives strategy. It announced plans to offer Philippines-linked derivatives products under a memorandum of understanding (MoU) with The Philippine Stock Exchange (PSE) and to develop ﬁxed income trading and posttrade services with PSE under a separate MoU; it licensed 14 new MSCI index products to provide its members with access to around 90% of the MSCI AC Asia Index; it signed an MoU with Korea Exchange (KRX) to explore collaboration in over-the-counter (OTC) clearing capabilities for ﬁnancial derivatives; it also signed up of its ﬁrst Taiwanese clearing member. However the success of initiatives cannot be judged by their number. Two important considerations when questioning the viability of any agreement are: where is the demand coming from and what is the cost beneﬁt?
other 90 are OTC trades” – Muthukrishnan Ramaswami, president Singapore Exchange
Taking the example of trading stocks between Singapore and London, it clearly provides a short-term beneﬁt as it can save a London broker a lot of money if it wants to trade into Singapore by giving it access without paying for a DMA broker. However until Asian night time liquidity picks up, that broker is effectively paying a liquidity premium. “If you are trading Asian stocks on the LSE there is no liquidity during the Asian night and so you are paying a premium to trade on those hours,” said one sell-side post-trade professional. “The view is, that it is not that compelling against trading it via a DMA broker.” However Ramaswami is quick to point out the model is intended to increase access but not replace direct access wholesale. “We are trying to provide an alternative for people to trade in the zone in which there is news ﬂow or activity around that,” he says. “It helps in our listing business as ﬁrms know they will not be shut out of trading in Europe; we will see how it develops.” The industry needs to see some concrete proposals with solid demand and transparent revenue streams if it is to be convinced that an LCH/SGX hook-up will work.
What’s new? The potential in the deal is apparent. The requirement to centrally clear OTC derivatives and the ability to design new derivatives contracts make trade and post-trade services more valuable than their cash market equivalent. Tying the two together businesses together will widen their respective markets. At a basic level, a purchase of a signiﬁcant stake in LCH would offer SGX an alternative new source of revenue, when consolidated as an associate. “In addition to the potential widening of product offerings that a stake in LCH may present, it could possibly be more on the types
of products SGX may be able to participate in and clear through LCH,” notes Ang. “A deal could possibly lead to even closer relationship being fostered between SGX and LSE, which may lead to further increase in offerings, should there be a demand for these products.” For LCH, the deal could solve a problem it has in accessing the region. “There aren’t many markets out here anymore that are easy to move into,” says Michael Steinbeck-Reeves at post-trade consultancy Catalyst. “Domestic regulators often don’t make it easy for offshore CCPs to get licenses. They frequently demand that operations stay onshore. You need a domestic mandate if you are really going to pull in volume. Those have gone.” They might also secure an agreement that the clearinghouse would not take on SGX in its home territory while also offering SGX some technical and operational resources, even if it is clearing itself. One broker who asked to remain anonymous said, “Market rumours are that LCH might clear all the OTC derivatives for SGX and so the view is should LCH become the strategic clearing house of the SGX across all asset classes. It would make a lot of sense, I could see that happening especially after the ASX deal fell through.” That would certainly help the sell-side says Steinbeck-Reeves. “If you speak to the big international banks the majority of them are trying to avoid joining any CCPs that they don’t have to; it’s an expensive process they can’t react to all the swathe of documents asking for comment that keep coming,” he observes. “They are worried about a major default because they would have to supply people for default management groups instead of bidding on auctions.”
Pushed beyond boundaries Technological advances have led markets to trip over their own feet, says Fred Stefan
n 1965 Intel co-founder Gordon Moore predicted that computer processors would double in power every 18 months. Termed Moore’s Law, this equation explains somewhat the enormous leaps in capability that ﬁnancial services ﬁrms made in the last 15 years. The technology of trading has put much emphasis on delivering best execution by paying millions to talented people, buying sophisticated software and infrastructure. But the effect of speeding up and multiplying the volume of trading can potential devastating effects when it goes wrong. There are many examples through real recent cases of what may go wrong and reasons of these failures. On 1 August 2012 one of the biggest American market makers for stocks, Knight Capital, saw a new trading algorithm go awry, losing the broker US$440 million in 45 minutes. According to one source, some developer code had been left in with the production code of the algorithmic platform. The test code did
not talk back to Knight and so the broker was receiving no feedback on the faulty activity. The ﬁrm’s shares lost 75 per cent of their in two days during 2012 as a result and it is now in the process of being bought. More recently in January 2013, an apparent software bug in an algorithm being used by market maker Eclipse, which is active in the Kospi future market, went wrong for over an hour, seriously impacting the market and the ﬁrm. It reportedly sent 100,000 small buy orders into the futures market for one lot each; with over 100,000 Kospi futures assembled together on the bid, turnover jumped 30% and the open interest increased tremendously. The error has been estimated to have cost between US$8 – 15 million for the ﬁrm; the ﬁrm did not respond to a request for conﬁrmation. Risks like these can only be mitigated by employing rigorous controls and tests. Testing is complex and costly because it incurs delay and eats up staff time. Tests are probably the
most undeveloped topic of the IT banking industry in term of procedures and expertise. The effect of such errors can be considerable. On 6 May 2010, the Dow Jones industrial dropped almost 1000 points, the biggest intraday fall in its history, before rebounding to almost completely recover by the end of the day in what is known as the ‘ﬂash crash’. A report by US regulators the Securities and Exchanges Commission (SEC) and the Commodity and Futures Trading Commission (CFTC) determined that the trigger was a large mutual fund’s sell order for an unusually large number of 75,000 E-Mini S&P 500 contracts, made as a hedge to an existing equity position. According to the SEC/CFTC report this ﬁrst exhausted available buyers, and then highfrequency traders (HFT) started aggressively selling, accelerating the effect of the mutual fund’s large sell order and contributing to the sharp price declines that day. The computer algorithm the trader used to trade the position
was reportedly set to target an execution rate set to 9% of the trading volume calculated over the previous minute, but without regard to price or time. The combined sales by the large seller and high-frequency ﬁrms quickly drove the E-mini price down 3% in just four minutes triggering the broader market decline. A second example from the US from the same year demonstrated the danger that trading programs can be used to manipulate the market, when Trillium Capital was ﬁned US$1 million by the sell-side regulatory body the Financial Industry Regulatory Authority (FINRA) for using “an illicit high frequency trading strategy and related supervisory failures”. “Trillium’s trading conduct was designed to improperly bait unsuspecting market participants into executing trades at illegitimately high or low prices for the advantage of Trillium’s traders,” said Thomas Gira, executive vice president, FINRA Market Regulation. “FINRA will continue to aggressively pursue disciplinary action for illegal conduct, including abusive momentum ignition strategies and high frequency trading activity that inappropriately undermines legitimate trading activity, in addition to related supervisory failures.” Trillium Capital is an HFT ﬁrm in New York that engaged strictly in HFT trades. Trillium entered many trades that were not considered to be in ‘good faith’ because Trillium had no intention of following through on these orders. The placement of the orders was to make the market think there was a large amount of activity happening in certain securities. These orders induced other traders to trade based on the mirage of demand or supply created by Trillium. Before these fake trades were entered, Trillium had real limit positions, which executed as a result of their traders creating buy- or sellside demand which moved the prices in certain directions. Once the real trades were executed, Trillium immediately cancelled its fake trades.
Where the buck stops HFT touches a nerve, frightening the world fuelled by the idea of machines making decisions that they are unable to identify as ﬂawed. As a result there are a number of ongoing regulatory analyses of HFT, its effects on the market and its possible prohibition. But technology can also fail as part of the trading infrastructure as has happened several times. In the US the Nasdaq exchange suffered a computer malfunction during the ﬁrst hours of the IPO of Facebook, leading to tens of millions of dollars in trades being wrongly placed. BATS Trading an alternative stock exchange in the US saw its IPO go wrong on its own exchange 23 March 2012 when some stocks,
“HFT touches a nerve, frightening the world fuelled by the idea of machines making decisions that they are unable to identify as flawed”
including its own, stopped trading. Prices plummeted with Apple’s stock falling nearly 10 per cent in minutes triggering a circuit breaker that suspended trading of the stock. BATS’ own stock, expected to launch at US$16 a share, fell to near zero and was remove from the exchange. Although the technology ﬂaw was corrected later that day the IPO was cancelled and never rescheduled. We are in a time of high technological risk where a single trader (or algo) has the potential power to burn billions away in a single click or event. The current economic circumstances put resources at stretch by rarefying people that are less directly productive such as security and operational risk ofﬁcer. It costs money and time to have all safety in place, all tests plan and procedures followed, a plan B tested and ready, plus all the resources recruited and trained. The limit between not enough and too much safety is debatable. This is crucial to have the right people aligned in the right organisation with the right procedures. The right people are the most experienced and innovative. But let’s be honest: a typical technical risk manager has most of the time a combined minimum power with average remuneration that is not appealing. Now the organisation usually offers little for the cautious. Deadline are tight to allow business agility, people’s turnover is high making company knowledge hard to protect, extra remuneration encourages short-termism through bonuses. Finally procedures are outdated quickly whenever new products or rules are issued. A well-balanced procedural environment is hard to ﬁnd. The cost runs too high to create and communicate through training the tremendous amount of information that all employees should be aware of, information encompassing technics, regulations, compliance, ﬁnancial products, accounting, operations, and so on.
One cannot omit the human factor from all of this. Technology only does as it is told, and an employee can create damage without control, particularly if he has strong ability and deep knowledge of the technical and functional environments. At Société Générale, Jerome Kerviel employed different means to avoid the bank’s internal controls and escape detection. Hundreds of thousands of trades were hidden behind offsetting faked hedge trades. Kerviel was careful to close the trades in just two or three days, just before the trades’ timed controls would trigger notice from the bank’s internal control system, and Kerviel would then shift those older positions to newly initiated trades. Kerviel uses his intimate knowledge and access to middle and back ofﬁce tools to accomplish his wrongdoing. Putting security in place is equivalent to a race with innovation: data access, system access, emails, USB keys, clear separation of duty, sensitive leave with no access to the company assets for at least one week, training and compliance duty, well deﬁned development, test and production environments, workers mobility. Probably the biggest advantage is to have talented and motivated risk assessors. Humans can set technology up to make mistakes. For example, Korea Exchange said the Kospi’s tumble on 11 November 2010, when options expired, was caused by program selling. Deutsche Bank breached stock exchange rules governing the disclosure of computer-driven trades by ﬁling a report one minute late that day, the bourse said. Technological innovation can ﬁnally go as fast as the regulatory and human factors can follow. And the quality of a workﬂow is as strong as the weakest component that makes it up. Recently, it seems that extreme costly cases have epitomised the many aspects of technological mishaps that theoretically exists. Being intentional or unintentional, back ofﬁce or front ofﬁce driven, initiated within an operational or market risk, originated by humans or computers, these undetected failures have cost billions directly and indirectly many more, by scaring clients away or putting culprits under heavy penalties. Saying “No” to tremendous opportunities is not a solution, companies must adapt to a new era by setting up adequate safeguards. This represents the pain of the gain. There are no magical solutions as usually companies must balance safety and opportunity. It seems that a fair solution would be a ﬂexible combination of business intelligence, processes knowledge and environmental awareness.
BA CK PA G ES
15 - 19 April
FundForum Asia 2013
China Cross-Border Trading
Trade Tech China
FISD Hong Kong
FX In Asia
Trade Tech Japan
Trading Architecture Asia
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