The silent growth of algorithmic trading has been one of the
most powerful trends in securities and derivatives markets in
recent years. But while plenty of attention has been paid to
this in North America and Europe, it is a lesser known
phenomenon in the smaller markets of Asia and the emerging
Algorithmic trading requires a combination of liquid
markets, technical infrastructure and institutional support
that are only patchily available in these regions. Yet
exchanges and brokers in Asia and Latin America are eager to
attract this kind of firm, because of the high trading volumes
they can generate.
Many algo traders, of course, rely on high frequency trading
– myriad trades in a fraction of a second to take
advantage of tiny pricing advantages or inefficiencies in the
Such firms have made considerable inroads in Asia in recent
years. "Volume is driven by a combination of local and global
players, with the latter group dominant," says Rama Pillai,
head of intermediaries at Singapore Exchange. "At the same
time, a number of global players are locating themselves in
Singapore or other parts of Asia, so the line between local and
global participants is rather blurred."
High frequency traders accounted for 26% of
SGX’s derivatives trading in the first quarter of
this year, against 15% for the same period a year ago.
One attraction of SGX is that several of its contracts can
be used as proxies for markets elsewhere – in India or
Japan, for example – that are more difficult to enter,
either because of regulatory or technology obstacles. The
exchange wants to become the gateway to Asia for algorithmic
"We want to offer access not just to Singapore products, or
Japanese products, or Indian products, but to a wide range of
products in the derivatives, securities and commodities space
across Asia. Our products cover 80% of Asia," says Pillai.
Many of today’s high frequency and algo trading
firms have grown out of options market-making firms in Chicago
Some have had great success, but entering the attractive
Asian environment – with its wide spreads and high
involvement by (typically less sophisticated) retail investors
– has not been without its casualties.
Citadel Investment Group, the Chicago high frequency
specialist hedge fund, closed its Tokyo office in December 2008
after heavy losses in the financial crisis, cutting 12 staff in
Tokyo and 25 in Hong Kong, an office it kept open.
Global Electronic Trading Co (Getco), a leader in high
frequency trading in the US and Europe, has taken a more
measured approach, gradually expanding its presence in Asia,
particularly last year, to ensure familiarity.
The technical battlefront
It is not just for their high volumes that Asian exchanges
seek out algorithmic trading firms. For these companies,
predicting the market is not the only battleground. They wage a
constant war to reduce latency – the time taken to
execute trades. This makes them demanding customers, but
lucrative ones – they will purchase additional
facilities such as colocation and enhanced order
Tokyo leads on matching speed
Over the last year Asian exchanges have worked hard
to solve the infrastructure issues preventing algo
traders from becoming more widely involved.
Much attention has focussed on the January launch by
the Tokyo Stock Exchange of its new Arrowhead platform,
developed by Fujitsu, which, it is claimed, will enable
participants to execute trades in only 5
In February Merrill Lynch unveiled
Japan’s first third party colocated
service for high frequency trading and direct market
access to multiple execution venues.
High frequency flow is already crucial to
Japan’s exchanges. Despite significant
delays in matching in the past, a UBS report last year
estimated that about 30% of Japanese equity trading is
now high frequency. Levels for derivatives are
The Osaka Securities Exchange will move its futures
and options trading engine to Tokyo in 2011, meaning
that firms will get lower latencies when trading its
High profile upgrades to matching engines have taken
place at the Tokyo Stock Exchange and the Singapore
Exchange. The Australian Securities Exchange has
recently announced a new platform for high frequency
Figures measuring latency – the time
between a trade being placed by a trading programme and
it being filled at the exchange – are
notoriously difficult to interpret. Latency can be
introduced by the network, the software, or the
computer processor at the matching engine. Where it is
measured, typically by exchanges and technology
providers wishing to market their services, it is very
rare for traders to achieve those speeds in
But here are figures given by some Asian exchanges,
along with the speeds which were common until
Tokyo Stock Exchange
before January 2010: 3 seconds
after Arrowhead: 5 milliseconds (ms)
Osaka Securities Exchange
until recently: around 200ms
now: around 15 ms
Australian Securities Exchange
now: around 300ms
target for 2010-11: 0.05ms
Hong Kong Exchanges and
now: around 15ms
The problem for the exchanges is satisfying the technical
needs of the customers. Compared with their Western
counterparts, Asian exchanges have severe limits on order
throughput – the quantity of orders a single
participant can process each second before flooding the
exchange’s matching engine.
"The throughputs on exchanges in the region can range from a
mere five to approximately 50 orders per second," says Alan
Donoghue, CEO for Asia of Nyenburgh in Singapore. The Dutch day
trading and arbitrage trading company has been active in the
region for three years.
Exchanges that rush to provide the frills of high frequency
trading without speeding up their own matching engines are
therefore putting the cart before the horse.
One example of such a frill is colocation, where exchanges
allow traders to place their servers alongside the
exchange’s matching engine to reduce the distance
(and therefore time) that messages must travel.
But as long as throughput to the matching engine is so
limited, the millisecond increases in trading speed offered by
colocation are ineffective.
A second obstacle concerns the speed with which traders can
receive market data from the exchanges to feed into their
algorithms, informing the trades. The amount of data the
exchanges can publish makes a huge difference to algorithmic
traders and, once again, is a function of the
"If a firm needs 100 meg to run a trading line (for a
massive wall of pricing data) and this is virtually impossible
to instal for its office in Asia, it can’t trade
in the way it does in Chicago or New York," says one former
Fear of unfairness
A third problem is regulatory. "On top of these physical
constraints there are the regulatory constraints that require
you to have a 'responsible person or designated
trader’ for each session," says Donoghue. If firms
want to expand their throughput by using multiple sessions,
this means they cannot.
"And most exchanges in the region have harsher member
requirements, costs and certainly take longer in application
than their US and European counterparts," Donoghue adds. Remote
membership initiatives have done little to solve this
In part, these regulatory obstacles come from the
exchanges’ wariness about being seen to give high
frequency or algorithmic traders an advantage.
"Regulation is one of the most inhibiting factors:
regulators naturally have questions about opening themselves to
sophisticated foreign participants whose market participation
may require exchanges to change the fundamental principle of
not allowing preferential treatment amongst participants," says
Chris Morris, director of Aequitas Associates, a London-based
consultancy to exchanges.
Asian derivative markets like South Korea, Hong Kong, and
mainland China are very retail-orientated. Investors there fear
that fast-working black box models put them at a disadvantage;
regulators are reluctant to risk retaliation from this
lucrative segment by pushing services like
Competition creeps in
"One of the reasons that facilities for high
frequency trading are less developed in Asia is that
brokers and traders have little leverage in lobbying
the exchanges," explains Christopher Morris of trading
consultants Aequitas Associates in London.
There are very few alternative execution venues in
Asia where participants can threaten to take their
business, so power is concentrated in the hands of the
national exchanges. But alternative trading venues are
beginning to become established.
In August 2009, Europe’s leading
alternative trading platform for equities, Chi-X,
announced a partnership with Singapore’s
SGX to launch Chi-East, the first so-called 'dark
pool’ in the Asia Pacific region. In March
Chi-East secured a licence to operate in Australia.
Hong Kong Exchanges and Clearing, for example, was loth to
comment for this article on the services it offers high
Vendors pave the way
In such a disparate operating and regulatory environment,
the role of technology firms as a way into the region is
crucial. SGX has licensed 12 software vendors to help get
traders up and running quickly.
"We get advanced orders from clients who want to trade in
Hong Kong at 'any price’," explains Benjamin
Bécar, SunGard’s algo trading specialist in
Hong Kong. "But this order type is not authorised by the
exchange. It can be confusing therefore for, say, a Japanese
investor, who is used to sending this kind of order.
That’s why they come to us."
Technology firms like SunGard allow trading models to
interface with the vagaries of the local operating environment,
such as tick size, lot size, opening and closing auctions and
market order types – as well as questions as simple as
whether there is a lunch break, and what type of trading can be
done during the break.
Explains Bécar: "It takes time and resources for
vendors or investors to create or adapt algorithms for a
specific market. Some harmony, like that provided by a united
trading association, would help the industry grow a lot."
Brazil finds the right mixture
Latin America’s derivatives market
contrasts with Asia’s in being highly
concentrated. Since the merger in 2008 of
Brazil’s futures exchange, BM&F, with
its stockmarket and equity options exchange, Bovespa,
this one venue has hosted over 85% of Latin
America’s derivatives volume, dwarfing
even the next-biggest markets, in Mexico and
And BM&F Bovespa is on a roll. Helped by an
unprecedented wave of interest rate speculation fuelled
by the impending resignation of central bank governor
Henrique Meirelles, the exchange blasted away its own
records in March, with an average 4.17m contracts
traded a day in its equity options segment and 3.1m in
its futures division.
BM&F Bovespa is now the world’s
fifth biggest derivatives exchange group, with 159m
contracts traded in March. Part of this rapid growth is
down to algorithmic and high frequency traders, which
the exchange has been wooing since early 2009, as part
of a wider effort to grow foreign participation in
derivatives flow from the current 20% to nearer the 35%
it enjoys in equities.
Drawn by the triple attractions of liquidity,
simpler regulation and high volatility, firms have been
coming to Brazil.
DMA takes off
Direct market access (DMA) – where brokers
provide traders with direct access to an exchange, via
a unique user ID – has surged since its launch
By March this year, 12.8% of average daily
derivatives volume, or 779,000 contracts a day, was
from DMA, up from 3% or 82,000 in January 2009,
according to the exchange. The vast majority of this is
from algo funds, though not all of those are high
frequency traders. In March high frequency firms
accounted for 3.5% of total trading, 207,000 contracts
Link Investimentos, an independent Brazilian
brokerage, estimates that trading by high frequency
traders grew over tenfold between February and October
2009, helped by latencies that dropped from 85
milliseconds last March to around 10-15 milliseconds by
Brokers are arriving in increasing numbers. In
November UBS became one of the first global investment
banks to offer customised algorithmic trading for
international clients, initially in equities. It has
now been joined by JP Morgan.
They join established domestic providers Interfloat
and Link Investimentos (which UBS is rumoured to be
close to acquiring).
Several foreign traders are active –
accounting for around 70% of high frequency volume
– including leaders like Getco and Jump
"Algorithmic traders employ a variety of strategies
on these contracts: arbitraging the main and mini
[Ibovespa equity] indices against the underlying
contracts," explains Mateus Bertti, head of IT
modelling at BM&F Bovespa. "Spread strategies are
popular – arbitraging one maturity against the
other – as are trading the Bovespa index
portfolio on the spot market against its futures."
Bertti expects future growth to spread to interest
A big impetus for the uptake of DMA was the mutual
order routing agreement with CME Group, introduced
either side of new year 2009. The deal created a low
latency intercontinental pipeline spanning the 5,000
miles from Chicago to São Paulo. US brokers
could connect to BM&F Bovespa via the CME Globex
platform, while Brazilian firms could trade CME
products through BM&F’s electronic
Once traders were confident that the trading
environment was reliable and there was money to be
made, the introduction of colocation in June 2009 was a
second important development.
"Now these participants are happy the market is
liquid enough and that they can make profits,
they’re moving to us to colocate," says
Bertti. "Message volume has increased hugely, driven by
these foreign players."
Meanwhile, the exchange has connected with four
software vendors, enabling algorithmic traders to have
their orders routed directly. SunGard won a licence to
provide this so-called 'Model 2’ access in
March, joining emerging markets specialist Marco Polo
Networks, Bloomberg Tradebook and the Brazilian firm
Cedro Market & Finances.
"The introduction of DMA Model 2 access in
particular was important, in that buy side traders no
longer need to rely on broker infrastructure for access
to the BM&F exchange order book," says Laurence
Latimer, managing director for trading and client
connectivity, Americas at SunGard in New York.
Some investors like this because it means their
orders do not have to pass through the infrastructure
of potential competitors, which might be able to
observe their sensitive trading activity.
"Hedge funds can be anywhere – São
Paulo, New York, London – sending algorithmic
orders. They just need a local member to sponsor them
on the exchange," Latimer explains.
Additional support for high frequency trading has
come from Brazil’s clear regulatory
framework. The regulator has been straightforward from
the beginning about how foreign firms can participate.
All foreign access is broker-sponsored, allowing a
client to use the broker’s exchange ID,
but requiring orders to pass through at least one level
of risk management.
In DMA Model 2 access, the broker provides this risk
management screening. For funds that use colocation
under Model 4 access, the risk management is provided
by the exchange. This prevents trading being disrupted
by thousands of erroneous orders placed by a high
For BM&F Bovespa to become established as a fully
mature hub of algorithmic and high frequency trading,
there is still considerable progress to be made. But
with the basic building blocks in place, this looks
likely to be rapid.