India may be catching up with established Asian markets in its adoption of electronic trading tools but many of the country's buy-side firms continue to prefer more traditional techniques, according to a new report by research group Celent.
Anshuman Jaswal, senior consultant and author of the report, subtitled ”No Country for Old Men', says that the trading desks of institutional investment firms in India are having to come to terms both with new tools and added responsibility for trade execution.
“As in many Asian countries, buy-side traders in India rely heavily on brokers for trade execution. To adopt electronic trading in greater numbers, they have to be comfortable not only with the technology but also the risk. This is impediment for smaller buy-side firms in particular,” says Jaswal.
Despite the caution of domestic buy-side firms and the regulatory hurdles faced by foreign institutional investors that wish to trade electronically in India, Celent predicts that levels of algorithmic cash equity trading will rise from barely 10% of overall trading volumes in 2010 to more than 20% by end-2012. Over the same period, algorithmic trading in Hong Kong is expected to increase from just under 40% of total equity volume to more than 60%. Celent forecasts Indian buy-side adoption of electronic trading and the FIX messaging protocol to treble from today's 10% by 2015.
Indian market participants have already embraced algorithmic trading in some other asset classes. For example, Celent estimates that 20% of Indian equity futures and options trading was conducted using algorithms in 2011 and expects the level to rise to 50% by 2015. In contrast, use of algorithms in India's currency futures market is expected to languish at 2% in 2011, in large part due to the fact that foreign institutional investors are not permitted to trade in the market at present. However, Celent expects the growing influence of prop trading firms to push use of algorithms for currency futures trading to around 15% by 2015.
A major development over the last 12 months in India's equity markets has been the launch of smart order routing (SOR). Although The Securities and Exchange Board of India (SEBI) outlined the regulatory framework for SOR in August 2010, a combination of burdensome documentary requirements and intense competition between the exchanges mean that volumes have been low to date. Only a handful of brokers have been approved to supply SOR services, while end-users must also register with exchanges prior to using them. Moreover, the Bombay Stock Exchange (BSE) has accused its larger rival, the National Stock Exchange (NSE), of preventing market participants that use its co-location facilities from routing orders to the BSE.
Jaswal concedes that the delays to adoption of SOR can be frustrating to market participants, but says the overall pace of change in India's financial markets has been rapid in recent years, noting that direct market access was only introduced in 2008. “Very few markets have had to handle this kind of change this fast. On the other hand, India's position as a fast-growing but still emerging economy is a reason for regulatory conservatism. A flash crash would be more harmful to India than it was to the United States,” he says.
A further constraint on SOR is the lack of interoperability between India's two clearing houses, each of which is partially owned by one of the two exchanges. This means that the price improvement achieved by routing between venues in search of best price may be offset by higher clearing costs.
“Discussions on clearing have been taking place for the last year or two, but I'm not sure that SEBI regards it as a priority. Moreover, clearing interoperability could threaten the NSE's dominance in the derivatives market as well as equities. As we are seeing in Europe, it takes time to facilitate clearing interoperability,” says Jaswal.
Nevertheless, he predicts that the share of SOR in Indian cash equity market trading will rise from 4% this year to around 26% in 2015, with foreign institutions employing the technology for 30% of trades in four years' time.
While his report asserts that the recent period of liberalisation has equipped India to become a major international financial centre, Jaswal says that further reforms are needed. India's Securities Transaction Tax can make algorithmic trading unprofitable, he says, warning also that the state of Maharashtra, of which Mumbai is the capital, may add to trading costs by raising stamp duty. “The government should amend its tax regulations to ensure that the Indian capital markets are not left behind their global counterparts when it comes to adoption of new technology, because this might make them uncompetitive and result in business going offshore,” said Jaswal.