Inside Business

November 12, 2013 12:31 pm

Asia stock exchanges and watchdogs grapple with HFT dilemma

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A curious thing happened recently on SGX, the Singapore exchange. In a matter of hours, about S$8bn (US$6.4bn) was wiped off the combined market value of three little-known stocks.

Shares in Blumont Group, Asiasons Capital and LionGold Corp slumped after mysterious trading activity that has been blamed on everything from aggressive short selling to outright market manipulation or insider trading.

The Monetary Authority of Singapore has pounced and is investigating. The city-state’s shareholder association has called on listed companies to tighten up on public disclosures.

The watchdog has said the episode had also “surfaced broader issues regarding the [exchange’s] market structure and practices” that could lead to reforms.

Not long afterwards, SGX revealed that it was taking the first baby steps towards embracing electronic market makers – sometimes referred to as “high-frequency traders” – for its equities market.

SGX, one of the few bourses that has not yet embraced HFT in equities, is considering offering financial incentives to encourage electronic market makers. Typically these players use their own balance sheet to provide bids and offers, spitting out thousands of algorithmically driven orders in an attempt to profit from minute changes in prices.

It is too easy to speculate that the two developments are linked. The mystery plunge of the three stocks could be the result of a classic boiler room “pump and dump” scheme, still all too common with penny stocks globally.

That has nothing to do with an exchange’s attempt to boost volume and liquidity by attracting market makers.

But it is hard to resist a flashback to the 2010 “flash crash” in US equity markets when a rogue computer algorithm sent the market plunging – and back up again – in a matter of 20 minutes.

That incident led to a root-and-branch review of the benefits and downsides of a market where trading is driven almost entirely by machines. Ordinary investors were spooked and remain suspicious of secretive traders who send orders into a market to which they have entrusted their retirement nest egg.

Now, that same debate is happening in Asia. China got a taste of wayward trading technology when an electronic “fat finger” error resulted in broker Everbright Securities being fined half of its 2012 profits in August by regulators.

SGX’s response to the two events of recent weeks encapsulates the dilemma faced by the region’s exchanges and regulators as they grapple with the issue.

Like any other exchange, SGX is trying to expand its business. It recently embarked on a push to plug into the big trading communities abroad, with plans to open a sales office in the US and an expanded presence in London. The move will inevitably involve wooing the big companies that account for the bulk of activity on exchanges – companies such as Getco of the US, and Optiver and IMC of the Netherlands.

If SGX can get its offering right, it will be pushing on an open door. The big market makers face a growing clampdown on HFT in Europe. Margins are getting squeezed too. Optiver’s net trading income fell 24 per cent last year, prompting it to look eastward to the Chinese market for growth in coming years.

Phillip Futures, Singapore’s largest local futures broker by volumes, says it is receiving “lots of requests” from proprietary trading companies to connect to SGX.

HFT often has been unfairly demonised. A recent report by the European Central Bank said it made markets more efficient. But SGX does not want to risk scaring off ordinary investors, who provide the backbone of its market. It is campaigning to persuade Singaporeans to invest more of their retirement funds in equity.

Yet neither the mystery blow-up of three penny shares nor an aggressive push to embrace HFT are likely to persuade ordinary folk to invest more in the stock market. SGX has faced criticism that it was slow to explain what happened with Blumont, Asiasons and LionGold, but it did reiterate plans to implement circuit-breakers to stop wild price swings. It is also moving slowly with HFT.

Other markets in Asia are rightly taking a measured approach. In January, new rules in Hong Kong will require not only brokers providing trading algorithms but also their clients – such as fund managers – to ensure they understand how they work.

Placing the due diligence burden on the so-called “buyside” is unprecedented, and there are reports that fund managers are cutting down on their use of brokers and technology vendors to avoid getting sucked into expensive compliance.

At least Hong Kong appears to be encouraging what was singularly lacking in western markets for so long: a race to the top on standards.

Jeremy Grant is the Financial Times’s Asia regional corporate correspondent

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