Making the most of local brokers

Punit Mittal, head of execution products, BNP Paribas, Tokyo explains why brokers in Asia may choose to put institutional flow through local peers rather than direct into the market.

Global brokers are on the whole well represented in the membership of Asian equity exchanges. BNP Paribas, for example, has seats on exchanges in Tokyo, Hong Kong, Singapore, Korea, Taiwan, Malaysia, India and Thailand, the latter two being joint ventures with a local broker.

Yet, we, along with many of our peers, will feed certain orders through local brokers even when we are represented on the exchange. At first glance, this may seem counterintuitive. After all, we are presumably adding to trading costs by introducing another intermediary and in so doing are giving a lower public indication of our market share.

There are a number of reasons for adopting this approach, particularly in ID markets. One of the most obvious is to avoid gaming and front running. In markets such as Korea, a large and sophisticated retail investor base is attuned to large orders being placed by bulgebracket brokers, the assumption being that foreign institutions lie behind them. In such situations, we tend to feed large institutional orders through a combination of our own seat and a local broker.

Choosing a local partner

We have enhanced our connectivity with a chosen partner in each of the markets concerned. Our clients can therefore use our system to select a local broker to execute a particular order. Alternatively, the order can be distributed in an automated fashion, where, depending on size and trader preference, we would split the order between the local broker and our own seat. The benefits of this approach are most evident where our flow is mingled with that of a large retail broker, making our own clients’ trading decisions less conspicuous.

A number of local brokers have adopted a strategy of developing regional franchises. While these may turn out to be ideal partners, our policy is still to select the local partner on a market-by-market basis. Essentially, our selection depends on two major factors. One is the nature of that broker’s domestic flow. Brokers with sizeable institutional flow of their own are susceptible to similar gaming strategies and are therefore less attractive a priori than those with a large retail client base. However, an equally important criterion is the need to minimise information leakage. A particular issue in ID markets is the danger of negatively impacting trades as a result of exposure to a broker who is less than careful about information seeping through to other traders on the desk, particularly where those traders have a relationship with local institutions.

Costs

I have already acknowledged that it is impossible to introduce an extra link in the trading chain without adding to trading costs. That is always a concern in such a strategy. There is also the danger that by channelling flow through a local counterpart, a broker may give the impression of accounting for less flow than they actually do. Market share is after all a factor that buy-side traders may take into account in deciding where to direct their orders.

In our view, both of these risks are more than offset by the benefits that accrue to the client from such a strategy. Our clients pay us for best execution. They will not begrudge a few extra basis points of commission costs when set against the market impact on a particular trade of information leakage that could easily add 20-30bps to the cost of the trade. By feeding trades through large retail brokers, there is the added benefit of gaining access to that retail flow. One positive development in Asian markets is a trend towards networking among local brokers to stimulate liquidity and flow. A recent example is the consortium with kabu. com, UBS, Credit Suisse, MUFJ and ourselves, which, unlike Turquoise in Europe, involves a sizeable retail player.

As for market share, the impact on reputation can be countered by demonstrating the benefits of expanding clients’ execution options. We believe that as long as clients understand the reasons for our strategy, our reputation is secure.