FiNETIK – Asia and Latin America – Market News Network

Asia and Latin America News Network focusing on Financial Markets, Energy, Environment, Commodity and Risk, Trading and Data Management

Mexico, The Emerging Latin American Powerhouse

TABB Forum:  For the past few years, coverage of Mexico in the U.S. media has largely been dominated by stories of violence stemming from the country’s drug cartels. Lately though, the media have increasingly been turning their attention to the story of Mexico’s booming economy, and new president Enrique Peña Nieto’s bold moves to radically reshape it. This robust growth in Mexico looks set to continue for some time, which has led the Financial Times to label Mexico as the “Aztec Tiger.”1

MexDer, the nation’s only futures exchange, has been taking steps to ensure that it grows apace with the nation’s economy by making substantial upgrades to its matching engine, while continuing to make it easier for foreign investors to access the market. As a result of these changes, as of yesterday, April 14, north-to-south routing to MexDer via CME Group’s Globex® platform is available on Trading Technologies. You can read the details in the news release that we published today and on  TradingTechnology website.

The Aztec Tiger 

A perfect storm of positive influences is coming together to make Mexico one of the world’s emerging economic powerhouses. Mexico has a young and growing population, low levels of government debt and low inflation. The country is developing into a leading exporter due in part to widespread implementation of new manufacturing processes, but also due to the fact that Mexico has free trade pacts with 44 countries—more than any other nation on earth.These forces have combined to make Mexico’s economy one of the few bright spots in a global economy still working off the hangover resulting from the credit bubble. Mexico’s economy grew at around four percent in 2012, quadruple the growth rate of Latin America’s largest economy, Brazil.2 The Mexican peso hit a 19-month high against the U.S. dollar in March, and has outpaced 16 other major world currencies over the last month.3

With its growth track record and favorable conditions for growth to continue, a Nomura Equity Research report in July 2012 predicted that Mexico would overtake Brazil to become the largest Latin American economy within the next decade.4 In addition, Standard & Poor’s and Fitch have indicated that in the near future, they are likely to upgrade Mexico’s debt, which is already investment grade.5

A Pact for Mexico, An Open Door for Growth

Much of the optimism for Mexico’s future can be traced back to its new president, Enrique Peña Nieto. He hails from the Institutional Revolutionary Party (PRI), which ruled Mexico uninterrupted for 71 years and was identified with corruption and inefficient bureaucracy. That being said, President Nieto is quickly making himself known as a risk taker, willing to take on fights in which none of his predecessors seemed willing to engage.

Within two days of his swearing-in last December, Nieto’s PRI signed a “Pact for Mexico”6 with the opposition National Action Party (PAN). This pact outlines 95 proposals to modernize and liberalize Mexico’s economy. Nieto began by taking on the richest man in the world, Carlos Slim, by announcing plans to foster competition in the telecommunication and television industries, which are currently dominated by monopolies. Later this year, Nieto is expected to propose his most significant change, opening up Mexico’s energy market and allowing the state-run oil concern Pemex to work with the world’s largest oil companies. It’s expected that these reforms, once enacted, will increase Mexico’s GDP growth from four percent to six percent a year.7

Making MoNeT

In parallel, MexDer and the Mexican government have done quite a bit to attract foreign investors, and to make it easy for them to access the market. Perhaps one of the most significant changes has been the development of the MoNeT matching engine, which went live on Bolsa Mexicana de Valores (BMV), the equities segment, last fall.

The MoNeT matching engine was designed to attract high-frequency traders, mainly from the U.S. and Europe. It boasts internal latencies of 90 microseconds, which is faster than the 110 microseconds of NASDAQ or 125 microseconds at the London Stock Exchange.8 BMV volumes have increased 30 percent to 40 percent since the launch of the new matching engine.9For international traders and investors, accessing MexDer is straightforward. The north-to-south routing available via CME Globex allows any TT customer with an existing CME infrastructure to route orders to MexDer’s matching engine. MexDer is also accessible now in TT’s MultiBroker environment, which is currently available in beta. Additional information regarding how CME users can access MexDer is posted on the CME website.There are a number of other reasons why doing business in Mexico is easier than most other Latin American countries. Unlike Brazil, there is no withholding tax of any kind on foreign investment. The Mexican peso is a freely traded and easily convertible currency, and MexDer’s clearing house, Asigna, accepts U.S. dollar-denominated collateral.

La Oportunidad Está En Todas Partes

Owing to the fact that the U.S. does $1.5 billion per day in trade with Mexico,10 the Mexican markets are, predictably, highly correlated with America’s. North-to-south customers trading MexDer via Globex have access to a number of financial futures that allow for arbitrage opportunities against their American counterparts.

MexDer lists the IPC index of the BMV, which in general tracks closely to the S&P 500. The full Mexican yield curve is available on MexDer, from one-month bills to 30-year bonds, and it converges with the U.S. yield curve. Finally, MexDer lists a Mexican peso/U.S. dollar FX future, one of the 20 biggest FX futures contracts in the world by volume, which sets up arbitrage opportunities with the CME’s equally liquid peso/U.S. dollar future. In a recent MarketsWiki interview, MexDer CEO Jorge Alegria indicated that going forward, the exchange would likely look to list commodity futures linked to similar contracts listed on CME Group.

BMV IPC vs. S&P 500
Chart obtained from Yahoo! Finance

The ascent of the Aztec Tiger is no sure thing. There is always the danger of President Nieto’s PRI party losing its appetite for reform and returning to its old ways. There’s the chance that the hiccups in the U.S. economic recovery may impact Mexico, given that 30 percent of the Mexican economy is tied to U.S. exports. There may even be signs that Mexico’s economy is stalling already, which led the central bank to reduce interest rates for the first time since March 2009. Either way, TT users now have the ability to participate in one of today’s most interesting markets.

1 Thomson, Adam. “Mexico: Aztec tiger.” Financial Times. January 30, 2013.
2 Rathbone, John-Paul. “Mexico’s reform plan lifts hopes for greater prosperity.” Financial Times. March 20, 2013
3 Kwan Yuk, Pan. “Mexican peso hits 19 month high”. Financial Times. March 14, 2013.

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Filed under: BMV - Mexico, Exchanges, Latin America, Mexico, News, Trading Technology, , , , , , , , , , , , , , , , , , ,

Coming to Grips With Big Data Challenges by Dan Watkins

The rate of data growth in financial markets has scaled beyond the means of manageability.

Debates have gone so far as to dismiss Big Data as being tamable and controlable in the near term with the current computing architecture commonly adopted as an acceptable solution. I agree but argue that conventional data transport – not management – is the real challenge of handling and utilizing Big Data effectively.

From exchange to trading machine, the amount of new ticks and market data depth are delivered only as fast as the delivery speed can endure. Common market data feeds that are used in conventional exchange trading are but a fraction of the market information actually available.

Perhaps due to high costs of $100,000 per terabyte, many market participants deem the use of more data as a bit too aggressive. Or they believe that high performance computing (HPC) is the next generation technology solution for any Big Data issue. Firms, therefore, are sluggishly advancing their information technology in a slow cadence in tune with the old adage: “if it ain’t broke don’t fix it.”

Over the last decade, Wall Street business heads have agreed with engineers that the immense perplexity of Big Data is best categorized by Doug Laney’s 2001 META Group report’s Three B’s: Big Volume, Big Velocity and Big Variety.

When looking at “Big Volume” 10 years ago, the markets had just defragmented under Regulation ATS. A flurry of new market centers arose in U.S. equities as did dark liquidity pools. This gave rise to a global “electronic trading reformation.” Straight-through processing (STP) advocates and evangelized platforms such as BRASS, REDIPlus and Bloomberg Order Management Systems (OMS) resulted in voluminous and fragmented market data streaming to 5,000 NASD/FINRA trading firms and 700,000 professional traders.

Today, the U.S. has 30+ Securities and Exchange Commission-recognized self-regulatory organizations (SROs), commonly known as exchanges and ECNs. For the first time since 2002, full market depth feeds from NASDAQ allow firms to collect, cache, react, store and retrieve feeds on six hours of trading for nearly 300 days a year more transparently than ever. Big Data volume has grown 1,000 percent and has reached three terabytes of market data depth per day.

Billions of dollars are being spent on increasing “Big Velocity.” The pipes that wire exchanges through the STP chain to the trader have become 100 times faster and larger but still not fast enough to funnel the bulk of information laying idle back in the database. Through “proximity hosting,” the telco is eliminated and latency is lowered. This structure results in adjustments made for larger packets but not really for more information as Big Data remains the big, quiet elephant in the corner.

Five years after Reg ATS, markets are bursting at the seams with electronic trading that produces explosive market data that breaks new peak levels seemingly every day. The SEC’s Regulation National Market System (Reg NMS), struck in 2007, requires exchanges and firms to calculate the best price for execution to be compliant. Firms are also now mandated to sweep all exchanges’ market order books and process all of that data for a smart execution.

After the execution, traders have to track the “order trail” from price to execution for every trade and store all of that information for seven years in the event of an audit recall of a transaction.

Under Reg NMS, subscribing to the full depth of all 30+ markets in “real time” would mean a firm would have to have a 1x terabyte pipe for low latency. Since a T-pipe is not realistic, data moves at 1x gigabits, which is relatively slow with the data in queue at 50-100 terabytes deep. Multi-gbs pipes, as fast as they seem, are still similar to driving five miles an hour on a 55 mph highway.

Analysts typically call data from a database with R (Revolution Analytics) and “SAS” Connectors. The process includes bringing data to an analytical environment in which the user runs models and computations on the subsets of a larger store before moving on to the next data crunch job. The R and SAS Connectors between the file servers and the database are at 10/100BASE-T, making the movement of 50 terabyte environment like driving one mile per hour in a 55 mph zone.

We all hear the polemics regarding data formats and the jigsaw puzzle of unstructured data and the fact that “Big Variety” is the obstacle. Even after standardization of SQL-based queries where analysts can ask any “ad hoc” question, too many sources and too many pipes from analytic servers cause traffic jams. SQL databases are ideal for unstructured queries but are slow in unstructured data compiling. Aggregating market information is where much of market’s processing technologies are being evaluated today to meet the requirements of regulations, sweeping for best execution and for risk management.

Comparing where current prices of stocks are against bids and asks to trade across multiple exchanges, markets, sources, asset classes and clients is essentially the Big Data task of risk management. In addition to managing data changes, firms are also tasked with managing their trading accounts, client portfolios and trading limits such as with the implementation of Credit Valuation Adjustments (CVAs) for counterparty risk.

So why are we still piping data around the enterprise when we just need more compute and memory power? Hardware-accelerated core processing in databases such as XtremeData’s dbX and IBM’s Netezza are powered by FPGAs (field programmable gate arrays). Processing of massive amounts of data with FPGAs can now occur at “wireless” speed. Along with high performance computing, high-speed messaging technology provided by companies like TIBCO, Solace Systems and Informatica have redefined transport times into ultra-low latency terms from one database to another in single microseconds, sometimes in nanoseconds, from memory-cache to memory-cache.

The colloquial phrase “in-database” analytics is an approach of running analytics and computations as near as possible inside a database where the data is located. Fuzzy Logix, an algorithmic HPC vendor, replaces the need for SAS and R connecting analytics, which stretch along the wire from the database to the analyst. With Fuzzy Logix, the need to call a database for small files is eliminated because computations can be done with the rest of the database in real-time: days to seconds faster.

With in-database or in-memory analytics, BI engineers can eliminate transport latency altogether and now compute at server speeds with computations sitting inside the database or in memory for tasks to be completed locally, not on the transport wire.

Wall Street is as risk averse as ever in today’s atmosphere so the adoption of new technology or new vendors continues to present operational risk challenges. ParAccel is a company that appears to be addressing the operational risk of new technology adoption by helping firms utilize the power of parallel processing of Big Data analytics on OEM hardware.

Since ParAccel is software, an IBM, HP or Dell shop could essentially rely on the reliability of their well-known, established database vendor but use next generation Big Data analytic processing an order of magnitude faster than what is currently in place. ParAccel allows firms to aggregate, load and assimilate different data sets faster than traditional platforms through its “columnar database” nodal system. The columns in a ParAccel environment provides firms with the flexibility to first run analytics in-database or in-memory, then bring massive amounts of data to a common plane and finally, aggregate the unstructured data and do it all in lightning speed.

Other companies like NVIDIA have been building graphic processing units (GPUs) for the video game industry for three decades and are now swamped with customer requests to help build parallel computing environments, giving financial firms the ability to run trillions of algorithmic simulations in microseconds for less than $10,000 per card, essentially. GPUs can have up to 2,000 cores of processing on a single NVIDIA Tesla card embedded inside. A GPU appliance can be attached to a data warehouse for advanced complex computations. Low-latency processing can also be achieved due to minimum movement of data over a short distance analyzing most of what Wall Street claims is Big Data in seconds compared with the days it takes now.

The vendors and players are ready to get to work; there just needs to be some consensus that the Big Elephant in the room is there and it’s standing on a straw when it could be surfing a Big Wave!

Source: Tabb Forum , 02.05.2012 by Dan Watkins, President @ CC- Speed dwatkins@cc-speed.com

Filed under: Data Management, Market Data, Risk Management, Trading Technology, , , , , , , , , , ,

Market Data Technology to Hit $3.6B in 2012

Demand for market data acceleration is driving the global investment in sell-side, market-data distribution technology in 2012 to $3.6 billion, according to a report released by the Tabb Group.

The report, Market Data Acceleration: More than Just Speed, also predicts 4.5% compound annual growth in these investments for the next three years based on expected growth in FX, Derivatives and Commodities as well as movement by Asian markets towards automation.

The largest segment of this investment, 73%, will come from Europe and North America, but according to Tabb Group, there’s considerable growth potential from the Asian markets.

Moreover, while the equities markets are matured from a growth perspective, driving 45% of the global spend, a strong percentage of growth will come from over-the-counter (OTC) derivatives, FX and commodities.

According to the report, market data is an area where performance can play a crucial role for a host of trading activities. Obtaining, decoding and utilizing market data in a timely and efficient manner are no longer the purview of the ultra-low-latency firms; everyone involved needs to be able to get at market data in as timely a fashion as possible.

“This is not to say that everyone needs to be at the ‘tip of the spear’; however, it does mean that anyone who is actively involved in trading needs to be moving in that direction,” said the report.

However, according to the research firm, firms are struggling with conflicting pressures of the “need for speed” in comparison to the “need to save,” as they try reconcile price with performance.

“Market participants need to ensure that their investment in speed gets them more than just a solitary solution for a single platform,” said Tabb partner and report writer Alexander Tabb in a statement.

Different firms, according to Tabb, have different strategies, thus different needs. Whether a firm is a high frequency trader, an institutional market maker, or an algo-trading desk, the challenge is placing speed into its proper context within the accelerated market data equation.

“Due to the democratization of speed, it’s essential for every buyer to remember to factor in total cost of ownership, price versus performance, operational flexibility, control, scalability and time-to-market,” says the report.

Source: Securities Technology Monitor. 23.04.2012

Filed under: Data Management, Data Vendor, Market Data, , , , , , , , , , ,

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

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

Latin American Electronic Trading: Caliente!

Latin America, dominated by Brazil and Mexico, is growing faster than fortune seekers from the global exchanges, banks and vendors can fly south.  The major stock markets were up 400% over the last decade, and the Brazilian derivatives market, BM&F, is now the sixth largest derivatives market in the world with growth of 67% in Q1 2010. In March 2010 the number of single stock option contracts traded on the Brazilian derivatives exchange BM&F passed the number of contracts traded on CBOE, ISE or NasdaqOMX.

Brazil and the rest of Latin America have not received the same adulation as other emerging market rock stars.  This changed in 2009, as Brazil emerged early and unscathed from the worldwide financial crisis.

Latin America’s time has now come. In the last two years, major exchanges have gone public, trading volumes have soared, brokers have rushed to deploy electronic trading services, early mover technology vendors have racked up impressive sales, and high frequency trading has begun.

Proprietary trading shops of local banks co-located at the exchanges battle it out with traders who have just flown in from Chicago.  Brokerage firms rush to deploy new algorithms to their buy-side clients. Exchanges play “hard to get” with global exchanges eager to bolster their emerging market credentials. Local technology vendors with relationships try to keep out foreign vendors with advanced technology. Brazilian bankers migrate back from New York to Sao Paulo because the bonuses are better. And everyone’s trying to arbitrage local stocks against American Depository Receipts.

This report is your map.
Latin America. Caliente!

This 41-page PowerPoint report focuses on the two largest markets Brazil and Mexico, but also covers Chile, Argentina, Peru and Columbia. The report covers both equity and listed derivative markets.

The report is divided into these sections:
Overview of the economies in the region, and stock market performance.
Exchange trading volumes – Data on size and growth rates of Latin American exchanges with a focus on BOVESPA (Brazil equities), BM&F (Brazil derivatives) and Mexico Exchange.
Exchanges – Review of the current state and future plans of the major exchanges in each market, including BM&FBovespa. Mexico Exchange, Santiago Exchange (Chile), and Argentinian exchanges. Technologies used internally, trading systems and networks offered to clients, partnerships such as BM&F and CME, regional alternative marketplaces.
Brokerage – Local and international equity and derivative brokers, recent acquisitions, technologies used in house and offered to clients.
Three case studies of local brokerage firms showing what in-house and vendor trading technologies they use and offer to clients.
Buy Side – Data on the types of asset management firms and what assets they own. Pension funds/hedge funds/retail investors/proprietary trading groups/foreign investors. Trading software and network vendors used by the buy side, including both local and foreign vendors.
Technology vendors – Market shares by OMS technology vendor, including local and global vendors. Usage of OMS, EMS, equity and derivatives systems, market data and network connectivity. Including local vendors CMA, Extol, Cedro, Estado, Apligraf and international vendors GL Trade, Bloomberg, Reuters, Fidessa, Marco Polo Networks, Charles River RTS, Pat Systems, Trading Technologies, CQG, TradingScreen, NYSE Technologies/NYFIX, BT Radianz, Progress Software Apama, Streambase.  In-depth information about local OMS, market data and network vendors CMA and Extol.
High frequency trading – Data on the growth of DMA/algorithmic trading/high frequency trading in Brazil during the last two years across both equity and derivatives trading. Review of what high frequency or algorithmic services exchanges and brokers provide. Case study of a high frequency trading firm in Brazil, with detail on the technologies used
Merger & Acquisition targets – local technology vendors with potential to be acquired.

About the Author
Martin Koopman has worked in the securities trading industry as President Cameron Systems, President North America Orc Software, CEO FMO Pty Ltd and as a consultant with The Boston Consulting Group. He lives in New York City and can be contacted at martink@aditat.com

Source: TABB Group, 28.04.2010

http://www.tabbgroup.com/PublicationDetail.aspx?PublicationID=608&MenuID=44&ParentMenuID=2&PageID=43

Filed under: Argentina, Brazil, Central America, Chile, Colombia, Exchanges, FIX Connectivity, Latin America, Mexico, News, Peru, Trading Technology, , , , , , , , , , , , , , , , ,

ASEAN markets cross trading links in demand – TABB Group

In new equity markets research published today, TABB Group says US and European demand for electronic linkage to Association of Southeast Asian Nations (ASEAN) exchanges is strong and primed to expand, as seamless access will attract brokers already trading in other parts of Asia. However, there is a wide range of needs across the different market segment, including direct market access (DMA), low-cost versus real-time market data, advanced order types, and reliable trading platforms.

TABB’s senior analyst Kevin McPartland, who authored the ASEAN Equity Markets Pinpoint report, an industry update on equity trading in the ASEAN region covering the Indonesia, Philippines, Thailand, Vietnam, Malaysia and Singapore exchanges, says the global financial crisis had little impact on growing buy-side demand for trading in ASEAN markets.

“More seamless access will drive brokers already operating in other parts of Asia to begin trading in the ASEAN markets,” he says, with the sell side set to benefit most from that seamless access. Explaining that the availability of real-time market data is crucial for all trading in the ASEAN markets, and that real time data is a requirement for the sell side even when trade volumes are low or non-existent, he adds, “High costs and time zones do tend to limit buy-side market data usage outside of the region.”

Addressing the relationship between the buy side and sell side, McPartland says that although no single broker currently dominates across all Asian markets, over 90% of buy-side firms are unwilling to give brokers full discretion over their orders. However, while the buy side does look to their brokers for market access, they agree that more seamless access would lower costs for execution and market data. There is also significant support for the idea of central ASEAN execution venue, McPartland adds.

The report’s in-depth coverage includes 24 charts:

  • Support for a central ASEAN venue
  • Improving ASEAN trading
  • Sell-side interest in ASEAN linkage
  • % of bulge-bracket participants trading in each market
  • Impact of the financial crisis on ASEAN interest
  • Roadblocks to sell-side trading in ASEAN markets
  • Buy-side broker usage – all Asia ·
  • Buy-side broker usage – ASEAN markets
  • Top brokers by country (by # of mentions)
  • Bulge-bracket participants trading in each market
  • Mid-tier participants trading in each market
  • Buy-side interest in a seamless ASEAN linkage
  • Roadblocks to buy-side access of ASEAN markets
  • Average number of buy-side orders per week
  • Average blended commission rates (bps)
  • % for which counterparty risk is an issue
  • Importance of each component when trading in ASEAN markets
  • Markets providing real-time market data to sell side
  • Market data sources for sell side
  • Markets providing real-time market data to buy side
  • Reasons for buy side’s lack of market data
  • How the buy side trades ASEAN markets
  • % of buy side using multiple data providers ·
  • Sell-side and buy-side market data providers

TABB Group collected data through interviews with heads of electronic trading from 12 top global broker-dealers, 9 hedge funds and 14 institutional asset managers. On the buy side, participants had combined global assets under management (AuM) of approximately $6 trillion and are currently trading in Asia from slightly under $10 million to over $5 billion monthly.

Source: MondoVisione, 23.10.2009

Filed under: Asia, Data Management, Exchanges, Indonesia, Malaysia, Market Data, News, Singapore, Thailand, Trading Technology, Vietnam, , , , , , , , , , , , , , , , , , , , , ,

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

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