High-frequency traders are helping to drive up flows on Japan’s proprietary trading systems (PTSs) – but the effects of a multi-market environment may not be entirely positive for long-term investors, according to new research by trading technology company Fidessa.
“The evidence from Japan and other markets shows that with multi-markets come diminishing trade sizes, greater off-exchange activity and, contrary to regulatory intention, a reduction in transparency,” said Steve Grob, director of group strategy at Fidessa and author of 'Rising sun: how Japan’s evolving markets might herald the dawn of a new era'.
PTSs have existed in Japan since 1998; however, Japan has no definition of best execution that compels traders to consider PTSs, even if they offer a better price. That has meant they initially struggled to gain market share. Even as late as March 2011, none of the rival platforms had more than 1% market share – the largest, Chi-X Japan, stood at 0.93% while rival SBI Japannext held just 0.89%, according to figures provided by Thomson Reuters.
Since January 2011, the PTSs have increased their share of the Nikkei 225 index significantly. Part of the driver for that success was the introduction of the Tokyo Stock Exchange’s (TSE) new Arrowhead trading platform, according to Fidessa, which succeeded in providing a faster, more reliable platform for the TSE, and so attracted HFTs to Tokyo.
But because HFTs work best in a multi-platform environment, reduced latency at the TSE has actually caused a boost of activity on Chi-X Japan and SBI Japannext – an irony, considering that Arrowhead was meant to help TSE prevent the loss of its market share to rival platforms. As of April 2012, the two PTS platforms held 2.09% and 2.90% Japanese market share respectively.
The issue for long-term investors is that trade sizes on the PTSs vary between 1,000 and 2,000 shares, according to Fidessa, with an average value of between ¥500,000 and ¥1 million. That compares with an average trade size of 4,000 shares and average value of ¥2.5 million on the TSE. Smaller trade sizes make it more difficult for long-term investors to trade large blocks of stock and could potentially create more opportunities for HFT firms to pick off asset managers before they can get a good price for their trades.
Restrictions remain on the rise of the PTSs. The takeover bid rule, which obliges anyone buying up to 5% of a company’s stock during a 60-day moving average period to mount a full takeover bid for that company deters many of Japan’s larger investment houses from buying on PTSs. In addition, any trading venue that has 10% or more of market share is required to become a full exchange – again restricting the scope for PTSs. But the paper suggests buy-side firms should invest in technology to best prepare themselves to gain from the country’s changing market structure.
“They will need to invest in technology in new ways, but those firms that can do this successfully may well ride out of Japan on a wave of pan-Asian, or even global, dominance,” said Grob.