Beyond HFT

Last week I attended the Tokyo Financial Information Summit, put on by Interactive Media. The event was interesting from a number of perspectives. This event focuses on the capital markets; attendees are usually domestic sell side and buy side firms and vendors, including global firms active in Japan. This year there was good representation from around Asia ex-Japan as well; possibly attracted by the new volatility in Japan’s stock market. The new activity in the market was set off by the government’s Abenomics policies aimed at reinvigorating the Japanese economy. But I suspect the fact that Japan’s stock market is traded on an increasingly low latency and fragmented market structure gives some extra juice to the engine. Speaking of high frequency trading, Celent’s presentation at the event pointed out that HFT volumes have fallen from their peak (at the time of the financial crisis) and that HFT revenues have fallen drastically from this peak. In response to this trend, as well as the severe cost pressures in the post-GFC period, cutting-edge firms seeking to maintain profitable trading operations are removing themselves from the low latency arms race. Instead, firms are seeking to maximize the potential of their existing low-latency infrastructures by investing in real-time analytics and other new capabilities to support smarter trading. HFT is not dead, but firms are moving beyond pure horsepower to more nuanced strategies. Interestingly, this theme was echoed by the buy and sell side participants in a panel at the event moderated by my colleague, Celent Senior Analyst Eiichiro Yanagawa. Even though HFT levels in Japan, at around 25 – 35% of trading, have probably not reached their peak, firms are already pulling out of the ultra-low latency arms race–or deciding not to enter it in the first place. The message was that for many firms it is not advisable to enter a race where they are already outgunned. Instead they should focus on smarter trading that may leverage the exchanges’ low latency environment, but rely on the specific capabilities and strategies of a firm and its traders. Looking at this discussion in a global context, it seems interesting and not a little ironic that just as regulators are preparing to strike against HFT, the industry has in some sense already started to move beyond it.

The Market structure debate in Asian context

The recent debate about the impact of High Frequency Trading (HFT) and on the issue of market structure in general is no more confined within the US market. Regulators and market participants worldwide are discussing this issue seriously. The chairman of the Australian Securities and Investment Commission (ASIC) recently detailed the position of the Australian authorities in this regard. Incidentally Australia, along with Japan, is one of the few Asian countries that have multiple trading venues, a necessary condition for the growth of advanced trading and order routing capabilities, including HFT. It is worthwhile to look at the state of adoption of the Asian region in terms of adoption of advanced trading tools, and the role of the Asian exchanges in that regard. The different Asian markets are at different levels of maturity, and therefore it is difficult to analyse the region as a single homogenous entity; rather the Asian markets can be grouped into two broad categories. The first category belongs to the advanced economies like Australia, Hong Kong, Japan and Singapore which have well developed capital markets. Exchanges in these countries are at par with western competitors in terms of latency and adoption of advanced trading technologies. The second category consists of exchanges in emerging economies like India, China, Malaysia, Korea which are somewhat lagging their Asian counterparts in the first category. However, there is a common factor that runs across the two categories of exchanges – lack of competition from alternative trading venues. This means that most of the Asian exchanges are largely national monopolies without significant competition from alternative providers, though the situation is slowly changing in some markets (e.g., Australia, Japan). This is one aspect which distinguishes Asia from the western markets where the competition among exchanges and alternative trading venues is severe. Another key challenge in Asia is the fragmentation of markets and lack of harmonization – regulatory, economic, monetary and technological – in trading and settlement practices. This restricts the growth of cross border trading volumes and greater regional integration at an Asian level. The ASEAN initiative is a move in that direction, but it is still early days to judge its potential for achieving regional integration. Asia has also lagged the western markets in terms of adoption of advanced trading tools and technologies (like DMA, algorithmic trading, high frequency trading etc). Some of the Asian exchanges, particularly the ones in the advanced economies, have adopted latest technologies with low latency and colocation offerings, but some of the above mentioned factors still present challenges. For example, lack of multiple trading venues limits arbitrage opportunities. Lack of regional integration means cross border flows have yet to realize its full potential. These prevent growth of trading volumes, need for advanced trading tools and technologies, and participation of foreign players in domestic markets. Regulators in Asia are traditionally very conservative. Therefore decision making for significant changes in market structure and practices takes time. In a rapidly evolving trading world, this means Asian exchanges find hard to stay abreast with global trends. Also because domestic exchanges are perceived more as national utilities, any proposal that threatens the position of incumbent exchanges is met with resistance and difficult to implement. Some of the Asian exchanges have been very aggressive in exploring newer avenues beyond the traditional revenue sources. The Singapore exchange is a good example of that. It started offering clearing services for commodity derivatives through its AsiaClear offering a few years ago. In addition to providing CCP services as mandated for OTC derivatives under the proposed reforms, the SGX is collaborating with the Korea Exchange to develop the latters’ OTC clearing capabilities. Therefore in some markets (like Singapore) the incumbent exchanges are taking a leading role in clearing of OTC derivatives as proposed by new regulations. It will be interesting to see if new players will be able to enter and succeed in this business. Low volumes in the Asian markets, proliferation of CCPs, and competition from international ones may result in each CCP specializing in specific niches along product lines or local currency instruments.

CARTES Asia: A new payment industrial revolution in SoLoMo era

For participation in the ceremony of the award, where I was honoured to be a member of the jury, and presentation in the conference, last week, I visited Hong Kong. The venue, Hong Kong Convention & Exhibition Centre is vibrant as always. There were three big events around the same time.

The event, CARTES Asia is the leading smart technologies event in Asia Pacific. CARTES Asia has brought together innovative solution providers and market leaders from the card manufacturing, payment, security, identification and mobility industries. Some 3,000+ visitors in the banking, telecom, transportation and security sectors have a unique opportunity, not only to discover international exhibitors’ innovative technologies, but also to enhance their knowledge through the conferences and round-tables, which present the latest trends. I gave a presentation for the Cards & Payments session entitled "Payment Systems Trends in Japan."

The Asian SESAMES Awards aim to reward the most innovative technological applications developed for the Asian Pacific market in the field of smart cards, digital security, identification, secure transactions, and contactless technology. The Awards reward the best projects in 3 categories: Advanced Payment and Mobile Money; Card manufacturing & Personalization; and Secure Identity. As a juror, I evaluated the submissions independently and impartially.

Through the examination of this award, innovation, was proved to happen in places where new markets and new technology meet. Award winners all developed the frontiers of both technology and market. And the priority in technology and market was SoLoMo (Social, Local, and Mobile) once again. We are in the midst of ongoing technological changes and evolution, i.e. a new payment industrial revolution in this SoLoMo era.

About CARTES Asia:


Celent Round Table: When and Where Innovation Happens

Innovation is a key issue for financial institutions and a highly complex topic that demands attention when considering the business operations of tomorrow.

In light of its importance in the financial industry, Celent has planned two events in Tokyo focusing on innovation at financial institutions. The first was an innovation roundtable that was held last month. This and similar roundtables have been extremely well received in money market centers worldwide.

For the recent Tokyo event, a number of opinion leaders from Japan’s financial industry gathered to discuss and share two things: insights on effective approaches to promote innovation; perspectives of other leaders. Participants represented an array of sectors, including banks, insurers, leading brokers, dedicated online businesses, and foreign-capitalized companies. However, this diversity of participants from entities with differing business scale, history, format, and market size, shared a uniform passion when it came to their comments on innovation.

Prior to the roundtable discussion, Celent set the stage with two presentations.

The first, titled “The Search for Disruptive Innovation," took up “promoting innovation” as a theme. Specifically, it covered the reality and expectations of innovation among global financial institutions based on a Celent survey on innovation. The presentation put forth the following three points:
1) The use of ubiquitous data and breaking through traditional practices
2) Service strategies to respond to changing user expectations
3) Innovation-creating ecosystems and revision of internal rules

The second presentation, "Virtual Case Studies on Disruptive Forces," framed the technological changes and evolution witnessed since the 1970s as a new industrial revolution in a SoLoMo (social, local, and mobile) era. For the purposes of this discussion, the technologies driving disruptive innovation were categorized into three trend areas:
1) Analytic
2) Digital
3) Collaboration
Noted as common to these categories were that efforts to “respond to changing customer expectations” would drive innovation, which would be “led by firms willing to take risk.”

The subsequent lively roundtable discussion highlighted participant opinions including a range of expectations for “responding to changes the social environment,” “creating new frontiers in business,” and “shifting from continuous creation to discontinuous one.”

On the other hand, a number of factors that inhibit innovation were also mentioned, including the following: management placing priority on ROE, corporate culture that is averse to change, and enormous legacy assets. We learned two important things from some success stories introduced there: the effectiveness of initiatives by subsidiary firms which have a clear purpose and an unrelenting approach; and the importance of management that has taken innovation to heart and “made it part of the corporate DNA” to enable these initiatives to take root.

The scope of the discussion significantly transcended the prepared agenda, driving home the high expectations observers have and the vast potential see when it comes to financial innovation in Tokyo. Celent hopes that opportunities such as this that cut across the financial industry will act as a catalyst to drive the innovation at these respective firms.

Celent is committed to working with financial innovation leaders to explore the ideas that will shape financial industry of tomorrow. This discussion will be carried over and continued at events in March in Singapore and Chicago in April in New York. These will be followed by a June gathering in Tokyo that will focus further on innovation. We hope that you will continue to expect insightful things from Celent.

On Innovation

Celent held our most recent Innovation event in Singapore the last week of November, following similar events in New York, Boston, Toronto, Tokyo, London, and, most recently, San Francisco. Most of Celent’s work is focused on specific financial industry verticals, but Innovation is a topic that transcends industry barriers, and so—by design—do many of our Innovation events.

In Singapore we had representation from the entire financial services spectrum—banks, credit cards, insurers, capital markets firms and exchanges. We presented some of Celent’s recent thinking on innovation, much of it from our new innovation survey. But the main event was a peer discussion between the participants themselves.

It was one of the more lively discussions I’ve seen. We set aside two hours for the peer discussion, and it went by in a flash. Participants jostled to get their say in, and the session ended with the feeling that it could have gone several hours more. I think one of the keys was that there were a lot of different types in the room: the abovementioned full spectrum of FIs, from both the business and IT side, and even from compliance.

Everyone was naturally interested in how their “colleagues across the aisles” looked at innovation, how far each had come in achieving it, and what their technology, operational and cultural approaches were—or were not. Participants brimmed with on-the-spot case studies of initiatives at their firms. This was also refreshingly unusual, since firms are often reticent to divulge competitive information and “secret sauces.”

I think the reason for this relatively high level of enthusiasm lies in the industry’s realization that innovation is crucial to long-term success–and considering the rapidly expanding number of disintermediators, and the remarkable success of some of them, maybe even needed for short-term survival.

Use of OTC Derivatives by Asian Corporates

Asia accounts for less than 10% of notional outstanding of the global OTC derivative market. Even within Asia, trading activity is primarily dominated by the four advanced countries Japan, Singapore, Hong Kong and Australia. Most of the OTC products in Asia are plain vanilla in nature, and as a result the OTC markets emerging Asian countries are at a very early stage of development. Corporates in Asia primarily use OTC derivatives to satisfy their need for customization. Foreign Exchange (FX) derivatives are the most popular OTC instruments used by Asian corporates. Many corporates have regional or international operations; they use cross currency swaps as net investment hedges for foreign currency exchange risk of international operations. In addition, corporates engaged in significant imports and exports use forward foreign exchange contracts as cash flow hedges for exposure to foreign currency exchange risks arising from forecasted or committed expenditure. Interest rate instruments are also popular among Asian corporates. Many Asian corporates have issued foreign currency denominated debt and therefore use cross currency interest rate swaps to hedge interest rate risk and cash flow hedges to hedge currency risk arising from issued bonds. In addition, corporates also engage in OTC commodity derivatives.  Commodity derivatives, particularly those involving palm oil and rubber, are in demand from Southeast Asian corporates. Moreover, corporates in the energy and manufacturing sectors use them to hedge against price fluctuations in the underlying commodities. Emerging Asian countries lack necessary infrastructure for onshore OTC commodity derivatives trading. Corporates in those countries therefore have to deal with international exchanges or with international counterparties.  Asian corporates typically engage in OTC derivatives for hedging, and not for trading purposes. Therefore many of them have not set up infrastructure for exchange trading. Small percentage of them is using centrally cleared derivatives at present. However, this is likely to change in the future since regulators are now encouraging and incentivizing central clearing of standardized OTC derivatives as part of the OTC derivative market reform process. While reducing counterparty risk is an obvious benefit of using central clearing, CCP also reduces clearing costs, as without central clearing one has to pay higher margins up front. With requirements of central clearing and other associated reforms, it is argued that the use of OTC derivatives may decline. If that happens, it will be mostly limited to financial institutions’ use of these instruments who engage in them for trading purposes; the need for OTC derivatives for hedging purpose is likely to increase. Non-financial corporates accounted for around 20% of OTC derivative trading in the emerging Asian economies, while they accounted for only 6% in the four advanced countries. This indicates the involvement of real economic actors and trade related activities are higher in the emerging country OTC markets. This is also due to the fact that in advanced countries large dealers and other financial institutions engage in significant trading and market making activities in the OTC space. Corporates’ high share in emerging country OTC market is likely to continue or even increase as the real economic output of the countries grows.  This will be driven by economic growth, growing international operations and trading activity of local firms, liberalization of financial markets and regulatory initiatives facilitating more cross border trading. The developments in the emerging economies will also contribute to the growth of OTC activity in the advanced countries, particularly in Hong Kong and Singapore, as a significant proportion of activity in those markets comes from investors in the neighbouring countries who cannot meet their demand in local markets. However, this process is likely to evolve slowly as regulators in the region are traditionally conservative in nature.

Exchange initiatives in Asia

In a recent post we discussed that OTC derivative market reform process is giving rise to new opportunities for several market participants. We identified provision of collateral management services as one such opportunity. It comes as no surprise that the Singapore exchange and Clearstream are partnering to offer precisely such service. This development also highlights another trend that has been observed for some time now – that of partnership and alliances in the exchange landscape, particularly in Asia. Even though the Singapore Exchange (SGX) failed in its bid to take over the Australian Stock Exchange, it has been very active in forging partnerships and alliances with other exchanges, both in the region and globally. Recently it bought a controlling stake in the clearing house LCH.Clearnet. It also partnered with the London Stock Exchange to provide investors in each country the opportunity to invest in the most actively traded stocks on the other’s exchange. It has similar partnership for cross trading of certain products with other exchanges like the National Stock Exchange of India. The exchange has increased the trading hours to accommodate such collaborative initiatives with other exchanges. Besides partnering with other exchanges, it is also adding new services to expand vertically. The exchange started offering clearing services for commodity derivatives through its AsiaClear offering a few years ago. In addition to providing CCP services as mandated for OTC derivatives under the proposed reforms, the SGX is collaborating with the Korea Exchange to develop the latters’ OTC clearing capabilities. Going beyond traditional partnerships with other exchanges, the SGX partnered with Chi-X to offer a dark-pool platform to the investors in the region. Even though that initiative did not meet with much success in terms of attracting volume, it displayed the exchange’s intention to explore newer opportunities. The SGX is one of the four exchanges to join the ASEAN trading link, an initiative  that offers a common link to investors in the seven ASEAN bloc countries to trade in other member countries. In addition it is looking for organic growth by adding product base and improving distribution services (e.g., developing Chinese Yuan capabilities). Not to be left far behind, the Hong Kong Exchange has acquired the London Metal Exchange. Regulators in Malaysia have allowed CME to buy a 25% stake in the Bursa Malaysia’s derivative business and revamp its technology. In Japan the Osaka Securities Exchange merged with the Tokyo Stock Exchange to make it the third largest exchange by market capitalisation. These developments show that the exchanges in Asia have been very active in forging new partnerships and broaden their suite of offerings. The trend is expected to continue in the future.

OTC Market Reforms in Asia: Presenting New Opportunities

In another blog we discussed the issues that will have serious implications for different market participants in the OTC derivative market reform process in Asia.  Here we look at its impact on different market participants. The move towards central clearing is likely to create more demand for clearing services. Currently a small number of brokers offer clearing service in this space, and they may not be able to handle the sudden rise in demand. Some of the major international clearing firms are in the process of scaling up their operations in the region. Even though the volumes in the OTC segment are low at present, the growth prospects of the Asian economies in general, and niche areas (e.g., NDF clearing) make the region strategically important for many of these firms. However, some participants are wary about the costs of having to join many clearing houses and the issue of assuming unlimited liability in case of default. International banks have significant share in the OTC derivatives space in Asia; if these issues are not sorted out, some western banks may withdraw from some markets, or even the whole region, which would likely have an adverse impact on liquidity. Regulations mandating central clearing will create business opportunities for centralized clearing. In some markets like Singapore, the incumbent exchanges are taking a leading role in this regard. It will be interesting to see if new players will be able to enter and succeed in this business. Low volumes in the Asian markets, proliferation of CCPs and competition from international ones may result in each CCP specializing in specific niches along product lines or local currency instruments. The business models of new CCPs will come under heavy scrutiny from regulators, breaking trends from the past. As large number of OTC trades move to the CCPs, the concentration risk at some of them would be significant and national regulators would want to make sure those risks are adequately managed on a continuous basis. As CCPs replace bilateral trading, and market participants face the choice of executing trades at different CCPs, they will also need tools for managing and optimizing the use of collateral. This represents an opportunity for some market players who specialize in providing collateral management solutions. Needless to say, the kind of solutions needed and offered in this space will depend largely on the maturity of specific markets and market participants. Thus, while Credit Support Annexes (CSAs) may be sufficient for emerging countries of the region, advanced services (like collateral transformation, outsourcing of collateral management) would gain traction in the leading countries like Australia, Hong Kong and Singapore. Reporting banks would come under greater regulatory scrutiny and will have to run stress tests and ensure capital requirements on an ongoing basis.

Call for submission for the fourth annual Celent Model Insurer Asia Award

Through our Model Insurer Asia Awards Program, Celent recognizes the top technology initiatives in the Asia-Pacific region. Past winners include Calliden Group (Australia), Partners Life (New Zealand), PICC Health (China), HDFC Standard Life Insurance (India), IndiaFirst Life Insurance (India), Nextia Life Insurance (Japan), Prudential Life Insurance Company of Korea, Baoviet Holdings (Vietnam), PT Prudential Life Assurance (Indonesia), HNB Assurance (Sri Lanka), AIG Asia Pacific, Zurich Insurance, to name a few. (View past winners of the Model Insurer Asia Awards ) Award criteria:
  • The initiative has been implemented at an insurance company, a company that takes on risks under the policies it sells in return for the payment of premiums
  • The nominated insurer has been involved in the submission
  • The nominated initiative is live and functioning
  • Quantitative success metrics are measured and provided
  • The initiative must have been implemented in the Asia Pacific region, and should not have been submitted for another Celent 2014 Award, e.g., Model Insurer
Nominations for Celent Model Insurer Asia Awards are currently being accepted. To nominate an initiative at your company as a model insurer component, please complete this nomination form. Please note that vendors are welcome to assist their client insurers with their nominations, however vendors/suppliers are not qualified to receive an award. All nominations MUST include insurer contact information, and all follow-up will be done with the insurer, not the vendor. The importance of the quality of the nomination itself, and of the supporting information, cannot be overemphasized. The nomination should be as specific, accurate, and complete as possible. It is imperative that the true merits of the initiative be conveyed through this information. Keep in mind that in most cases those involved in the selection process will have no personal knowledge of the nominated initiative and will lean heavily on the information provided below for the information they need to make reasonable judgments.  In some cases, Celent will check publicly available information to augment or substantiate the information provided. The deadline for nominations is November 29, 2013. Winners of this year’s awards will be announced at the Model Insurer Asia Summit in March 2014 in Singapore. A report including winner case studies will be published on the same day of the event.

OTC Derivatives in Asia

Over-the-counter (OTC) derivatives have come under scrutiny since the Global Financial Crisis (GFC) of 2008. The global OTC derivative market is primarily dominated by the US and Europe, with Asia accounting for less than 10% of notional outstanding. The Asian financial market, unlike its western counterparts, is not a homogeneous entity. Rather, the countries in the region are divided along jurisdictional lines with limited regional integration. Thus Asia not only consists of a large number of countries with each at different level of economic development, they also have different regulatory and monetary regimes. This has resulted in a number of highly localized markets with the exception of a few, notably Hong Kong and Singapore. In two new reports Celent discusses the development in the OTC markets in 11 Asian countries, divided into two groups. The first report looks at the advanced economies and includes Australia, Hong Kong, Japan, New Zealand, and Singapore. The second report covers the emerging economies of China, India, Indonesia, Malaysia, South Korea and Taiwan. It is interesting to note that the emerging countries account for only 9% of total OTC turnover in these countries, even though there share is much higher on other economic and financial