My City – Brussels

October 16, 2018

By Fabien Oreve, Global Head of Trading, Candriam Investors Group

Best thing about your city?
Brussels is the capital of Belgium, a country of great cultural and linguistic diversity and is at the heart of the European Union, hosting some of the largest EU institutions (Parliament, Council and Commission). There are numerous fast train connections each day from Brussels to London, Amsterdam and Paris, making business trips quite easy.

Worst thing about your city?
Traffic congestion in and around Brussels is a real concern, in particular during EU summits. You can waste a lot of time when driving in or out of Brussels.

Getting to work?
Driving, as I prefer to be boss of my own I drive or take the bus to the office (approximately 20 minutes), depending on the level of traffic.

View from your desk?
I have a view on Luxembourg Street near the Place du Luxembourg, which is a nice square in the European Quarter of Brussels.

Where to take guests to dinner?
I take my clients to some great restaurants such as Lola, Place du Grand Sablon, or Kamo, La chaussée de Waterloo.

And a relaxed spot with family or friends?
There are many relaxed spots where you can enjoy local dishes with your dear ones in Brussels. I like De Nordzee, Sainte- Catherine street, for its home-made shrimp croquettes, and Chalet Robinson, Bois de la Cambre, for its traditional Belgian waffles with hot chocolate sauce.

Best place to stay when visiting?
I would stay a bit outside Brussels Centre, near Avenue Louise, a trendy area where you can find stylish, modern and comfortable hotels.

Best tourist site?
Most of the best tourist sites are located in Brussels Centre, the Grand Place and its amazing architecture, the Manneken-Pis, the Galeries Royales Saint-Hubert and the Mont des Arts. In the north of the city, a visit to the Royal Greenhouses of Laeken is also very nice.

Internationalising China’s Trading Standards

GlobalTrading

October 16, 2018

By Mao Ting, Senior Manager, China Foreign Exchange Trade System, and Jim Northey, Co-Chair Global Technical Committee and Co-Chair High-Performance Working Group, FIX Trading Community.

CFETS is keen to work closely with the FIX organization and ISO TC68 to improve standardization in China’s domestic market and share its experiences with the world.

The China Foreign Exchange Trade System (CFETS), also known as the National Interbank Funding Center, was founded in 1994. CFETS adheres to the principles of “multiple technical approaches, varied trading mechanisms and integrated demands from multitiered markets,” and is committed to developing infrastructure and providing innovative products and mechanisms for the China interbank market. Its strategic goal is to become “a major global trading platform and pricing centre for renminbi (RMB) and related products.”

By applying advanced information technology, leased lines and the Internet, CFETS provides a range of services covering issuance, trading, information and post-trade activities for the RMB-denominated interest rate, the RMB exchange rate and related products in the cash and derivatives markets. Every business day, it publishes market benchmarks including the RMB central parity rate, the Shanghai interbank offered rate (Shibor), the loan prime rate (LPR), the CFETS RMB index series, the fixing repo rate, bond indices, yield curves, etc. By the end of July 2018, CFETS has over 23,000 market participants.

The total trading volume in the first half of 2018 reached RMB 557.5 trillion ($81.4 trillion)

History of IMIX
In 2004, CFETS started to work on the messages standards of the China inter-bank market, so as to enhance inter-system connectivity and improve message transmission efficiency. Three national industrial standards have been published so far, including “Interbank Market Metadata”, “Interbank Market Information Exchange Protocol (IMIX)” and “Interbank Market Data Interface”. These three standards jointly form the basis of the Unified Business Data Exchange Platform.

Ever since its release, IMIX Protocol has been widely used in China’s interbank market, covering pre-trade, trade, and post-trade processes. IMIX is used not only between interbank market participants and CFETS, but also between CFETS and other interbank infrastructures, such as Shanghai Clearing House, Shanghai Gold Exchange and China Central Depository & Clearing Corporation.

The IMIX protocol was based on FIX.4.4 firstly. CFETS extended more than 100 message types and 1000 filed tags to support the business in the China market. Until now, the most used protocol format is “Tag-Value”. In addition, IMIX protocol also supports Google Protocol Buffer and JSON format. CFETS, now a FIX Trading Community Global Member, is working on updating the IMIX to support FIX.5.0, SBE and the other FIX standards.

Standard usage in FX trading system
CFETS launched the new generation of its FX trading system, called the New Trading Platform (NTP), in February 2018. NTP supports FX spot, forwards and swap products and the Quote Driven Model (QDM) and Order Driven Model (ODM). CFETS adopted the IMIX protocol to build the interfaces of the system, including market maker interface and taker interface.

Taking request-for-quote (RFQ) as an example, the RFQ process is initiated by the member sending a quote request message (QuoteRequest). This contains specific products, trading volume, trading direction and expiration time. Each RFQ is identified by the QuoteReqID field, which will appear in all messages associated with the RFQ. After the system processing the quote request message, the member can receive a series of quote or quote revocation messages. Each quote message will overwrite the previous quote for the same QuoteReqID, LP and product. Members can submit a limit order with only one QuoteReqID, which will match all eligible orders in the RFQ pool.

Members can also initiate a new order for a specific offer, the order type is Previously Quoted (PQ), and the message contains the QuoteReqID and the QuoteID corresponding to the offer of the desired deal. At this time, the order will only match the quote.

Both limit orders and PQ orders are a combination of Full Amount. The member will then receive an ExecutionReport (ER) to accept or reject an order (if accepted, there will be a further ER indicating the deal or the order is revoked). The termination of the session will end all RFQs.

The following is a flowchart corresponding to RFQ in the case of quotation execution. The flowchart describes the process of how members and trading centers conduct transactions through IMIX messages.

Experience in submitting ISO 20022 messages CFETS also seeks to make China interbank market standards more internationalized, to keep in line with the internationalization of China’s financial markets and currency. One strategy is to get involved in the implementation of ISO 20022.

After gap analysis of the current ISO 20022 messages and IMIX messages, CFETS developed and submitted two business justifications for new messages in January 2014: “FX Post Trade Trade Capture” and “FX Post Trade Confirmation”. Message models and MDRs were submitted and approved in February 2016. The eight FX Post Trade Trade Capture and FX Post Trade Confirmation messages are designed to be implemented in the orange boxes shown below:

Ever since their release, these eight messages have promoted the rapid development of trade confirmation and straight through processing (STP) APIs of FX market in China.

ISO 20022 semantic models
The IMIX standard created by CFETS is based largely upon the FIX.4.4 standard. IMIX is represented by QuickFIX data dictionary definitions. One of the goals CFETS has set is to align its standard closer to the FIX standard and at the same time help to integrate the FIX standard within ISO TC68.

One of the long-standing objectives of the ISO and FIX Trading Community has been to integrate the business level semantics of the FIX protocol within the ISO 20022 standard. The ISO 20022 standard includes both a business domain model and a message model. The scope of ISO 20022 is all of financial services, including core banking, payments, credit card processing, custody, collateral, and settlement. The FIX standard is focused on pre-trade through post-trade/pre-settlement processing for financial instruments.

The financial instruments that are traded using the FIX protocol have expanded well beyond equities to include listed derivatives (futures and options), FX, FX swaps, fixed income, repos, interest rate swaps, and OTC-like derivatives traded on a venue. The FIX Community invested considerable effort in mapping FIX into the ISO 20022 model. However, the benefits of this major effort were elusive due to the limits of the modeling tools and the approach.

ISO TC68 initiated a working group to bring Web semantic technology into the ISO 20022 standard in 2014. The working group spent considerable time understanding semantic technology. The working group is now identified as ISO TC68/SC9/WG1 after a strategic realignment of the subcommittees (SC9/ WG1). SC9/WG1 has created a multistandard semantic portal that was derived by enriching the metamodel of ISO 20022. This new semantic model of messaging and the corresponding business model provides a common structure to represent multiple disparate standards.

Once in this standardized model format, automation tools and even semi-autonomous machine learning can be used to begin to provide convergence across the disparate standards that exist across the financial services industry. Two of the protocols that are now available via the multistandard semantic portal are the FIX Standard and IMIX from CFETS.

To the Web
CFETS, now a FIX Trading Community Global Member, is working with the FIX organization and with ISO to create international standards for the use of Web-based APIs. Many readers may have heard of RESTful APIs or REST-based APIs that use the HTTP internet protocol. Financial services, along with all other sectors, has been inundated with the API revolution across payments, card processing, and trading. The problem with REST is that it is a synchronous protocol that does not scale, nor does it lend itself to the high volume asynchronous messaging requirements of trading.

CFETS and FIX have both pioneered the development of asynchronous messaging using Websockets, which is an IETF standard that is now widely available.

Websockets functionality will be fully integrated within the next version of the HTTP protocol, HTTP/2. Both CFETS and the FIX Trading Community are actively participating in the ISO TC68/SC9/WG2 Web service-based API in financial services. FIX Trading Community recently released a proof-of-concept system that implements the FIX application level semantics (the business messages) encoded in Simple Binary Encoding (SBE) or JSON (Javascript Object Notation) over a secure Websockets layer. This working example is available via Apache 2.0 licensing to all users of FIX, such as asset managers, brokers, venues, independent software vendors, and other service providers.

It is hoped that this pioneering work will help inform and assist the ISO TC68/SC9/WG2 in addressing the need for an international standard for financial messaging over web technology.

Buy-Side Multi-Asset Trading: Challenges and Opportunities

GlobalTrading

October 16, 2018

By Terry Flanagan, Managing Editor, MarketsMedia

For the buy-side, multi-asset trading offers the promise of efficiencies, cost savings, and closer alignment with an increasingly interconnected global marketplace.

But how far do large investment firms wish to go to amalgamate legacy siloed trading desks? What is the blueprint? And most critically, what are the risks and rewards?

Those questions were among topics explored at a September buy-side roundtable in Boston, hosted by the GlobalTrading Journal and sponsored by TradingScreen.

As the buy-side universe is expansive, with an abundance of investment models and strategies, each journey toward multi-asset trading is unique. But there is one common denominator that’s vital in driving the process forward: the underlying technology.

“All of the consolidation and activity in the trading-technology space highlights the need for integrated workflows and increased automation across asset classes,” said Varghese Thomas, Chief Operating and Strategy Officer at TradingScreen. “Leveraging established and trusted technology partners are necessary to help bridge the gap between current solutions, fintech platforms as well as new emerging asset classes.”

At a TradingScreen-sponsored roundtable in New York in June, participants noted that the buy side was shifting to buying technology rather than building technology; interoperability of systems and ‘big data’ management were core challenges; and automation of processes, while a key ingredient in the evolution of a buy-side trading desk, has its limits.

The Boston discussion addressed the latter point.

“The reality is that not everything in multi-asset trading can be done programmatically — there will still be a need for human oversight,” said Joseph Bacchi, Head of Multi-Asset Trading and Investment Operations at Acadian Asset Management. “There isn’t one venue, one strategy, one platform or one relationship. That’s the foundation of multi-asset trading.”

Market Recon

Some senior traders and technologists who attended the roundtable event said they were there to gather market intelligence, i.e. assess industry trends and vet what an individual firm is doing versus what the broader marketplace is doing. In multi-asset trading, in particular, there is ample opportunity to learn from earlier movers.

“Firms are at varying stages in the migration to a multi-asset class environment – some are just starting, some are fully multi-asset,” said Rob Hegarty, Managing Partner at Hegarty Group and roundtable moderator. “Others prefer to keep equity separate from fixed income and currency, at least for now.”

As drivers of the migration to multi-asset trading, Hegarty cited increasing cost pressures; opportunities for collaboration; the availability and ubiquity of data; the rise of quant resulting in cross-asset strategies; advancements in available technologies such as Execution Management Systems; and new asset classes such as cryptocurrency.

One roundtable participant noted that consolidation of trading technology across asset classes is a lengthy process, and there is the question of whether technological products are mature enough to support multiple trading scenarios.

This person said one approach to technology is to leverage vendor platforms to handle ‘plain vanilla’ tasks, which frees up traders to concentrate on higher-value, more strategic workflow.

Another participant agreed. Amid the evolution of high-touch and low-touch trading, “you need deep-level experts to deal with the more difficult order flow,” this person said. “There’s lots of easy-to-do stuff on every desk. The challenge for the team is how to siphon that out.”

One topic of interest was the recent flurry of mergers and acquisitions in the vendor space — State Street acquiring Charles River, SS&C acquiring Eze Software, and Ion acquiring Fidessa. The deals are in line with the overall theme of consolidation and reduction of technology footprint in the front and middle office.

“The buy side appears to be strongly in favor of the (M&A) strategy, as it should help them reduce costs,” Hegarty said.

Investment managers are closely watching the emergence of cryptocurrencies. Roundtable participants weren’t so much interested in whether the price of bitcoin will rise or fall, but they are very interested in whether crypto has staying power, and if so, how a firm can integrate it into a multi-asset trading framework.

One trading technologist said he believes cryptocurrency is for real, and his firm has set up a committee to study the asset class. “It rides some of the same rails we have today, but there are some new ones,” this person said. “Security is a huge deal and custodial aspects are monumental.”

“Once it gets up to speed you’ll see a lot of similarities to currency trading, and ETFs will be involved,” the participant continued. “But there are scary pieces and you really have to be very cognizant of how it works.”

Another person noted there are many new trading platforms, primarily in fixed income and cryptocurrency, but some of these are “pop-ups” that disappear as quickly as they appear. “There doesn’t seem to be much staying power,” this person said. ‘Who will be the winners? We can try to pick one but then we may find out later that the liquidity isn’t there.”

Why The US Treasury Market Needs Algorithmic Execution

GlobalTrading

October 9, 2018

By Alastair Hawker, Global Head of Sales, Quantitative Brokers

Algorithmic execution strategies are available for buy-side firms to automate execution in US Treasuries, improving performance and efficiency.

Automated trading, or specifically, algorithmic execution, of cash equities is prevalent to the point where execution without an algorithm is a rarity. In futures, use is not quite as extensive but it is well established. Even FX markets, which are greatly fragmented, have seen growth in execution algorithms in the last couple of years. And then there is fixed income, where it is almost non-existent in comparison.

Have a think about what the publisher of this magazine represents: the important FIX protocol that enables standardized messaging for order flow across the industry. It is used extensively for cash equities and futures, so why not cash Treasuries (USTs)? Why should most of the buy-side execution in one asset class be instant via a request-for-quote (RFQ)? Why should executing 1000 ten-year Treasury futures contracts be done differently to executing $100 million ten-year treasuries?

Buy-side firms have FIX connections to utilize many types of algorithms that enable them to access liquidity, reduce costs and enhance efficiency. However, although electronic trading of the US Treasury market is widespread between dealers and liquidity providers (the “inter-dealer” market), the buy-side is only at the beginning of the inevitable journey towards automation through execution algorithms.

It’s hard to imagine that USTs will not eventually be like cash equities and futures. We are not talking about the liquidity challenges of corporate credit markets here – the US Treasury market is an enormous market ripe for automation and the buy-side stands to benefit from an alternative to RFQs.

Fragmented market

Similar to equities markets and in contrast to futures markets, the electronic Treasury market is characterised by a fragmented landscape, consisting of numerous central limit order books (CLOBs) and direct pricing streams. The result is a complex structure that needs smart order routing (SOR) for successful navigation: aggressive orders need to be routed to where the cost is the lowest, achieving best price and minimum transaction fees. Passive orders are more challenging – they need to be divided between venues in such a way as to maximize the fill rate.

Recently, Quantitative Brokers (QB) completed a project on machine learning (ML) for SOR, which facilitates the intelligent aggregation of liquidity from multiple sources. It will be used to solve the problem of where to send child orders when there is a choice between different liquidity pools.

Current trading practices by the inter-dealer market participants have established a model for successful adoption of automation by buy-side firms. Almost 70% of all volume traded in the US Treasury market is conducted via electronic trading platforms, with over 90% of the nearly $200 billion traded daily (interdealer) executed electronically, according to research by Greenwich Associates.

Nevertheless, it is surprising how comparatively little buy-side execution in US Treasuries is automated and undertaken directly with electronic liquidity. RFQs still dominate – part of the reason is habit, but for various reasons there has also been a lack of investor access, or willingness to access, electronic liquidity.

Independent algorithms

Some of the challenges with access can be alleviated by firms that represent the buy-side as impartial agents, providing the connectivity and technology to aggregate liquidity and automate execution. QB is neutral and conducts no proprietary trading – its interests are entirely aligned with its clients.

QB’s suite of algorithmic execution strategies help buy-side clients minimize transaction costs, hide their footprint, and improve their productivity. These are available for on-the-run USTs, as well as futures markets.

QB’s flagship “Bolt” algorithm facilitates best execution across wide-ranging market conditions, benchmarked to arrival price. “Closer” provides optimal trading into the market close (settlement price benchmark); “Legger” intelligently manages legging risk for multi-leg orders; and “Strobe” attempts to capture the spread within a client’s defined time schedule, tracking a volume weighted average price (VWAP) or time-weighted average price (TWAP) benchmark.

Data

The key ingredient for successful automated trading is data. What matters for investors is understanding what means of execution is best for them. It is not just about requesting multiple quotes and trading at the best-quoted price. It is evaluating an entirely different way of executing and whether that is more optimal, taking into account pricing, anonymity and information leakage. Comprehensive transaction cost analysis (TCA) helps with this and is another part of QB’s client service.

There was also the introduction of TRACE reporting for US Treasury transactions in 2017. This has provided regulators with a more comprehensive picture of US Treasury market activity, but there is an unresolved debate about broader dissemination of this data to the public. Given the full transparency and resulting efficacy of listed markets, it is hard to understand how releasing this data would not be in the public interest. While this remains in discussion, the good news is that there is still enough data available for execution algorithms to work effectively. More data would always be welcomed, especially to help TCA benchmarking.

Third Party Clearing: Have Brokers In APAC Reached The Tipping Point?

GlobalTrading

October 9, 2018

An Exclusive Global Trading Roundtable

Outsourcing clearing can provide capital efficiency and access to liquidity as well as ensure that brokers are compliant with new regulations and accommodate the latest technologies, according to a thought-leadership discussion.

Many Asia-Pacific markets are implementing significant changes to their trading infrastructures, while new regulations, products and technologies are transforming their clearing and settlement practices.

The changes are not homogenous across jurisdictions, which add further complexities and risks to brokers’ operations.

In this environment of dynamic, diverse and rapid evolution, firms are being forced to question whether their historic models of self-clearing are competitive and cost-effective, or if recourse to third-party clearing (TPC) is a more viable and efficient alternative.

TPC has already been widely embraced in Europe where more than 85% of equities clearing is now outsourced, but Asia-Pacific offers unique challenges – as well as opportunities – to its successful provision and adoption in the region, agreed participants at a GlobalTrading roundtable discussion sponsored by BNP Paribas Securities Services on 9 May 2018.

Managing liquidity in Asia-Pacific offers particular challenges. Investors selling a security in one market are required to go through an FX transaction to cover a trade settling in another market which causes a delay in funding and affects intraday liquidity requirements.

Similarly, brokers may need to move funds from market to market to ensure the timely settlement of transactions with their clients.

One solution is for brokers to seek intraday liquidity from their banking partners. This needs to be flexible enough to cover any peak activity that can come from rebalancing periods for their clients, while not creating significant fixed costs that can hit profitability. For instance, the banking partner may request collateral from the broker to provide a necessary credit line.

Liquidity in fragmented markets

Alternatively, TPC can provide intraday liquidity solutions to the broker on an uncommitted, undisclosed basis to assist in the coverage of their daily activity or, at an extra cost, on a committed or overnight basis to add more certainty.

Compliance with the standards and rules governing custodial, clearing and settlement services is critical, but it imposes an expensive and time-consuming burden on a self-clearing broker to invest and adapt to regulatory adjustments and to infrastructure alterations.

TPC offers flexibility and efficiency as an alternative to legacy account-operator models. It can reduce capital expenditure on back-office systems and staff hires as well help streamline the clearing and settlement process, taking care of project expenditure on operations and IT, thereby freeing up the broker to focus on its core business.

TPC can deliver other cost savings. Although IT expenses are hard to quantify – and it can be difficult to prioritise post-trade operations as budgets are constrained – freeing up capital could save hundreds of millions of dollars if a broker moves its clearing to a TPC. Payment of margin calls and contributions to the default fund are passed to a TPC partner, who also takes on the responsibility of preparing for future changes to market infrastructure.

In Hong Kong, the Financial Resources Rules (FRR) imposes strict and onerous capital regulations for clearing, providing a substantial incentive to choose TPC. Brokers can now include receivables in their liquid assets but cannot net them off against payables (although the Securities and Futures Commission is considering the possibility), which means brokers are wasting capital by not using TPC. If they do not clear trades through a third party, brokers are better off setting up affiliates elsewhere in the region to book trades.

Systems inertia

However, arguably it makes little sense for a broker to switch to TPC if, as is largely the case now in Asia-Pacific, the service can only be provided for cash equities. Unless a comprehensive, multi-asset service is offered, then a broker will still need to dedicate resources to back- and middle-office clearing and settlement functions – for example for fixed income transactions – which might negate the cost-benefits of moving to TPC and might even increase operational complexities within a firm.

Although it is a challenge to TPC providers to cope with the diverse jurisdictions, market infrastructures and regulations in Asia-Pacific – especially in order to facilitate cross-market transactions – it is also a tremendous opportunity.

Fragmentation might make the task daunting, but it will be rewarding to those TPC providers who can solve the complexities.

One concern is that the continual changes underway make it difficult for brokers to evaluate outsourcing propositions. It is tough to plan and make long-term commitments when the future regulatory environment is so unclear. It is also hard to justify jettisoning legacy systems built up during the past 10-to-15 years to meet the requirements of market evolution successfully and outsourcing (and ceding control of) those settlement and clearing functions to an uncertain future.

If current clearing models are working well, then why take the risk and suffer the inconveniences that the disruption and complexities of switching to TPC entail? Perhaps, it is premature to move to TPC when you don’t know what’s around the corner. In addition, there is concern that vendors might miss new regulation and fail to make necessary adjustments to their systems, leaving brokers exposed to financial penalties and reputational risk.

On the other hand, a skilled and experienced TPC operator can provide clients access to its technological expertise, saving them the effort of developing, maintaining and upgrading in-house technology, or the aggravation of finding a vendor to outsource their technology needs.

Compared to self-clearing’s high fixed costs such as capital for collateral, staffing and compliance, outsourcing the service can lead to lower and more manageable variable costs and reduces the monitoring required by an international broker for every change in each local market.

There are also concerns among brokers that a rival bank – one that offers a TPC service but nevertheless competes for investor trading business – might have access to the broker’s transaction data. A “utility” TPC, with several banks contributing to its funding, might be a more attractive model to brokers worried about client confidentiality breaches.

The creation of such a model is probably a long way off, as TPC is likely to remain a revenue-earning service and continue to provide a commercial edge for individual banks for the foreseeable future. Moreover, if competitors come together in such a joint venture, disputes about who is benefiting or paying the most are perhaps unavoidable.

Asia-Pacific evolution

Yet, regulatory changes and the introduction of technological innovation indicate that Asia-Pacific is moving towards adopting new practices. For instance, exchanges in Hong Kong, Singapore and Japan are assessing the merits of blockchain technology following Australia’s lead. Meanwhile, India and Malaysia, among other Asia-Pacific markets, are considering adopting SWIFT’s ISO 20022 messaging format, which could replace legacy systems connecting to central counterparty clearing houses and central securities depositories.

Moreover, global investors will have access to a large slice of China’s $7 trillion market following MSCI’s decision to include China A Large Cap stocks in its benchmark emerging markets Index; and late last year HKEX announced major changes to its listing rules and procedures in a bid to gain a bigger share of the global IPO market.

These and other factors present a significant opportunity to investors keen on diversifying their portfolios in Asia-Pacific and benefiting from the region’s growth story, while brokerages should expect to play a major role in facilitating the process.

During a period of rapid developments in regulation and technology, brokers that do not review their revenue models are risk. Some might choose to maintain the status quo, but they should at least examine the viability of existing models and assess the opportunities of TPC.

Institutionalising China’s Equities Markets

GlobalTrading

October 9, 2018

By Andrew Freyre-Sanders, Managing Director, Brina Tan, Director and Vernon Willis, Executive Director – Execution Services, Haitong International Securities

Foreign investors raising allocations to China following MSCI partial inclusion will encounter a radically evolving market and will require expert guidance.

The most important recent development in China’s equities markets is the establishment of a domestic institutional investor infrastructure. Pension reform and new asset management rules, culminating in the creation of the Financial Stability and Development Committee in November 2017 to formalise, regulate and develop China’s financial system, have set in motion a fundamental shift towards institutionalising the markets.

Total domestic assets under management (AUM) held by insurance companies and mutual funds should rise by 30% a year as a result, according to Z-Ben forecasts, and will help erode the dominance of retail investors who currently make up around 80% of market activity.

The transfer of 10% of state-owned enterprises’ equity holdings to the existing Rmb2 trillion ($292 billion) National Social Security Fund (NSSF) is one of the largest asset transfers in China’s history. In addition, seven of the Rmb6 trillion local social security funds are moving to the NSSF to manage and invest in broader asset classes than just government bonds and cash, and 21 external fund managers have also been appointed to manage local social security funds. The introduction of tax-deferred pensions will further boost the savings industry.

The domestic asset management sector has also been fortified by new regulations, including limits to off-balance sheet offerings, a ban on guaranteed return products and the setting of a 10% provision target for fund managers. Meanwhile, the insurance, banking and fund management sectors have been opened up to foreign investors, allowing majority shareholdings which will rise to 100% ownership over the long term.

In combination, this means that China is not only going to see a rapid expansion in institutional pensions and other assets under management during the next five years, but also a major change in the fund management landscape, with greater openings for foreign asset managers and advisors balanced by the rising sophistication and development of China’s new breed of institutional investors.

The recent history of the Indian equities market provides a template. It rapidly evolved into an institutional investor-driven market as micro changes to its infrastructure were introduced, and global funds rushed to correct underweight allocations.

Foreign investor access

Of course, the eye-catching MSCI partial inclusion of A-shares in its benchmark indices this summer is significant and will attract foreign investors. However, despite the promise of faster MSCI inclusion than previously expected, foreigners’ relatively small size (3.7% of total tradable market) means their influence will be limited for the next couple of years at least.

Given MSCI’s endorsement of China Connect, foreign investors, including passive funds, have typically adopted this access mechanism to trade China A-shares. However, foreign investors still face considerable logistical and operational challenges accessing the market via China Connect in an efficient manner and satisfying best execution obligations. The magnitude of these challenges can vary depending on many factors including the number of sub-accounts, the use and costs of integrated broker model versus SPSA, the process of establishing SPSA sub-accounts, limited ability to trade on omnibus, tight custodian settlement cut off times, funding and CNH liquidity concerns, single-sided settlement. Success requires coordination and military-style planning across clients, their end clients, global and sub-custodians, brokerages and exchanges and this complexity requires expending human and financial resources.

Brokerages and foreign investors are required to set up with robust operating procedures. Proximity to the market helps provide reassurance. Many US- and Europe-based investors are understandably nervous about the operational risks, especially the certainty of trade settlement and integrating their Special Aggregated Accounts (SPSAs) within their back-office systems. Moreover, the broker-selection limitations inherent in the QFII and RQFII programmes arouse concerns that aspects of “best execution requirements” of MiFID II might be breached.

Dense and voluminous broker manuals are also off-putting. It makes sense, therefore, that investors collaborate with and use a broker who has a deep understanding of the technical and operational features of both the China market and how to access it seamlessly.

Trading China

Haitong International considers the microstructure and liquidity of the equities markets in Shanghai and Shenzhen as particularly well-suited for electronic trading and algorithmic strategies. To simplify their China instrument order routing, some of our institutional clients have indicated they would prefer one broker FIX connection for care and electronic trading orders irrespective of whether they are trading on (R)QFII, B-shares or via China Connect and we are in process of implementing this facility. Looking further ahead we intend to deploy our electronic trading platform onshore to provide institutional clients WFOE operations the same execution tools as their offshore trading hubs.

Haitong International’s algorithms have been configured and adapted to handle some of the nuances between trading via China Connect and directly on the Shanghai or Shenzhen Exchanges. These include the three-second market data latency in Shanghai, client odd lot requirements and adaptable trading strategies, trading behaviour around limit up/down alerts, and local regulatory interpretation and market guidance on cancel/fill ratios, order submission numbers and close participation. Our China-focused quant models have shown encouraging results, for example during retail-centric liquidity bursts.

Haitong International also aims to utilise Haitong Securities onshore presence and relationships to assist clients to engage the regulators and the exchanges to shape discussions about the common challenges and concerns.

The introduction of the Shanghai exchange closing auction on the 20th August appears to be a good example of the Chinese authorities listening to international investors concerns and acting relatively quickly ahead of the next phase of MSCI A-share inclusion. Indeed, as the China markets open up to offshore funds, Haitong Securities onshore presence will be an important resource we hope clients will tap into as they increase their presence.

We believe that if foreign investors had three wishes to improve China market access, then amongst their priorities would be:

an extended settlement cycle in line with other regional markets to manage cash flows and accommodate investors in non-time zone locations,
the introduction of omnibus trading similar to the models adopted in other ID markets, and
making it easier for participants to agree, transact and report block trades in A-shares. On this last wish, the provision for both foreign and domestic funds to transact block trades consistently (including within stock connect) will be a milestone, and already it seems a marker has been laid down with a $700 million block which was reported to the exchange on 8 August and appears to have been crossed between an offshore and onshore investor.

Clearly, brokerages and buy-side trading desks need to aware and prepare for the growth and changing composition of the international and domestic client base over the next decade, and be sufficiently agile to adjust to changes taking place in the structure of China’s markets.

China’s Markets Enter The Mainstream

GlobalTrading

October 1, 2018

By Stephane Loiseau, Managing Director, Head of Cash Equities & Global Execution Services for Asia Pacific, Societe Generale

MSCI’s partial inclusion of China A-shares in its benchmark indices is a catalyst for inflows of global capital, and has prompted traders to rethink their algorithmic strategies.

Recent developments mean that international investors must build their capacity for efficient and seamless trading in China’s onshore equities. Several enhancements to the Stock Connect schemes introduced by the Chinese authorities have eased risk and regulatory concerns, while the well-established Qualified Foreign Institutional Investor (QFII) and Renminbi QFII schemes have familiarised brokerages and buy-side firms with the idiosyncrasies of China’s capital markets.

The catalyst, however, for a surge in expectation and active participation has been the MSCI’s decision in June 2017 to include renminbi-denominated A-shares into its benchmark Emerging Markets and All Country World indices. MSCI added around 230 predominantly blue-chip stocks in a two-step process in June and September this year, following a fourth consultation with global investors since discussions began in 2013.

This year’s five percent partial inclusion, making up approximately 0.73% of the MSCI EM index and 0.1% of the MSCI All Country World Index, is likely to attract about $20 billion of capital into the Chinese equities markets – the third biggest in the world.

Passive investors tracking the benchmark emerging market index had already been required to prepare, but active investors have also been prompted to put systems in place to meet the benchmark requirements, and to benefit from opportunities to earn alpha returns. Moreover, the proliferation of active onshore investors has also encouraged a view of China not only as a liquidity option, but also a trading prospect.

Evidence of this renewed interest is not hard to find. There were about 4000 special segregated accounts (SPSA) before the implementation of the first inclusion by MSCI in June this year; by the beginning of August the number had soared to more than 5800, just before the second inclusion commenced on 1 September.

The MSCI decision was based on positive responses in their consultations with international investors, whose attitude was in turn shaped by improvements to the Stock Connect schemes and to the functioning of the Chinese markets by the Mainland authorities. The Chinese authorities seem clear in their intention to open up their markets to overseas investors and hence re-balance flows, as well as introduce the disciplines of professional institutional fund management in markets that are still around 80% dominated by domestic retail investors.

Indeed, the only significant differences between trading the Chinese market and the US and Japanese markets are some residual operational hurdles which, nevertheless, are navigated by dedicated teams at brokerages, such as Societe Generale. Local skills and professionalism in the Chinese financial industry have also improved in recent years, while a repeat of the destabilising stock suspensions common during the 2015-2016 market turmoil have been forestalled as the authorities pursue a rule-based roadmap to improve market integrity.

Removing operational obstacles

Although international access to the Chinese market was inaugurated as long ago as 2002 with the launch of the QFII programme, regulatory initiatives during the past four years have accelerated. In particular, the launch of Shanghai-Hong Kong Stock Connect in November 2014 and Shenzhen-Hong Kong Stock Connect two years later have spurred global investor interest and activity.

These two-way investment schemes between Hong Kong and the mainland’s two main bourses allow investors to buy Chinese shares through Hong Kong, and vice versa. The daily quota for “northbound” purchases of shares quadrupled to Rmb52 billion ($7.6 billion) from Rmb13 billion on 1 May.

China’s regulators have been quick to address several criticisms of the operational aspects of the Connect schemes, such as trade settlement and custodial idiosyncrasies and they continue to act on recommendations from international investors.

For instance, in June the Shanghai Stock Exchange introduced a consultation to include a closing auction, which is widespread in developed markets and a necessary mechanism for daily valuations of US- and European-managed portfolios. While normally domestic investors are trading intra-day based on market opportunities, many have responded to the recent MSCI trends, by trading towards the close of business too.

Perhaps the greatest problem for international fund managers is the number of days that the market is effectively closed to them. Trading through Stock Connect is conducted with offshore renminbi (CNH) and investors cannot buy CNH on public holidays when the Hong Kong Stock Exchange (HKEX) is closed, and nor can they on the day before the holiday. The problem can be exacerbated by the closures of the exchange on typhoon days.

HKEX could alleviate this obstacle, at least for purchases; sales would be harder to accommodate because the banking system also shutters on these days. In the meantime, this issue is one of the main reasons why many investors also retain their QFII accounts.

Meanwhile, ambiguities about beneficial ownership have been resolved and the T+0 trading cycle is now manageable through SPSAs and augmented by the 24-hour coverage of trade pre-allocation by brokerages.

It is unlikely that QFII will be abandoned any time soon; instead it may be preserved and enhanced as one of the several parallel routes to China’s capital markets. QFII has attractions in addition to its consistent availability: the channel provides entry to a wider variety of instruments, and recent measures have removed the lock-up period for principal and, crucially, allowed onshore currency hedging. Of course, many of the largest investors with exposure to China would like the fungibility between the QFII and Stock Connect schemes, but it is not seen as the highest priority for them or the authorities at least for now.

Optimizing trading

Societe Generale has been trading Chinese equities since the launch of QFII in 2002, and is fully aware of the markets’ idiosyncrasies and challenges as well as its opportunities.

Traders have had to adapt their algorithms and electronic trading practices to markets dominated by retail investors who sometimes are driven by speculative purpose or indeterminate information, and where daily volume distribution tends to be flat rather than peak at the end of a trading session which is more commonly observed in other regional and global markets.

Societe Generale’s full suite of algorithmic strategies, offered to the firm’s institutional clients and equally suitable for QFII and stock connect, are adjusted to fit the individual volume characteristics of around 3500 individual mainland Chinese stocks, and reflect their particular correlation disparities with the index. In addition to trading volumes, they encapsulate volatility and fair-value calculations.

Sensitivity factors are built into the algorithms that include a wider acceptance of individual stock price movements from its sector index, yet with maximum limits applied, therefore providing a sound level of risk that incorporates a combination of several microfactors. Gathering data is also difficult, but inroads are being made into identifying informative news and trends from social media.

As China continues its effort to open up its capital markets to international investors, the MSCI is likely to decide on full inclusion of Chinese stocks in its benchmark indices which, according to analysts’ estimate, would attract an inflow of $300 billion from international investors. It is therefore essential that trading desks and portfolio managers have the capability to transact effectively as soon as possible.

Technology For The Portfolio Lifecycle

GlobalTrading

October 1, 2018

By Damian Bierman, Head of Asia-Pacific, Portfolio Management & Trading Solutions, FactSet

Buy-side technology continues to evolve, but solutions offering different pieces of the portfolio lifecycle form a patchwork landscape.

The integration of the portfolio lifecycle is fraught with complexity and challenges for all firms who navigate it. This has created an opportunity in the market for a new approach.

When we talk about the portfolio lifecycle, we mean, in the broadest terms, the process of executing an investment idea: Everything from researching the idea, generating an order, running it through compliance, trading, settling, and tracking performance attribution.

Most buy-side firms tend to fall into one of two categories when approaching a technology provider for the systems required for servicing their portfolio lifecycle. Either they’ve adopted (or evolved) a “best-of-breed” approach engaging multiple vendors, or they work with a single vendor who promises a complete “end-to-end” solution.

Best-of-breed or one-stop-shop

Firms that go best-of-breed have bought themselves a P+O+EMS (portfolio, order, execution management system) by engaging multiple vendors for the different pieces, and have most likely spent years integrating all of it, getting the different systems talking to each other. Then, once their solution is up and running for a while, what inevitably happens is that something changes which causes a disruption to that delicate balance – maybe the firm’s investment strategy evolves, or a particular set of regulations are introduced – and suddenly they have to deal with a multitude of vendors to make the necessary adjustments to get the new workflows to concord. It can quickly become a huge headache.

Firms that go the other route, to the “one-stop-shop”, live in a world where their vendor manages everything, but the trade-off is that they forfeit full autonomy. They can have control of the front-to-back operations, but only until they want to diverge from the prescribed solution. Even a slight amendment means surrendering some autonomy.

So, if you’re a small firm dealing primarily in a single asset class and you’re of a certain size with a relatively simple set of compliance rules, there are solutions on the market that will work well for you.

Until, of course, they don’t. Eventually, you’re going to want access to other asset classes, and as you grow your compliance rules are going to become more complicated. For instance, you may find that you need a different answer for transaction cost analysis to the one that’s being provided for you. In short: these products work well, until you outgrow them.

What ends up happening in the traditional one-stop-shop model is that, instead of the technology bending and moulding to fit the needs of the business, the business is forced to mould to meet the limitations of the technology. This limits the asset manager’s ability to implement an investment process that fits the requirements of their business, so they are forced to either to compromise on what they can actually do because of those technology limitations, or they are faced with numerous frustrating inefficiencies in the form of manual processes that lie outside of what their “all-in” system is capable. The result is incomplete information at different stages of the lifecycle, and information that’s not always there where and when it’s needed – most harmfully, at the point of decision. This approach leads to a “one-size-fits-none” type scenario, and it’s not a good spot to be in.

A third way

But what if there was a better way? The ideal would be a complete solution with a degree of flexibility that allows a firm to have the best of both worlds. In effect, it would be a comprehensive system within an open platform. It is a compelling proposition for a number of reasons, not least of which is that a buy-side firm rarely if ever finds itself in a position to replace its entire technology stack at once. Clearly, there is demand for a higher standard, more flexible solution which provides a complete answer from end-to-end along the portfolio lifecycle. It should be inherently open and modular, built around a robust set of APIs that can be connected into whatever pieces of the portfolio lifecycle that a buy-side firm can’t, or isn’t yet ready, to replace.

In order for such an approach to be viable, the vendor offering it has to be fluent in several core competencies. First and foremost, it needs to have extraordinary system integration capabilities built into its DNA. It needs to know how to work with, manage, concord and align data from numerous, disparate sources. It also must be capable of managing complex workflows across multiple asset classes in a manner that’s robust and yet nimble enough to adapt to markets, strategies and regulations that change constantly. Moreover, it needs to be built for complexity, speed, and scale, and needs to have evolved capabilities for intelligently automating workflows to free up its human operators to add value in ways that machines alone cannot yet accomplish.

Real-time analytics

The common thread binding all those pieces together has to be a world-class analytical capability. This allows a portfolio manager to have real-time access to the trade executions happening on the dealing desk throughout the course of the day, as their investment ideas are turned into reality.

The very moment their investment ideas are transacted in the market, the portfolio manager is aware of what had been a trade simulation is now an active order that’s being filled; and as it fills, it immediately becomes part of the portfolio.

Having the ability to update all those analytics – contribution, attribution, performance, risk – in real-time is hugely valuable, but generally unavailable in the marketplace today. Yet, consider just how important it is when one misplaced tweet can send a company’s stock price into a free-fall. If you are portfolio manager holding that stock, surely you cannot afford to wait 24 hours to assess the extent of the damage to your portfolio. Instead, you would want to act immediately to restrict losses. A comprehensive solution that facilitates that timely response is a true game-changer.

Can Technology Solve the Expanded Risks of Multi-Asset Trading?

GlobalTrading

September 18, 2018

By Joseph Bacchi, Head of Multi-Asset Trading and Investment Operations, Acadian Asset Management

Multi-asset trading requires a dynamic combination of available technology, broker partnerships, an educated trading team, and belief in the importance of human oversight.

As multi-asset strategies proliferate, more and more traders are being asked to expand their knowledge base beyond a single asset class to include a host of new instruments. To be successful, these traders need to master the mechanics of these new asset classes, be aware of a whole new array of risks, and take a new approach to risk management. For the multi-asset (M-A) trader, risk management is less a concept than it is a way of life.

From a pure trading standpoint, risk is as broad as the asset classes the M-A trader navigates. And while not all risks will be new to the equity trader, multi-asset requires an understanding of risk across the full spectrum. Risk awareness needs to be front-to-back, from reconnaissance to, in many cases, the last line of defence. Moreover, unlike in the world of equities, technology is not going to offer seamless support. M-A traders must finesse among multiple and imperfect systems, and gain consistency not from technology, but from human understanding and oversight.

Expanding the risk landscape

The diagram below illustrates the multitude of risks that many traders deal with on a daily basis. While breaching any of these can lead to adverse results, in equity trading there is typically an understanding that many downstream risks are being systematically managed and can be largely assumed to be under control. For an M-A trader, choosing which to focus on or ignore is not an option. Trading multiple products, in multiple venues, with multiple trading partners means having to understand not only the inherent front-end execution nuances in each, but also their back-end processing mechanisms, as well as an awareness of all issues related to regulation, settlement and compliance.

For illustrative purposes only.

Here are a few ways that the expanded risk insight can play out in the multi-asset world:

Understanding the context of the trade at hand is the key to the determination of strategy. Here the M-A trader serves as the fulcrum, bridging from the portfolio manager’s desired exposure (and reasons for wanting that exposure) to management of execution risk to all of the downstream dynamics of the trade – including fees, clearing and settlement. Often this is in the context of structured products and other complex instruments, where the trader works directly with a broker to tailor a unique position. This combination of knowledge also gives traders the opportunity to offer their insight back to the portfolio managers in the form of idea generation and position protection.
Impact risk, both from explicit and implicit costs, is much more complex in multi-asset. When you move from the well-defined cost analyses for cash equities to the more specialized roll costs determination and trend analysis for futures; seasonality and roll yield analysis for commodities; interest rate curves and flow measurements for foreign exchange and fixed income related products; and balance sheet usage and funding requirements for over-the-counter (OTC) products, it is clear that not knowing every aspect of M-A trading can have material impact on performance.
Compliance issues are also much more at the forefront of M-A trading. Multiple products mean multiple regulatory environments and multiple forms of compliance risk. Futures and options mean understanding margin risk. OTC trading requires attention to credit and counter-party risk. Consideration of these risks plays directly into the trading process.

How can firms most effectively create a trading team that can accomplish this? Education is the key. In addition to training on instruments, operations and regulations: don’t ignore the opportunity to learn from the sell-side. Relationships are essential to the success of multi-asset trading. Viewing the sell-side as a partner, with ideas and experience to offer, can be very productive.

How Technology Can – and Can’t – Help

Gone are the days when a trader can simply worry about execution and leave the rest in the hands of technology overseen by others. While there are platforms that can address some needs, they are not all easy installs and do not come cheap.

A central, robust order management system (OMS) should effectively support:

M-A portfolio positions
Benchmarks to track exposure management
Clearly defined protocols for pre-trade violations
Reporting platforms for post-trade exposure management (by rule, regulation, product, counterparty, etc.
Valuation/collateral management for esoterics

The hazards of notional calculations, performance and fee payments, credit facility usage and collateralization – to stress just a few – means that the M-A infrastructure needs to be designed with the mindset that back-end processing is equally as important as front-end execution. Think of the audit issues if it were not!

There is no doubt that technology plays a major role in the M-A architectural blueprint, but are machines enough? Can risk be mitigated simply by routing trades through a series of automated checks? The answer is no and it doesn’t appear that in the near future technology will fully take over the process. FX options, total return swaps, structured and commodity products and many other exotics do not have electronic platforms from which to trade, and none of these have systemic, equity-like protocols for booking, settling and processing. As much as one may want automation, the solutions simply have not caught up to the demand. As trading enterprises have moved toward automation for efficiency and cost reasons, the human touch is still a necessary requirement.

Think of all the moving parts: negotiated terms, distinct trade structuring, term sheets, margin requirements, multiple sourced fee management, collateral postings, varying settlement instructions and multiple clearing relationships. All require experienced oversight and expertise to manage effectively. In certain parts of the process where there is no standardization, it is nearly impossible to create a cost-effective technological solution that addresses all components in a holistic manner.

This is further proof that when structuring trades, the M-A trader needs to consider more than just the execution. The trader must also ensure that important allies in legal and compliance, risk and operations departments understand the design and the desired result of the trades, so that they too can help to fill the gaps that technology currently cannot address.

Diligence is the byword

For some, risk is solely an execution problem. Which algorithm offers the best access and protection? Which trading strategy is best suited for the context? When is the right time to attempt to take advantage of liquidity?

For the multi-asset enterprise, risk goes beyond the order itself. It’s embedded in the operational infrastructure, in the execution pathways to various venues for various products with various brokers, in the functionality of the OMS, in the reporting platform and in cash/credit profile management.

There isn’t one system to manage these risks or one report that can proactively identify them. Multi-asset trading requires a dynamic combination of available technology, broker partnerships, an educated trading team, and belief in the importance of human oversight.

Enhancement in risk management for multi-asset trading is an ongoing enterprise. It may never be fully solved, because the products – both investment and tradable – are evolutionary. Like home improvement, as soon as you get the last room the way you want it, the first room needs to be updated. Diligence needs to be the byword and the rule.

This document was prepared by Acadian Asset Management LLC. The views expressed within are those of Acadian and are subject to change with market conditions. It must not be construed as investment advice, or an offer to sell or a solicitation of an offer to subscribe or to purchase, shares, units or other investments, or as an endorsement, recommendation, or sponsorship of any company, security, index, strategy or advisory service, or to establish any investment relationship.

This document has not been updated since it was published and may not reflect the current views of the author(s) or recent market activity. No representation or warranty, express or implied, is made as to the accuracy, reliability or completeness of such information. Historical economic and performance information is not indicative of future results. The views expressed are subject to change based on market and other conditions.

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