A better spread

Matthew Carr, managing director and head of international equity sales at BNP Paribas, examines how alternative execution venues are set to circumvent the inefficiencies of Asia’s exchange-driven markets.

While Europe and the US have witnessed a burgeoning growth in ECNs, ATSs, dark pools and other alternative sources of liquidity, the use of dark books in Asia has yet to develop fully. Why is this the case? Although one of the reasons may be a reluctance from regulators to promote competition, leading to a highly monopolistic situation with the exchanges dominating the space, it can also be argued that brokers have been equally responsible.

Historically, brokers in Asia have not delivered sufficiently high-quality products in terms of execution and crossing. Instead, what they have mainly been doing is internalising their flows, which typically does not provide any incentive for clients to do block crossing. In Japan, for example, there is really no meaningful alternative to the dominance of the stock exchanges, despite the Tokyo Stock Exchange's recent capacity problems and very high latency.

In Asia, generally, many of the markets have relatively poor latency around half a second to one second, which compares very unfavourably with Europe and the US where latency is measured in milliseconds. During particularly volatile periods, order acknowledgements can be in terms of seconds or even minutes, thus leaving traders with the nightmare of “have I been done yet” scenario. Additionally, as we all know, the bid-ask spreads have been extremely wide in some of these markets, including Australia and Japan, despite them being two of the biggest markets in the world. This makes it very difficult to achieve superior execution performance. As one trader said to me, using a baseball analogy, they are fed up with swinging and missing. And that’s true of several of the different exchanges across Asia.

Exchange competition
Because of this, changes are afoot. Following regulation in the US and more recently in Europe, with the implementation of MiFID, there is a growing awareness of the benefits of crossing outside the exchanges. The inefficiencies of Asian exchanges are starting to be exploited by a new wave of crossing engines, alternative execution venues and dark liquidity pools opening in the region. More and more pockets of liquidity are starting to offer genuine competition, with the consequence that the exchanges are waking up to the fact that they need to compete. One just needs to look at NYSE Euronext and its SmartPool to see the direction that Asian exchanges may be heading towards.

These markets are far from fragmented, but new execution venues will not complicate the trader’s life, if anything it will make his job easier. By using the more traditional execution methods, he can post an order into the alternative execution venue and control the cross to match his own needs.

This year, BNP Paribas is offering its own dark liquidity pool, BNP Paribas Internal Exchange, or BIX. Launched in Japan in June, BIX will be rolled out in other Asian markets, such as Hong Kong, Singapore and Australia, over the next few months, and then in Europe shortly afterwards. Unlike other broker offerings, which have generally been rolled out West to East, BIX is very specific to the Asian market in that it has been built from scratch and launched in Japan. BNP Paribas runs a 4- 5% market share in Tokyo, so it was natural for us to go where we have liquidity.

BIX is not about internalising a client’s flow against our own flows. The aim is to enable the client to find the other side of the trade through technology, which is completely dark, but at the same time be completely compliant with the regulators and the execution policy. This is one of the first steps we have taken where we can consolidate client flows with BNP Paribas flows in a way that allows clients to actively manage their orders – whether they are controlling their market impact or seeking out liquidity in markets where it is typically scarce.

BIX has some very unique features, like crossing within the spread, and not at the static point of the spread, like most crossing engines do. Considering that every spread in Japan can be very wide and jumping it with an algorithm can be very expensive, crossing inside the spread is a huge performance boost. Also, we have introduced new order types that are not available on the exchanges or any other venue. Pegged orders, for example, allow a client to peg a bid or an ask at the midpoint, so when the market moves the client is always on the top of the priority because they are always pegged to the bid-ask.

By introducing these new order types and crossing within the spread, we are giving an execution performance to the client through which he can really create alpha through trading, not only through portfolio management.