The two-month consultation on electronic trading regulations by Hong Kong’s Securities and Futures Commission (SFC) comes to an end on 24 September, with market participants viewing the process as bringing the exchange largely in line with what’s happening around the globe.
The thrust of the proposals is centred on three main areas: algorithmic trading, internet trading and direct market access, closely mirroring guidelines from the International Organisation of Securities Commissions (IOSCO) on the regulation of electronic trading.
The SFC consultation paper also includes requirements for testing algorithmic trading systems, intermediary responsibility for risk management controls and supervision, as well as record keeping.
“Reading the IOSCO reports usually gives a three to six-month heads-up on what local regulators will be focusing on, so they’re essential reading for anyone in this line of business,” said Liam Madden, head of Asia-Pacific legal and compliance at agency-broker Instinet. “We’ve also seen Australian Securities and Investment Commission (ASIC) looking at very similar issues, so if you’re in the Asia-Pacific region, none of what’s in this consultation paper should come as much of a surprise.”
According to David Jenkins, head of business development at Fidessa, most of the checks and surveillance which are going to be required by the new guidelines are already in use by many market participants.
“The two things that are different are the need for credit controls and the outright prohibition of sponsored access where the client doesn’t go through the members’ pipes, which wasn’t a widespread practice anyway,” said Jenkins. “The challenge is going to be for people to apply credit controls over potentially multiple access points to the exchange – that will require some system renovation.”
“It has been traditional for a client coming through a members’ infrastructure to give their risk system to the member in order to control the parameters of their flow. That has now been explicitly prohibited,” added Jenkins.
The fact that Hong Kong is still so centralised makes it relatively easier than other markets to control credit risk because trading is not happening across multiple venues, pointed out Jenkins.
“Coming through multiple gateways and managing the credit can be a challenge because you need to apportion the credit out to different parts of the infrastructure, but it’s still very much a single trading venue, so I don’t see the kind of multi-market issues that might occur in other parts of the world, such as Australia or Japan,” said Jenkins.
However, the consultation process could have examined the “multi-asset nature of trading these days, and been more explicit about which assets it covers,” believes Jenkins. “A lot of strategies now have multiple asset classes, and trying to credit control that is a challenge, because if you’re only applying credit on one side of that multi-asset strategy, then you’re not doing it across the entire trading activity of the client.”
Overall, the proposals and consultation were welcome, Jenkins suggested. “We look at them as leading to more certainty as to what our regulators expect from us.”
Defining the problem
However, as has happened with the ASIC consultations in Australia, definitions of terms in the regulations have caused concern.
“Terms such as ‘internet trading’ could refer to almost anything, though it seems to be used here to talk about retail trading through an online platform,” noted Instinet’s Madden.
“One of the terms we’re quite sensitive about is ‘algorithms’. A lot of the bad press you see around algorithms is to do with the high-frequency end of the spectrum, and even defining the difference between trading that’s fast and high frequency trading is a very important split,” said Madden. “For example, there is a big difference between our clients who we are executing for or who are using direct market access – where there will be benchmark algorithms involved – and high-frequency traders who have their own cash at stake and are using more predatory algorithms. We would like to see that distinction clearly defined.”
Pre- and post-trade supervision on the part of intermediaries is also examined in the SFC paper, suggesting a greater onus is going to be placed on them to keep tabs on clients’ activities.
“How much of a client’s overall trading should a broker be responsible for, since they may trade through multiple brokers like most of our clients do,” questioned Madden, who expressed concern that the burden of responsibility might be shifted too far towards brokers.
The minimum client competency requirements outlined in the paper are appropriate for the retail space, but not when it comes to professional and institutional clients, suggested Madden.
“If you’ve got a trader who sits on the desk of an institutional buy-side investor that doesn’t understand the tools he’s using, that’s more of a management issue for them,” Madden said. “Our experience is that when it comes to institutional investors, they generally know what they’re doing, and the regulations should reflect that.”