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Innovations in Accessing Asia: Listed Equity Derivatives and Delta One Products.

Institutional investors seeking exposure to emerging Asian equity markets face challenges in accessing many of the region’s closed markets and are turning to exchange-traded derivatives markets, as well as over-the-counter (OTC) instruments that can provide the exposure they need, says TABB Group in new research published today, “Innovations in Accessing Asia: Listed Equity Derivatives and Delta One Products.

Investment managers are active users of OTC equity derivatives, including contracts for differences (CFDs), equity swaps, participation notes and other structured products, says Andy Nybo, a TABB principal, head of derivatives research and the report’s author. “However, global regulatory efforts to reduce concentration of counterparty risk have driven investment managers to explore alternatives for exposure, leading them to centrally-cleared, exchange-traded products that can lower overall levels of risk.”

According to TABB, as the appeal of developed markets waned in recent years, investors began examining new markets, searching for investment opportunities offering higher alpha and greater returns, especially emerging markets in Asia. Hedge funds are focusing their attention on the APAC markets, with 33% of US and European funds targeting the region for new investments. However, Nybo explains, direct investment in the emerging equity markets of Asia has been hindered by low market capitalization, restrictive regulatory environments and capital constraints that prohibit direct access to cash markets.

“Asia’s relatively stable political and regulatory environment has done well to attract investor interest,” Nybo says, “but some of the region’s regulators seem to use regulation as a policy tool in an attempt to control market fluctuations.” He adds that markets with heavy-handed regulatory authorities face a backlash from investors seeking opportunities and provide an opening for regional exchanges to launch products designed to meet investor demand for exposure to more closed markets.

“Pent-up demand from investors will contribute to innovation and new product launches by these emerging Asian exchanges to capture investment flows from both international investors and Asian-domiciled hedge funds,” he adds. “Many of the region’s regulators are very keen to promote greater participation in the financial markets. They are eager to attract strong capital flows from investors all over the world.”

The 33-page report with 24 exhibits is available for download by TABB Research Alliance Derivatives clients and pre-qualified media at https://www.tabbgroup.com/Login.aspx. For an executive summary or to purchase the report, visit http://www.tabbgroup.com or write to info@tabbgroup.com.

Other recent TABB derivatives research includes: Accelerated Expirations: The Growing Relevance of Short-term Options; US Options Trading 2011: Finding the Other Side of the Trade; Feeding the Options Beast: Big Data in the US Options Space; EU Equity Options Market Structure: Opening The Door To High Frequency Flow; VIX Trading: The Structure of Uncertainty; and TABB Group Options LiquidityMatrix.

Innovations in Accessing Asia:Listed Equity Derivatives and Delta One Products – Executive Summary

Source: MondoVisione, Tabb Group, 15.03.2012

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Filed under: Asia, News, Trading Technology, , , , , , , , , , , , , , , ,

Dark Pools: HKEx chairman slams dark pools

Ronald Arculli joins the ranks of those criticising alternative trading platforms for creating an unfair playing field.

Much has been said and written in recent months about dark pools, and on Wednesday the chairman of Hong Kong Exchanges and Clearing threw his hat into the ring. Not surprisingly, Ronald Arculli is not in favour of such trading platforms, which only require prices to be published after a transaction is complete.

He set out his stall in a speech at the Foreign Correspondents’ Club in Hong Kong titled ‘Roles and Challenges of Stock Exchanges’. Highlighting the benefits of exchanges (good risk management, transparency, liquidity fairness, a reliable infrastructure and central counterparty services, among other things), he said they demonstrated their worth during the crisis: “Almost all exchanges continued to function normally and remained open during the turmoil.”

Arculli also remarked that governments worldwide have recognised the “unique value” of exchanges, with a number of moves afoot to standardise over-the-counter contracts and move them onto exchanges. This is in stark contrast to well publicised concerns of regulators, such as the US Securities and Exchange Commission, as to whether dark pools create unfair advantages for some in the market. Arculli believes they do and clearly outlined his concerns.

Firstly, these platforms lack transparency, as they show buy and sell orders and deals that are not transparent or available to the general investing public, he argued, effectively creating a two-tiered market. They are typically run by broker-dealers and large market-makers looking to save on transaction costs and fees, and do not alert the broader market of impending deals which could affect a stock’s equilibrium.

Powerful technology can be used to conduct high-frequency algorithmic trading in dark pools through both on- and off-exchange platforms to profit or arbitrage on small price differences, said Arculli. This has resulted in dark pools accounting for 12% of market trades in the US now, up from 1.5% just five years ago, while in Europe they account for some 4% of equity trades. In Asia, these venues make up a much smaller percentage of the average daily turnover, he added, but in a globalised marketplace, they still raise significant concerns.

Besides transparency, another issue is that the proliferation of alternative platforms means liquidity is increasingly fragmented, diverting volumes away from publicly traded exchanges, he said. Smaller companies may suffer as high-frequency traders tend to prefer larger, more liquid shares. Such fragmentation not only affects effective price discovery, said Arculli, but also increases price volatility and adds to surveillance difficulties.

Moreover, the lack of regulation and transparency of dark pools could result in notable systemic risk, he said, citing the problems surrounding Lehman Brothers and AIG last year. “As dark pools typically lack a central counterparty, the default of a large participant could have severe consequences on market stability,” he said.

In addition, these platforms raise concerns over company ownership. “Arguably when shares are held only for fractions of a second, it is no longer about participating in the ownership of a company or ensuring it is well run,” he said. “The opaqueness of trading, and its fragmentation have negative implications for effective corporate governance.”

Arculli suggests the rise of such platforms set up by investment banks might indicate a trend towards the re-mutualisation of stock trading. Originally stock exchanges tended to be set up as associations by their trading members, he said, but have since de-mutualised and become commercial, often listed, corporate entities to better serve their stakeholders.

“Now as the bigger trading participants are getting together again to create their own networks, is the trend reversing?” said Arculli. “Complicating matters even further, some exchanges have decided to join the fray and team up with large institutions to set up their own dark pools.” Singapore Exchange’s recent tie-up with Chi-X is one such example. Other trading platform providers, such as Liquidnet, are also working on expanding into Asia.

Arculli went on to say that regulators in the EU and the US have been reviewing dark pools and considering stricter measures to ensure a fair and stable trading environment. Investors — especially institutional ones — are seeking better, faster and cheaper services for more computerised methods of trading. Hence, he added, exchanges must continue to offer better execution and more efficient pre- and post-trade services to stay competitive, while protecting investors.

Despite his worries, Arculli, said, competition is welcome. China, for example, has the capacity and the need for more than one successful financial centre. But he added a caveat.

“We welcome challenges that strengthen our markets and make them more effective and efficient,” said Arculli. “But we are concerned by those that increase systemic risk or disadvantage a certain segment of investors to the benefit of others.”

Source: AsianInvestor.net, 11.12.2009

Filed under: China, Exchanges, Hong Kong, News, Risk Management, Singapore, Trading Technology, , , , , , , , , , , , , , , , , ,

Asian dark pool BlocSec removes minimum order size requirement

BlocSec, the first Asian dark pool to cater to the buy-side and the sell-side, owned by CLSA Asia-Pacific Markets (‘CLSA’), will remove the current minimum US$250k or 20% of the 30-day Average Daily Volume (‘ADV’) order size requirement 1.

Removal of such minimum order size requirement will enable smaller size orders to flow into the system, increasing both liquidity and matching. BlocSec clients can continue to submit and trade large size block orders in BlocSec simply by specifying the minimum quantity fill for their executions.

Christian Chan, Director of Electronic Execution Sales, CLSA said: “We continue to improve and respond to client needs and have removed our minimum order size to source and deepen our liquidity pool, so as to provide greater flexibility across the platform and markets in which we operate.”

BlocSec has been designed to ensure complete anonymity for buyers and sellers. Order entry and matching occurs without the risk of giving away client name, side, position or price of an order which means zero information leakage.

“In addition, we have added the ability for our Client Relationship Managers to accept manual orders and route any balances to the CLSA trading desk if instructed to do so. Again, ensuring more flexibility for clients and a smooth and seamless trade flow process,” Chan added.

Since its launch in May 2008, BlocSec has become the preeminent Asian liquidity aggregator and electronic crossing network for Hong Kong, Japan, Singapore and Australian equities with an average daily liquidity flow over US$77m and an average cross size of US$1.04m.

BlocSec provides traders the ability to place orders with complete anonymity and zero information leakage into the market. BlocSec continues to gather momentum and build liquidity in over 800 distinct names with 50% of all clients entering orders securing a match.

As a CLSA group company, BlocSec has a substantial community of institutional investors with the ability to provide a deep pool of liquidity. Liquidity is also maximized as BlocSec is open to both buy and sell side clients.

Source: FINEXTRA 17.11.2009

Filed under: Asia, Australia, Exchanges, Hong Kong, Japan, News, Singapore, Trading Technology, , , , , , , , , , , , ,

TABB Group insight into High-Frequency Trading

TABB Group outlines a few principles to which it adheres when discussing the controversial subject of high-frequency trading.

The current discourse on high-frequency trading is often challenged by a distortion of definitions. Journalists, politicians and industry analysts bend or stretch definitions to meet their various (and often conflicting) objectives. For example, flash orders and high-frequency trading have been improperly used as equivalent terms. Front-running has been invoked when “liquidity detection” would be more accurate. While there is room for a legitimate debate over the scope, size and impact of high-frequency trading, the industry must first agree to terms. Below, TABB Group outlines a few principles to which it adheres when discussing this controversial subject:

HFT refers to fully automated trading strategies (in equities, derivatives or currencies) that seek to benefit from market liquidity imbalances or other short-term pricing inefficiencies. These opportunities could last from milliseconds to minutes and possibly hours. While these strategies can be employed overnight, the majority of HFT strategies attempt to be market-neutral or closed out by the end of each day.

The kinds of strategies that fall under HFT include electronic market making, liquidity detection, cross-asset arbitrage, short-term statistical arbitrage and volatility arbitrage. The most prevalent equity HFT strategy is electronic market making, in which firms attempt to profit from intraday imbalances in the supply and demand for liquidity. Not all market making is high-frequency (though almost all of it is), and not all high-frequency trading is market making, but market-making strategies profit by intelligently managing the risk caused by inconsistencies between buyers and sellers.

Perhaps the most controversial and least understood aspect of high-frequency trading falls under the category of liquidity detection. While classic market makers attempt to capture spread by aggressively quoting at the bid and the ask of a number of stocks, a liquidity detector uses techniques to sniff out large orders of blocks being sliced and diced (usually by an algorithm) that a high-frequency trader believes it can outsmart.

Who Does It?

Although HFT makes up a large portion of total trading activity, a relatively small number of firms are responsible for its volume. Three types of firms build their strategies around HFT: proprietary trading firms (virtual market makers), the largest hedge funds and investment banks’ proprietary trading desks. While each of these institutions has a unique position in the industry, their common ground is their mandate to achieve uncorrelated and high returns.

Approximately one-half of liquidity provisioning these days comes from traditional market makers or large broker-dealers. The remainder originates from low-profile (though this is now changing) high-frequency trading firms — the proprietary (prop) trading shops — that few other than the industry intimates have ever heard of. Prop shops have been around for many years, earning their profits by risking their own capital. They originated either from groups formerly within broker-dealers or independent firms that have the knowledge, skills and technology to fully automate the trading process; or from screen-based day-trading shops that began automating their strategies in the late 1990s/early 2000s. These prop shops virtually automated the market-making function by leveraging inexpensive computing cycles, low-latency infrastructures and fully automated trading strategies.

Asset Classes Traded by HFT Proprietary Shops

Most HFT prop shops choose to keep their identities and intentions secretive, operating under the radar in the hope of improving their chance to profit. Through a thorough examination of Web sites and other public information, TABB Group has found that while the vast majority of these firms trade U.S. equities, the firms are quick to apply their strategies to the entire array of asset classes (see chart).

Investment banks have always traded for their own accounts. Their prop desks typically operate from a distinct legal entity — separate from the entity that handles customer orders — within the investment bank; the bank risks its own capital by deploying trading strategies designed to maximize profit. Two divisions within investment banks that deploy HFT are automated market making and proprietary desks. Market makers are registered with the SEC, using traditional trading strategies to facilitate liquidity in the market. Prop desks implement a variety of arbitrage strategies, some of which are high-frequency (though certainly not exclusively high-frequency).

For the most part, high-frequency hedge funds engage in short-term trading opportunities rather than bona fide liquidity-based strategies. While the umbrella term statistical arbitrage is frequently applied to strategies with extremely high volumes, there is plenty of ambiguity in this term. It is also true that the majority of funds engaged in statistical arbitrage are not high-frequency by today’s standards. However, over the past 18 months the line between high-turnover strategies and HFT has blurred as hedge funds shorten their time horizons in the face of unexpected market events.

As a result, transaction costs are becoming even more paramount to this sophisticated community. The rationale is that as time horizons shorten, capacity constraints increase and transaction costs become a bigger piece of the pie. High-frequency hedge funds may be layering these liquidity strategies on top of their other strategies so that transaction costs are additive rather than negative.

How Big Is It?

The only art more forgivable than economic forecasting is estimating the market size of an industry that will never reveal its true number. Nonetheless, TABB Group estimates that high-frequency trading accounts for 61 percent of U.S. equity share volume (remember to double-count average daily shares!) and generates $8 billion per year in trading profits.

The methodology begins with an analysis of institutional equity trading volume that we have been collecting since 2006 from 115 U.S.-based equity head traders, including equity assets under management, average daily volume and the percentage of shares executed in blocks. We extrapolate that data to the broader institutional landscape. Retail trade numbers and data from the government are used to determine retail flow. Data from NYSE and Nasdaq and historical market making volumes enhances our picture of current electronic market-making volumes. Last but not least, we discussed our methodology and trading profit calculations (.0024/share) with several HFT hedge funds, independent high-frequency traders and registered market makers.

Is It Good for the Market?

This is the wrong question. The right questions are whether the current market structure can be improved, and what the role of HFT should be in any revised market structure. But that is a scary question because outside of consulting (ahem), IT and perhaps the end investors, there is little for the industry to gain out of major changes to market structure.

The market structure changes and technological advances over the last decade that have made it possible for virtual market makers to supplant the traditional players are viewed as primarily positive for the market. Very few participants or observers suggest that we should roll back the clock on decimalization and exchange competition. Participants feel today’s market structure is orderly despite its complexity, and that it does a very good job of encouraging price discovery (see chart).

How Well Does Market Structure Support the Following Characteristics?

High-frequency equity trading is the lovechild between 12 years of SEC rulemaking and advances in trading technology. The combination of these two trends has been necessary and sufficient to unleash an array of new trading strategies. The continued success of these strategies has exchanges and ECNs, brokers and clearinghouses, and market data providers and technology vendors launching new business models and offerings to support high-frequency traders or to help others adapt to this new environment. Imagining a U.S. equity market structure without high-frequency traders is like trying to remove the c from E=mc2.

Adam Sussman is director of research for TABB Group. Previously he served as a senior product manager at Ameritrade, where he was responsible for order management systems, routing and next-generation trading tools focused on the equities and options markets.

Source: Advance Trading, 07.10.2009

Filed under: Exchanges, News, Trading Technology, , , , , , , , , , , , , ,