Algorithmic Trading
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Buy-Side-Driven Trading Takes Hold in Hong Kong
April 3, 2007
Hong Kong is a major international financial center and a regional hub for institutional buy-side firms. Their presence in Asia, coupled with the growth of hedging strategies, has led to an increase in algorithmic trading in the region. Gabe Butler, Hong Kong-based director of sales and trading for New York agency brokerage Investment Technology Group (ITG) says that algorithms have been available there for three to four years, and "it is still a developing market that has been pioneered primarily by brokers using algorithms to trade on behalf of their clients."
According to various analyst estimates, 3 percent to 5 percent of order flow in Hong Kong is generated by algorithmic trading, compared to 13 percent in the U.S.
Asia in general, and Hong Kong in particular, has been slow to adopt algorithmic trading, Butler says, as electronic trading is not as developed. Asia took longer to adopt standardized FIX messaging and end-to-end trading systems, he points out, "and many people still prefer to deal with a person rather than a machine. To some, an algorithm represents a loss of control over the trading process." As a result, more education is needed as to the benefits, such as lower trading costs, that algorithmic trading offers.
The most common algorithms in Hong Kong are the fairly standard volume-weighted average price, or VWAP, and time-weighted average price, TWAP. "Much of the more general automated trading is also used for the proprietary trading of hedging strategies, as Hong Kong has a very active warrants market," Butler says.
Growth in algorithmic trading will continue, he says, as international firms already using it elsewhere will generate more activity in Asia. Meanwhile, local firms are becoming more comfortable with the concept, he says, adding, "There is also potential for the introduction of new or more complex algorithmic styles. For example, an algorithm based on market-at-close pricing may be popular due to the lack of a closing auction in the Hong Kong market."
Exchange Preparations
The Hong Kong Stock Exchange would seem an ideal venue for algorithmic trading because of its high rate of electronic trading and sizable volumes, says Sang Lee, managing partner at Boston-based research firm Aite Group. The exchange moved the process along by reducing spreads, he adds. Significant differences between bid and offer prices tend to hamper algorithmic trading. Unlike in the U.S., where spreads are set by the market, in Asia they are often fixed by regulators or exchanges.
Hong Kong's spread reduction has been gradual, with a first phase in spring of 2005. A second reduction early last year brought minimum securities trading spreads as low as 20 Hong Kong cents (2 cents U.S.).
"Hedge fund demand is not just a contributor to algorithmic growth in Asia, but a driver," says Wendy Garcia, a Tabb Group analyst in New Haven, Conn. "Hedge funds typically are the first to use alternative methods to execute a trade, and as hedge funds continue to move into the Asian markets in search of new or different liquidity stores, it is natural that the demand for such alternative trading tools as algorithms will readily grow in response."
Algorithmic trading improves execution, reduces market impact, increases the efficiency of trading desks, and ultimately reduces costs, she says. And that's the bottom line, where Asian securities firms are concerned. "We found in our research for global equity trading that cost is a primary driver of change in the Asian markets," says Garcia.
