Josephine Kim, director of electronic trading sales, Asia- Pacific, Bank of America Merrill Lynch, asks whether high-frequency traders and institutional investors can co-exist in Asia's securities markets.
While thinner spreads have provided tighter quotes, reduced tick sizes and competition across trading venues have made a more challenging environment for firms to generate profits today. The continued fragmentation of markets has been the key driver of automated trading. This has worked in hand with the proliferation of market data sources and technologies to provide high-frequency trading (HFT) firms with the capacity to guide different strategies across the asset classes.
Topics such as HFT and ultra-low latencies have captivated the media and stirred controversy. Is there really common ground for high-frequency traders vs institutional investors?
Growth of HFT
HFT is forecasted to continue gaining a greater share of overall volumes. Estimates vary by market but it already accounts for a majority of volumes in many exchange-traded securities today. In the US, penetration has reached saturation point. As a result, HFT firms continue to expand beyond the US in search of growth opportunities.
In Asia, markets have responded aggressively. Consensus figures put HFT at approximately 30% of volumes. Many futures contracts already have higher proportions and we have seen more markets offering co-location centres near exchanges.
HFT firms employ different strategies and these may not be mutually exclusive. Some firms employ several strategies while others use a particular automated strategy which may include various components (See Figure 2). HFT firms trade mostly with their owners’ money, easily trading thousands of shares in one transaction, only to offload them less than a second later before buying more. They can move millions of shares around in minutes, making profits by earning a tenth of a penny off each share.
From a trading perspective, brokers add value by providing quality execution – i.e. getting the best price and the most liquidity. They need to integrate HFT and institutional flow to improve liquidity for the institutional investors. This can be done by bringing HFT flow into broker dark pools or by accessing HFT flow on proprietary trading systems (PTSs). There is a constant debate on such integration as it often raises suspicion among institutional investors that have little or no visibility into the mechanisms in dark pools and smart order routers (SORs). However, in the face of persistently challenging conditions across global equity markets, HFT firms are widening their activities in the pursuit of trading alpha. Investors simply cannot ignore the issue nor can they expect high-frequency traders to leave the market any time soon.
A threat for some?
Critics say traders with access to the fastest machines win at the expense of ordinary investors by seizing on the best deals and turning fast profits ahead of others in the market. They also say the lightning-fast trading strategies can destabilise financial markets as the speed and volume of trades distorts prices. Conversely, high-Frequency traders say they have brought greater competition to the markets and have substantially cut trading fees for even the smallest investors.
Figure 3 shows different aspects of HFT from the viewpoint of various market participants. At the Bank of America Merrill Lynch Trading Forum in Tokyo in August, we invited over 70 key market participants to a live discussion and survey that reflected a mixed view on the pros and cons of HFT. On the buyside, 67% considered HFT as positive and 7% negative, with 68% viewing SOR and multiple trading venues as beneficial. One client mentioned that HFT has actually pushed the firm to adapt to new technology more quickly.
Irrespective of the concerns of a minority of some market participants, HFT is set to drive growth in the region. Exchanges are moving in the right direction. Singapore recently launched Reach, the fastest trading system in the world, oneand- a-half years after the Tokyo Stock Exchange (TSE) introduced the arrowhead system in Japan.
Brokers must provide metrics of performance (i.e. transaction cost analysis) to evaluate execution quality and they should also provide tools and configuration to tailor investors’ experience in dark pool and SOR to maximise performance. The Bank of America Merrill Lynch Global Execution Services (GES) team is working closely with institutional investors and various parties to improve understanding of dark pool and SOR mechanisms. BofAML is at the forefront of adapting and responding to clients and the rapid changing trading environment. Our recently launched best-of-breed suite of global algorithmic trading tool, Instinct®, can reduce parameter complexity and employ real-time signals and a quantitative model that can smartly calculate order tradability.
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