Australia's New Look

December 15, 2011

By Greg Yanco, Kent Rossiter
Australian Securities and Investments Commission’s (ASIC) Greg Yanco tells FIXGlobal how Australian markets are preparing for the future, including the launch of Chi-X Australia.
What are ASIC’s goals for an Australian consolidated tape?
ASIC has consulted with industry in relation to options to consolidate data from all venues. In Consultation Paper 145: Australian equity market structures: proposals (CP145), two options were put forward – a single provider established by tender process or multiple providers provided by ASIC. To this end, respondents overwhelmingly preferred a multiple consolidator model. As we have previously stated in the Response to Submissions on CP145 Australian equity market structure: proposals (REP237), this was based on industry expectation that existing data services can produce the most efficient outcome for users.
Submissions also overwhelmingly supported the proposal that market operators should be obligated to provide information to consolidators on a non-discriminatory basis in order to maintain a level playing field. While ASIC expects that more than one consolidator will emerge in Australia, if it becomes apparent that no industry solution is likely to eventuate to consolidate data from all markets, ASIC may revisit the issue and consider introducing a single consolidator via a public tender process.

Are additional clearing agents needed in Australia?
ASIC is aware that the topic of additional clearing agents in Australia is indeed a timely one. It is currently in discussion between industry representative bodies, ASXClear and RBA (as the regulator in the clearing & settlement space) with ASIC as an observer. Issues have arisen as to both quality and quantity of third party clearers, as ASXClear seeks to significantly increase minimum capital adequacy requirements for clearing participants, in particular third party clearers.
It is an area that ASIC will continue to monitor and a discussion that will be followed with great interest, both inside and outside of ASIC. We look forward to continued frank and candid discussions with the financial industry in this space.
How can smart order routing be most effective?
Smart Order Routers (SORs) will assist market participants in meetingtheir best execution obligations in a multi-market environment. Some participants will use SORs developed by independent service providers and some will build their own systems in-house.
Trading participants will be able to route orders automatically to different venues depending on specified criteria. In a multimarket environment the routing of orders could be split across venues depending on liquidity. In this way, ASIC expects that clients will received a better outcome overall, particularly so for retail clients, who will receive the best price across the markets unless they wish to instruct otherwise (e.g. for an order to be executed with an emphasis on speed, rather than price).

Does ASIC seek to encourage high frequency trading in Australia? If so, under what terms?
ASIC neither encourages nor discourages the practice. High frequency trading is, however, an area that is continuously monitored by ASIC, and we will respond if necessary to ensure that any such activity does not interfere with market integrity and fair, orderly and transparent obligations. In addition, market operator platforms must have adequate and scalable throughput capacity.
In the coming months, ASIC will release a consultation paper (CP) pertaining to the broader enhanced market structure. This CP will discuss, among other things, the issue of market makers in the cash equity products. We look forward to industry feedback to this CP when released in the next few months.

Is fragmentation a concern?

Given the growth in the use of dark pools of liquidity overseas, ASIC has previously stated that it is a trend that may also emerge in Australia, which can lead to fragmentation, in addition to impacting the price formation process on markets.
As highlighted in CP145, price formation may also be undermined by fragmentation of liquidity, and can – as it has overseas – raise liquidity search challenges for market participants. Much like regulators in the US, Canada and Europe are all considering the impact of dark liquidity on price formation, including price volatility and spreads, ASIC will stay abreast of similar issues.
ASIC is similarly concerned about the potential adverse effect of this trend on price formation in Australia. As we indicated in CP145, ASIC proposes to make a measured adjustment to the framework that will minimise the potential for significant fluctuations in pre-trade transparent and dark liquidity.
What role does the FIX Protocolplay in facilitating market connectivity in Australia?
ASIC appreciates that the role of the FIX Protocol in facilitating market connectivity in Australia is predominantly in the client-toparticipant-to-client area. While the ASX platform has a proprietary messaging interface, it does offer a ‘translating’ gateway developed in conjunction with Cameron FIX. ASIC understands that Chi-X will accept FIX. The FIX Protocol will be important in ensuring consistency in the information coming from market operators.
Further to this, ASIC has published an Australian Market Regulation Feed standard which focuses on communication of market and regulatory data from market operators to ASIC’s surveillance systems. More information on this can be found at: www.asic.gov.au/asic/asic.nsf/ byheadline/Australian+Market+Regulation+Feed?openDocument
RCM’s Head of Asia Pacific Trading, Kent Rossiter, comments on the advent of Chi-X Australia. *Interview conducted before the launch of Chi-X Australia.

Chi-X Australia has not launched yet, and since their entry has been so long anticipated, even before obtaining ASIC approval, it has given the ASX time to lower fees and develop a more competitive product suite. Brokers themselves have had plenty of notice to ensure they are ready for the launch. Chi-X Australia will not be able to quote inside the ASX tick size in Australia, so that competitive feature of Chi-X Japan will not be an incentive, but with expected lower pricing, it is a clear advantage to brokers to select Chi-X wherever possible.
Though under the same full market hours as the ASX, there is some expected differentiation in Chi-X continuous trading model regarding the open and close, so this will provide opportunities. However, since Chi-X will be using the ASX clearing and settlement services to begin with, there is a limit to price efficiencies. Additionally, in support of Chi-X take-up, there are probably fewer regulatory hurdles to overcome in Australia; for example, there is no Tender Offer Bid (TOB) restriction as seen in Japan for Australian equity traders to worry about.
One of the biggest results that Chi-X Australia has caused is to shift some of the regulatory oversight of trading from the ASX to ASIC. ASIC has put out a relatively strict best execution policy which should level the playing field and keep Chi-X relevant. This has caused a flurry of brokerage interest to sign up, so much so that there is a decently long waiting list.

Korea Sets the Course for FIX and Low Latency

edward_mangles

December 15, 2011

By Edward Mangles

At the FIXGlobal Face2Face Forum in Seoul, Korean firms announced the formation
of a FIX working group and the Korean Exchange’s intention to build an ultra low
latency trading platform.

The opening speaker at the FIXGlobal Face2Face Forum Korea was keenly anticipated by the 200+ delegates, (a quarter of whom were made up of the buy-side and a third the sellside), as he was raising many of the issues that surround the HFT arena, but that are rarely touched on at industry events in Korea. By placing HFT in context , Edgar Perez, author of the recently published “The Speed Traders”, highlighted many of the opportunities and challenges that markets around the world face, in the low latency trading strategies environment. Not least, he pointed out the colossal task facing regulators and associated technology costs, just to monitor high-frequency trading, post trade, let alone real-time.

A recurring theme throughout the day, latency was covered by most of the presentations, especially in the context of FIX. Deutsche Borse’s Hanno Klein, and NYSE Technologies Asia Pacific CEO, Daniel Burgin, stressed that FIX standards are quite at home in the low latency environment, with exchanges around the world already using FIX for their low latency systems. As Mr. Burgin pointed out, “FIX is not slow, but through poor implementation, it can be made slow – and this has happened in various markets”. These comments rang true with the attendees, especially as Mr. Kyung Yoon, Division Head of Financial Investment IT Division of KOSCOM, outlined their plans not only to implement the latest version of FIX at the Korean Exchange, but also that when the new exchange system is rolled out in 2013, that speeds as low as 70 microseconds will be their benchmark. To the ‘icing on the cake’ Mr. Yoon then expressed KOSCOM’s commitment to helping establish a FIX liaison group in Korea that will ensure a highly ‘standard’ implementation of the FIX Protocol.

MC for the day, FIXGlobal’s Edward Mangles, (also FPL Asia PacificRegional Director), welcomed the announcement, stating that he and the FPL Asia Pacific group, looked forward to working more closely with KOSCOM, KRX and the Korean trading community as a whole. With delegates staying put to hear the bi-lingual presentations/discussions throughout the day, (with a few afternoon speakers actually commenting that the crowd in the room was unusually large for the final sessions), the updates on algorithmic trading (Josephine Kim, BAML) and TCA (Ofir Geffin, ITG) provoked a number of follow-up questions and discussions, indicating the delegates’ appetite surrounding these issues.

The event exhibitors especially enjoyed the networking between sessions, as even when speakers began their presentations in the conference hall, many groups hung back to discuss specific issues with the different experts attending. This was a full, lively and informative day, that clearly kick-starts a bright new era of dialogue and cooperation around the FIX Protocol arena, where Korea is now clearly gaining momentum and ready to start implementing FIX.

Japanese Markets Look Out of (and into) the Dark

david_degraw

December 15, 2011

By David deGraw
Daiwa Capital Markets’ David deGraw catalogs the movements of Japanese markets in 2011 and discusses the various approaches Japan could take with regard to dark pools and High Frequency Trading (HFT).
Volume and Liquidity in Japan
Right now, contagion from Europe and the turmoil from the United States have depressed equity transaction volumes across the globe. Once a recovery starts to gain steam, Asia will be the driver for growth and Japan will be a quality play. Due to the perennial underweighting of Japan, I expect volumes in Japan will quickly surpass pre-crisis levels in such a scenario. With exchange volumes being so low, non-traditional liquidity is playing an increasingly important role. We have seen transaction volumes on our nondisplayed liquidity pool as well as PTS volumes continue to grow relative to exchange volumes. We are trying to bring the benefits of crossing to as many client types as possible and our unique position as a principal domestic investment bank enables us to access semi- to non-professional liquidity sources, such as corporate and religious entities, educational endowments, quasipublic institutions, agricultural cooperatives, and retail investors.
Role of PTSs in Japan
The role of PTSs has increased steadily since the start of this year and has accounted for as high as 7-8% of market share. The success of SBI Japannext and Chi-X Japan PTS shows that the market is rewarding innovation and efficiency that is created as a result of increased openness and competition. Conversely, the closing of Kabu.com shows that a PTS’s revenue model may not be sustainable over an extended period of low trading volume. Therefore it is critical for participants to carefully evaluate the viability of a venue so that the large upfront technology investments are not wasted.
The implementation of centralized clearing through JSCC was critical for the existing PTSs to rapidly and dramatically expand their share in 2011. However, since August, growth has slowed somewhat along with the rest of the market. Having said that, there are still very good reasons to expect future growth in PTS market share. Both PTSs are working aggressively to on-board new participants and Chi-X has recently announced the introduction of liquidity rebates in Japan. Chi-X have a successful record of growing their market share in Europe with liquidity rebates, and such economic incentives are sure to be strong drivers for growth in Japan as well. In fact, it should open the door for a totally new class of venue fee arbitrageurs to trade Japanese equities. Furthermore, domestic institutions are expected to allow smart order routing to PTSs once regulations are amended to exempt PTSs from the 5% TOB rule.
On-boarding of retail clients remains an issue for PTSs as over half of the retail client base is trading on margin. The parent company of SBI Japannext also operates an online brokerage and have started to offer SOR to their PTS for their online retail client base this year. The Tokyo Stock Exchange (TSE) and Osaka Securities Exchange (OSE) merger is a sign of a mature market that is fighting for relevance against an evershrinking domestic economy that has been overtaken by China. The merger will technically create a larger single exchange for Japan, but there is no reason to expect meaningful growth in volumes or listings as a result of the union per se. Rather, it is imperative for the regulators to ensure that the new monolithic exchange does not unfairly squeeze out competition from alternative venues.
Dark Pools and HFT
Average dark pool crossing rates have increased across the board in 2011. This is a clear indication that more liquidity is available on dark pools as a result of broader acceptance by the buy-side trading desks in Japan as well as Asia. Although HFT and dark pools have not received the same backlash in Japan (as there have been no comparable cases to the US flash crash, breaches in client trust exemplified by Pipeline, or concerns over information leakage expressed towards Chi-X Europe and BA TS), it will be necessary to keep a close watch on the regulatory climate in response to the proposed regulatory changes to crossing networks outlined in MIFID II. Since the TSE and OSE have invested heavily in a bid to attract HFT liquidity, it would be contradictory for the regulators to reverse course and take a hard
line against HFT and dark pools at this point. A hard-line stance will be viewed as anti-competitive and derail the efforts by the regulators and exchanges to make the Japanese market more attractive. In the final analysis, the ultimate cost will be borne by investors in the form of increased transaction costs if the efficiencies are not realized and liquidity continues to dwindle.
Domestic Differentiators
Dark pools are attractive since clients can find liquidity in such names without disclosing their hand to the broader market. Therefore, one of the major differentiators is the ability of the broker to source liquidity in names that are typically illiquid on the exchange. The ability for a broker to source such liquidity will depend largely on its access to the wider class of non-professional institutional investors and retail clients. On the other hand, for liquid names, the differentiators are the matching ratio, the amount of price-improvement relative to the exchange, and lack of alpha leakage.

FX Markets Due for FIX

annie_walsh

December 15, 2011

By Annie Walsh
Annie Walsh of CameronTec spoke to FX users to better understand the topical issues and challenges facing the OTC Foreign Exchange market and the central role FIX can play in addressing these challenges.
Undoubtedly the capital markets in 2011 will be remembered for many history-making moments including some of the largest currency moves the market can remember. We have witnessed the global foreign exchange market — the most liquid financial market in the world with an average daily turnover in the vicinity of USD4 trillion — bear the brunt of one political crisis after another, causing widespread volatility and difficult to pick currency moves.

Currency friction in Europe and between the US Administration and China will no doubt remain a prominent feature of the global economy for at least the next 1 – 2 years. On top of this remains uncertainty of government, particularly in Europe, and the implications for continuity of fiscal and monetary policy.

Many investment banks too in their search for alpha have been left wondering ”where did the black box get it wrong?” following lack lustre P&L performance, almost industry-wide over recent months.

Without a formal open or close, the FX market presents a true ‘follow the sun’ global market, with inherent levels of opportunity and risk.

Against this uncertain backdrop, the FIX Protocol has great potential to centrally feature in what is undoubtedly the single greatest threat (opportunity, if you prefer) facing the global OTC FX market. That is of structural uncertainty compounded by impending regulatory change to be ushered in, courtesy of Dodd Frank, and MIFID II and III.

With no unified or centrally cleared market for the majority of trades, and little cross-border regulation, due to the over-thecounter (OTC) nature of currency markets, these are rather a number of interconnected marketplaces, where different currencies’ instruments are traded. Inevitably OTC FX will move, however grudgingly, away from its long-standing (self-serving) model of self-regulation, toward greater levels of transparency, regulatory oversight (either directly or indirectly) and centralised clearing.

A Two Speed FX Market

As currently drafted, spot, outrightsand swaps are to be exempt from Dodd Frank’s requirement to be traded via Swap Execution Facilities (SEFs) and be centrally cleared; FX options, Cross Currency (CCY) swaps and Non-deliverable Forwards (ND Fs), however, are not. A perhaps unintended consequence of this two speed approach is the potential for jurisdictional arbitrage, product/financial re-engineering and further fragmentation of execution venues and liquidity.

In the short term, it also means that the sell-side needs to fundamentally reconsider strategies for design, development and deployment of Single Dealer Platforms (SDPs). Multi asset class SDPs will now necessarily evolve to become simultaneously both an execution venue as a destination and a gateway to a SEF, depending on the instrument traded.

Precision and Control

In either case, FIX has a critical role to play. Greater standardisation of tags and increasingly the FIXatdl initiative are now at the core of FX volume growth from the algo and HFT community; central to this is the standard’s ability to communicate not just a ‘where’ but also a ‘how’ and a ‘when’ with the order, as well as address post-trade workflow.

To varying degrees of sophistication and complexity, the buy-side will move increasingly towards substantially automated execution via EMS/OMS; this is already well entrenched behaviour among larger asset managers and the leveraged community and will inexorably move down the FX food chain. Widespread FIX acceptance and adoption, along with the portfolio effect will drive this change, particularly as FIX evolves to address FX options and ND Fs.

“The FX market is still evolving at a fast pace and will need to adapt to the new regulatory environment with a lot of new SEFs,” says Stephane Malrait, from Société Générale Corporate & Investment Banking. “FIX will have to play a critical role to reduce the connectivity cost for new trading platforms and help with the automation of workflow for new market participants. Société Générale will continue to lead the effort to improve the eCommerce workflow using FIX-based solutions.”

Max Colas of CameronTec says an industry standard like FIX is a natural choice to approach the entire market holistically: “Currency trading, perhaps more than any other asset class, is the one truly global 24×6 market where the distribution of market centres scattered around the globe and the straight forward relationships between currency pairs create arbitrage opportunities limited only by latency constraints and computer speed. This puts pressure on FIX technology to deliver superior performance in distributed, continuous landscapes.”

Nishikant Parit at the privately held, hedge fund management firm Soros Fund Management comments that without FIX it would not have been possible to achieve STP from their trading desk to the back office. “We used FIX to efficiently integrate multiple FX EMS platforms with our OMS. This has helped us optimize our systems to support our continuously evolving business needs.”

Systemic Risk Mitigation

For those involved in FX day to day, it will have come as no surprise that the OTC FX market, unlike other asset classes, weathered the financial crisis as well as it did. This was due, in no small part, to managed systemic risk associated with entrenched, long standing market convention and dealing protocols. While FIX cannot resolve credit risk, it will most certainly play a constructive role in mitigating settlement risk, in a post Dodd Frank world.

The FX market is uniquely characterised by its ability to continue to evolve, re-shape and re-invent itself. Whether you are buy-side, sell-side, ECN or SEF, FIX has great potential to centrally feature in its next iteration.

My City : London

paul_squires

December 15, 2011

By Paul Squires

Algorithmic China

shen_tao

December 15, 2011

By Shen Tao
Guosen Securities’ Shen Tao reveals the latest trends in algo usage by Chinese asset managers, domestic mutual funds and Qualified Foreign Institutional Investors (QFIIs).
Who are the primary customers for algorithmic products in China?
Algorithmic trading started in the Chinese A share market some time in 2007. In 2005, the first commercial FIX engine went live to accommodate the execution needs of the Chinese A share market of Qualified Foreign Institutional Investors, or QFIIs, as part of the plan by the Chinese government to allow regulated capital market investment by foreign investors. After an initial experimental phase of FIX connectivity with global trading networks, the local FIX trading platform became solid enough to interface with a real algo engine. In 2007, some leading global investment banks (predominantly, QFIIs from the sell-side) began to offer algorithmic trading facilities for their clients and their own proprietary trading desks. Most of these facilities were located offshore (e.g. Hong Kong) and connected to the Chinese brokers’ FIX gateway via a financial trading network such as Bloomberg.
The earliest providers and users of algo trading in the Chinese market were solely QFIIs and their clients. In 2008, although the global market was in turmoil and many infrastructure budgets were cut across the international financial community, there were still some firms seeking expansion opportunities for the future. Among them, some global banks with local brokerage joint venture subsidiaries began to build their onshore algo facilities. At about the same time, some leading purely local brokers also started their efforts in algo development, Guosen among them. We started in March 2008 and also targeted QFII investors for algorithmic trading, however, we understood the future of algorithmic trading in the Chinese market would rest on the domestic mutual fund industry. In late 2009, the Guosen algo platform was almost ready and the aforementioned onshore algo facilities run by the sell-side joint ventures of global banks also went live. The day of the algo had finally arrived for China.
In 2010, with support from a leading buy-side OMS vendor Hundsun; Guosen and UBS began their efforts by offering an algo solution for local mutual fund companies. In November 2010, UBS won its first success with two Beijing-based mutual fund companies, with Guosen securing a third six months later. Since that time, more than a dozen mutual fund companies have started using algorithms from UBS and Guosen. 2010 was the first year of the algo, from a local perspective. Currently, the momentum of mutual fund companies adopting algo platforms continues. We estimate that by the end of 2011, in terms of assets under management, over 40% of the local mutual fund industry could be covered by broker-provided algo services.
In retrospect, QFII investors were the founders of the market, but soon, the local mutual fund industry will become the primary user of algos. In addition, we foresee insurance companies adopting algo trading soon.
What are algos used for in China: execution, complex event processing (CEP), pairs or basket trading, etc?
Currently, algorithms are used for pure execution, mostly for single orders. Pairs and basket trading require a compatible OMS platform, which is already under development. We believe such functionalities will be available to Chinese traders in the next six months. Also, while many traders understand the concept of complex event processing, it will take a while before anything like this is put into real production.
What testing and due diligence is required before an algo can be deployed in a Chinese market?
We see different patterns of testing and due diligence processes across mutual fund users. Regarding speed to market, Beijing-based companies seem more enthusiastic and are quick to make a decision, whereas Shanghai-based companies tend to be more cautious. Generally speaking, algorithms will undergo testing for at least a month before they are put into use.
More companies are seeking dual listings in China and in Hong Kong, the US and elsewhere, but is arbitrage growing at the same rate?
Arbitrage cross market is unlikely to happen on a noticeable scale with Chinese capital flow controlin place.
What new products are your clients asking you for? What new algo products are in development?
Clients are requesting DMA and algorithms that will replicate the trading capabilities of hedge fund strategies as well as algos that are designed primarily for standard mutual funds (long only). Some clients are also demanding strategies for illiquid stocks, volume deals (e.g. single order accounted for a substantial fraction of average daily volume), Market on Close or list order types. All of these are under development or consideration, according to their respective commercial potential.

Making it Right, Again.

matteo_cassina

December 15, 2011

By Matteo Cassina
Matteo Cassina of Citadel Execution Services Europe comments on the development of a European consolidated tape as well as a unified concept of best execution.
The long awaited proposals on the review of the Markets in Financial Instruments Directive (MiFID) were published in October 2011. The so-called MiFID II and MiFIR proposals aim to address, among other things, changes in the European market structure and competition between trading venues. Whilst the proposals, in their current form, do not provide as much detail as market participants had hoped, they represent a unique opportunity to address fundamental issues impacting the efficient functioning of Europe’s equity markets.
The EU legislative process is such that the European Parliament and the European Council will agree their negotiating positions, before embarking on a trialogue process mediated by the European Commission. The final legislative text may not be ready for implementation until as late as 2014, but this timeframe represents a good opportunity for the rules and their impact to be given adequate consideration. In particular, the issues of best execution and consolidated tape need to be given greater prominence during this review process, if policymakers are to honour the original objectives of MiFID, protect the retail investor and ensure Europe’s equity markets become efficient and competitive.
A key benefit of regulation is that it drives standardization of behaviour but thus far, this has not materialised (in the retail broker community in relation to best execution requirements). Large institutions have the capabilities to take advantage of the proliferation of alternative trading venues and are benefitting from cost reductions by being able to execute their orders in the venue which offers the lowest price for a security at a given time. The majority of retail investors, however, are still either unaware of, or do not have, the opportunity to access alternative trading venues. This means they do not always benefit from prices equal to, or better than, those available in primary venues.
While the principle of best execution is reiterated in MIFID II, it is not included in MIFIR which means that — once again — best execution is a principle, not a rule and therefore open to interpretation at the national level. This is in stark contrast to the best execution model in the US, where the requirements to achieve best execution are much more stringent. Currently, a retail broker in Europe can chose to route all of its trading to one single venue, on the basis that it has a good commercial relationship with that venue, or that it is too costly for the broker to connect to multiple venues. The broker may choose to send all orders to a venue with the highest chance of getting the best price, without necessarily guaranteeing that it is the best price at that moment in time. This is an unfair outcome for the retail investor and MiFID II/ MiFIR proposals, regrettably, do not go far enough to redress this.
Enforcing best execution will take time and will depend on broader market harmonization, but now is the time for regulators and retail investors to demand a more compelling definition of best execution. In particular, greater clarity is required around the execution policies provided by retail brokers to their clients. These policies are documents in which retail brokers explain how their best execution obligations are fulfilled under MiFID. Trading venues and brokers should also be required to provide execution quality statistics, detailing how well they performed in achieving best execution. This much needed clarity would, for example, result in firms having to justify — to both regulators and clients — why certain trading platforms are listed on their best execution policy and, why others have been omitted. In short, how and why some orders are routed to specific venues and not to those with the best price.
Post-trade data is an important component of increasing transparency in the markets for the benefit of the retail investor, but equally important is that this data is accessible and affordable to all market participants including retail brokers and retail investors.
The provision in MiFIR to improve the quality and consistency of posttrade data via a consolidated tape is welcome. Indeed, we have long since advocated that the cost of pan —European data should not remain beyond the reach of ordinary retail investors. Today, the lack of an EU consolidated tape means that market data is not available on an aggregated basis to retail investors.
As a result, this prevents them from understanding whether best execution is being achieved. Again, this is an area where Europe lags behind the US since a consolidated tape on a utility basis is already available in the US market, although it is not without its imperfections.
The European Commission is now proposing a mandated tape as one of the measures aimed at improving consistency and quality of market transparency, as well as reducing the cost of data. Mandating a consolidated tape, however, is not enough. It will also need to be robust, free on a delayed basis for all users — including retail investors — and supervised by an industry body.
The remodelling of the European equities landscape since 2007 has resulted in increased competition, greater transparency and, in many ways, encouraged a better understanding of the functioning of the equities market for policymakers, institutions, intermediaries, end investors and media commentators. However, in order to achieve the goal of the protection of the end investor, further changes to MiFID II/MiFIR will be needed over the coming months.

Mexican Market Leaps Forward

Creating Digital

December 15, 2011

By Brian Ross

FIX Flyer’s Brian Ross briefs readers on the latest from Mexico including the regulatory and technology upgrades.

In the last 12 months dramatic changes have occurred at Mexico’s stock exchange and among its brokerage clients. Cross border partnerships, technology upgrades, new FIX infrastructure and business friendly regulatory changes have opened the Mexican market to high frequency trading (HFT).

While US regulators can be seen to scold HFT firms, the Mexican market has opened its arms. The Mexican Exchange (BMV) and its brokerage firms have upgraded their infrastructure and sought business opportunities north of the border. Earlier this year after the CME Group and the BMV signed their partnership, high frequency traders on the CME Globex trading system began to route orders to the Mexican Derivatives Exchange or MexDer. Today 90 percent of average daily volume on the MexDer comes from high frequency traders north of the border.

Mexico’s brokerage firms have completed significant infrastructure upgrades. Last spring only a few brokers in Mexico could handle a highfrequency hedge fund client and many Mexican brokers could process no more than one connection to the Bolsa Mexicana de Valores (BMV) at a time. The landscape has changed quickly and improvements in broker and exchange systems have ushered in a new capacity for speed in the transmission and execution of orders in Mexico.

Over the summer a major milestone occurred for the industry. Working with the BMV, Mexico’s brokers completed an industry-wide upgrade to FIX 4.4. The top 25 brokers are now certified with FIX 4.4 to the BMV. Leading the way, are brokerages like GBM, Interacciones, Actinver, UBS Mexico, IXE and others.

Now that Mexican brokers speak FIX 4.4, all of the order routing to the BMV can now be done through FIX allowing the BMV to retire the antiquated SETRIB protocol. The only way the BMV will allow Mexican brokers to continue to use SETRIB is by paying excessive fees, and even this will not be allowed by the end of 2011. Retiring SETRIB sets the stage for more positive changes in the industry and at the BMV.

Work is already underway to upgrade the BMV’s trade matching engine. The existing engine was built in the 1990s for a Tandem mainframe. Retiring the Tandem has many benefits. Faster order matching and processing is high on the list. In addition, more choices for application and software vendors and significant cost savings are expected. Retiring the mainframe will also eliminate the scheduling nightmares associated with the limited availability of the central mainframe for testing with the broker community. The new matching engine will be hosted on modern Unix based hardware. The release of the new matching engine and infrastructure is planned for the first quarter of 2012.

Another important milestone is the availability of a state-of-the-art co-location facility at KIO Santa Fe. The BMV infrastructure is located here and starting in October it will be easy for brokers and third party providers to collocate order routing and market data in this hosting facility leading to high throughput low latency services.

While all of the infrastructure and matching engine upgrades are momentous, they would bear no fruit without the simultaneous modernization of Mexican regulations. The initiative to modernize Mexico’s regulations, called RINO, began a year ago and phase two is due to rollout in the fall of 2011. The goal of RINO is to conform Mexican regulations to international standards. By converging with international standards, regulators hope to bring more international order flow and greater liquidity to the market, resulting in increased investment in the Mexican market.

While regulations in the US like Sarbanes Oxley and Dodd-Frank can be seen to drive businesses offshore, the regulatory changes in Mexico are removing handcuffs from businesses and facilitating opportunities. The first step forward occurred early this year with RINO I. RINO I allowed brokers to have multiple channels to the BMV’s electronic trading system. Previously all orders were in a single queue. Multiple access points per broker provides more flexibility in executing strategies and handling client requests, including separate BMV channels for program trading and orders called into the trading desk. RINO I also eliminated sizebased criteria from order management, thus leveling the playing field in the processing of orders. RINO II takes effect on October 10, 2011, bringing more modernizations including pegged orders, improvements in crossing operations, average price operations, price delivery regardless of volume, and decimal bids for fixed income securities.

Crosses, in which a brokerage carries out a transaction through the stock exchange between two of its clients, were permitted previously but the rules were very arcane. Starting in October, the crossing operations will be vastly simplified allowing clients to simply choose whether to cross inside or outside the spread. With this modernization, the BMV hopes to repatriate orders that brokers would previously carry out in the US, where crossing orders was possible using ADRs in dark pools or at the NYSE.

In addition the RINO II regulations a very important new mid-point hidden book order. The orders execute at the midpoint, broker anonymity is guaranteed and the order priority is determined by volume. This is effectively a dark pool. Similar to Xetra, this new BMV order helps the market participants and simultaneously protects the BMV from providers toying with moving into the Mexican marketplace.

As the regulations modernize and the FIX infrastructure hardens, opportunity beckons. Brokers are beginning to push for more high frequency trading algorithms, more efficient routing of international orders, and more sophisticated risk controls, all of which will attract even more international business. As the need for speed grows, co-location previously offered by the exchange may become more strategic, particularly to brokers wanting to attract high frequency traders.

All of this progress was made possible in large part because of the exchange’s demutualization and subsequent listing in 2008. The demutualization coincided with rule changes allowing Mexico’s pension funds or AFORES to invest. Before the rule changes, the AFORES were forced to invest almost entirely in short-term government paper. Today, Mexico’s pension funds are allowed to invest up to 25 percent, in individual stocks and shares and 12 percent in a hybrid of corporate debt and equity capital to allow companies to raise funds to expand businesses.

Considered together, regulatory improvements and infrastructure updates have morphed the BMV and the Mexican brokerage community into a thriving and modern marketplace. The BMV reported a 22 percent jump in earnings last year, with operating income increasing 70 percent in the last three months. A record six initial public offerings made it to market last year and overall trading volumes rose 50 percent in 2010. This year Mexico’s IPC index has tested and hovered near record highs.

In 2011 there are fewer IPOs, but trading volume remains strong. The order-routing agreement signed with Chicago’s CME Group has opened Mexico’s derivatives market to the world. Now, electronic trading infrastructure and investor friendly regulations have set the stage for act two.

Successful Integration of Exchanges in Chile, Peru and Colombia: MILA Update

Chile, Peru and Colombia formally combined operations of their stock exchanges on Monday June 3 2011 to form the Latin American Integrated Market (Mercado Integrado Latinoamericano, or Mila). The first operations of MILA on the Stock Exchange of Santiago were purc
hases of shares of Endesa Chile and Lan for Colombian brokers. MILA consists of the Lima Stock Exchange (BVL), the Bolsa de Valores de Colombia (BVC) and the Bolsa de Comercio de Santiago (BCS).

Chileans can now buy stocks from Peru and Colombia through local brokers who have counterparts in those countries. At the same time, foreign investors have greater and simpler access to the Chilean market. The MILA integration provides a cross listing of stocks that helps the three markets grow by providing a wider, more transparent and more complete market.

The markets are quite complementary and the synergies are important considering the growth in Brazil and Mexico. In the Peruvian Stock Exchange, they emphasize the qualifications of its mining industry, which has a strong presence in Chile, whereas Colombia has a strong energy sector with the petroleum company Ecopetrol. Regulators from the three markets have created a Supervisory Committee that meets periodically and monitors issues that arise with MILA.

Andrés Araya Falcone, CIO Santiago Stock Exchange comments “from the technology perspective, the launching of MILA has been very successful. FIX 4.4 interconnects the markets for order routing and market data. From a business perspective, trading volume as been lower than expected due mostly to external factors, such as the debt problems in United States and Europe.”

In addition, Araya adds that brokerage “tax issues and finetuning of back office systems have also affected trading volume. Even so, MILA has increased interest in Latin American Markets because this is a great idea and once these issues are worked out, we are sure liquidity and trading volume will increase.”

Expected in October is the issuance of shares from Inversiones Suramericana (Sura) who hopes to raise 1-4 billion USD to help fund the purchase of ING in Colombia, Peru, Mexico, Uruguay, and Chile, including AFP Capital. Sura announced it will pay 3.9 billion USD for the assets of ING. More than half of the shares will be offered to international investors, including AFP Capital and insurance companies in Chile. This transaction is expected on the Colombian Stock Exchange, making it available through MILA to investors in Lima, Santiago and Bogota, in addition to the United States and Europe.

Latin America has enjoyed a strong recovery for the most part it has sailed through the recession without lasting damage. Boosted by capital inflows, by record prices for commodity exports, by sound policies and by a heady expansion in domestic credit, the region saw economic growth of 6% last year and is on course to notch close to 5% this year. The region faces slower growth but not disaster. To up the pace, now is the time for reforms to boost productivity.

The main engines for growth in Latin America are China’s demand for minerals, food stuffs and raw materials – this looks set to continue – and consumption as tens of millions edge out of poverty and benefit from newly available credit.

Canadian Alternatives: Buy-side Case Study

Yulia Kuksina

December 15, 2011

Michael Thom, Equities Trader, Genus Capital Management offers a look into the Canadian equities world, including perspectives on dark pools as well as algo implementation and usage.

Inverted pricing models
We have just seen the introduction of more innovative pricing models in Canada, essentially since the launch of TMX Select. For most buy-side participants like me, we do not see our tick fees as rebates because they are bundled into the commissions we pay to our brokers. This is an exciting development for participants that thrive on different market structures, but I would not say that we particularly benefit from this market model. From an intellectual perspective, it is interesting to wonder what will happen as a result of these developments, but I would not say it has any immediate net benefit to us or our clients.
Trends for Dark Pools in Canada
Canadian regulators have taken the right approach. There are lessons to be learned from other jurisdictions where dark liquidity was left to develop and regulators then had to play catch up. I applaud the Canadian regulators for giving their approach to dark liquidity critical thought before it gets to the point of significantly damaging market quality. Regulators in Canada are at a point now where if they change the regulations significantly, venues and firms would be able to adjust. The debate over the trade-at rule in the US shows that whole business models are built around sub-penny pricing and trading not at the touch. I do not think that is where we want to go in Canada.
I am a little cautious around some of the regulators’ specific proposals on minimum size. I am more in favor of the minimum increment being set at a half penny. The minimum size is the more difficult concept because anything that functions around a single pivot size, either in value or number of shares, can disseminate information through trading around that pivot point.
Although to my knowledge very few participants choose to structure their orders in such a way, it should be up to market participants to build into their orders the minimum execution quantities for dark pools as they see fit. I do not think a lot of buy-side participants are currently building their orders or customizing their third party algorithms to that level of detail. From where I sit, it is not a perfect solution, but this compromise might be the best of the difficult alternatives.
It is important to point out that they are not putting in a minimum size right away. The architecture is built to allow the regulator to, on very short notice or if they start to see some compelling data points, put limits in place without going through the full comment and review process, which is all very prudent. They are giving themselves the tools to deal with all possible market outcomes. Flexibility does not come easily to regulators. Typically, they adopt very specific proposals and if those proposals fail, it is back to square one, whereas here they have given themselves a degree of latitude which is commendable.
Simplifying Algo Implementation The algo and DMA providers who are winning our business are those who can give us transparency right down to how they are interacting with each individual venue, what order types they are using and how they are implementing venue specific idiosyncrasies. If a venue has very unique order types, our providers should say how they are using those and why they made the decision to use the order types they did. Providing a transparent, empirical basis for decisions regarding algo structure, architecture, order types and routing is really important. Many decisions go into building quality algorithms and routing, and those who will share the data behind it are my providers of choice. Algo providers seem to now be more willing to tailor and be empirical about constantly improving the product to fit a firm’s or a trader’s trading styles. That is where algorithmic trading is headed, as it relates to buy-side, and we are just starting to see the leading edge of that in Canada.
The level of attention to the customization process differentiates a very small number from the bulk of providers. Canada has had a very interesting development in terms of its algorithm trading scene. You had the first pioneers who are the incumbents and now you are seeing the second and third generation players come in and really taking it to the next level. There has been an increase in third party algo usage or white labeling in Canada, but I think those who have made the investment to get a decent product off the ground are being rewarded for it.
The average Canadian buy-side trader’s ability to differentiate between a good algo provider and an average one is still developing. While there are a lot of commoditized algo products, it is when you start to tailor it to your execution and liquidity gathering philosophy that you begin to see the differentiation. For the most part, any algorithm will get your trade done, it is just a question of which ones and which providers will consistently perform better over time.
Pre-trade TCA
All our order flow does get pre-trade TCA snaps. Everything that goes through our desk gets a pre-trade assessment on it. We do not however rely on pre-trade TCA alone as most implementation cost estimate models we use tend to break down somewhat with larger orders or in less ordinary environments. Instead, we will look at the unique characteristics of the order with respect to the liquidity environment, as opposed to how it is profiled based on historical data. TCA is one input into how our trading decisions are made, but it is not the only one. In certain cases, we look at the trader’s knowledge of where and how to source liquidity much more than whether or not they are within a certain range of their benchmark or implementation cost estimate.
‘Dark’ Future for Canada?
Before we start to see more dark venues in Canada, we will need to see some validation of the business models that are already running. I think regulatory uncertainty is going to have to resolve somewhat before we will see more ATS and dark growth. Historically, Canadian participants have been slow to adjust, in terms of turning on venues and exploring new order types. From where I sit, I see the growth in number of venues will be slow, which is not to say we will not see any new venues open up or new order types emerge. But there are simply too many uncertainties for prospective entrants, with the pending Maple-TMX merger and forthcoming regulatory changes clouding the outlook. I do not think you will see a lot of bold moves into this space until some of that resolves itself.
To VWAP or not to VWAP
On the buy-side, I think algo usage will continue to increase moderately. Algo usage responds to so many different factors in terms of what the market is doing, volatility, the upstairs block market (which has traditionally been very dominant in Canada) and other factors. It also responds to how much PMs are comfortable taking a more passive strategy as opposed to seeking out liquidity aggressively by other means. Buy-side algo usage definitely tends to be more passive because VWAP and scheduling strategies are still predominant. We will continue to see growth, but it is going to be moderate, relative to the last three or four years, when it became a significant part of the market. I rarely use VWAP algos except in very limited situations, but I see a lot of fellow buy-side traders being held accountable to that benchmark, especially when that is the benchmark their PMs and management have been sold on from a policy standpoint.
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