High-frequency stock trading is spreading around the world into more and more asset classes, but progress is being slowed by poor infrastructure, heavy regulation and opposition from entrenched interests.
In some major markets in Asia, it can take seconds to execute an equities order. That's a lifetime for a trader who uses sophisticated algorithms to trade thousands of shares in a millisecond with the aim of earning a profit from market making and price imbalances.
Turf battles between exchanges also sometimes prevent the kind of interconnected market approach that provides fertile ground for high-frequency trading.
Traditional brokers and institutions, whose positions are threatened by upstart trading houses, also help to erect barriers.But the high-frequency wave, estimated to be responsible for about 60% of US stock trading, has already washed over much of Europe and is being felt in some emerging markets, particularly in Latin America. It is also making inroads in futures, options and foreign exchange.
In Brazilian stocks, there are signs that high-frequency trading is starting to get a grip, and some relatively small markets like Mexico and Colombia are encouraging major US trading firms to bring in their latest rapid-fire trading techniques.
Smaller markets are attracted by the promise of more liquidity, which can make investing and trading cheaper and easier for everyone and help those who want to raise capital. Concerns about algos gone wild setting off a market panic are secondary.
"It's a virtuous circle. The more people come, the more other people want to come," said Martin Piszel, head of alternative execution services at CIBC World Markets, the investment banking arm of Canadian Imperial Bank of Commerce.
Patchwork of regulation
In some European stock markets, high-frequency trading is already responsible for more than a third of all trading, according to several estimates. The electronic wave has dramatically narrowed spreads and driven down trading costs, opening up some markets like never before. Still, Asia, while having a lot of potential, is far behind.
"The regulatory environment in the US and Europe, which is geared toward best execution, does not exist in Asia," said Takayuki Saito, head of direct execution sales at UBS AG's Asia-Pacific division.
Rule changes in the United States and Europe have harmonized trading and sparked a price war among exchanges and alternative venues. But such changes are a long way off in Asia, where spotty liquidity and patchwork regulation are long-standing problems.
Also, most of the region's markets don't yet have the infrastructure to handle trading firms that use microseconds -- or a millionth of a second -- to measure the time it takes orders to reach markets.
"The systems in Tokyo and Hong Kong are very slow. It takes several seconds for the exchange to accept a trade," said Neil Katkov, senior vice president and head of Asia at financial consultancy Celent. "There are only a few that operate below the one-second mark, like Korea."
Much may hinge on a plan by the Tokyo Stock Exchange to launch in January a new trading system that has an order response system of 10 milliseconds or less, he said.
UBS estimates that about 30% of Japanese equity trading is high-frequency. That compares with up to 10% in all of Asia, up to 10% in Brazil, about 20% in Canada, and up to 40% in Europe, according to a report by New York-based agency broker Rosenblatt Securities.
High-frequency trading accounts for up to 40% of trading volume in US futures, up to 20% in US options, and 10% in foreign exchange, the report said. Traders and analysts said fixed income and commodities are also considered ripe for growth -- although it may come with a fight.
"The dealers put up a really good fight to try to keep the new breed of electronic liquidity providers out, and keep a tight-knit club on who can make markets" in over-the-counter foreign exchange, said Richard Gorelick, CEO and co-founder of high-frequency trading firm RGM Advisors LLC in Austin, Texas. "Gradually, it's become a market that''s a lot more open to diverse market participants," he said.
Taking hold in Brazil
The real bonanza could come as US and European politicians and regulators push more of the world's derivatives onto transparent exchanges, a change intended to avoid a repeat of the blowups that led to last year's financial crisis.
While fragmentation poses problems in Asia, high-frequency trading has taken hold in Brazil, due in large part to exchange operator BM&FBovespa, which has a virtual monopoly on stock trading in Latin America's largest economy.
Trading has boomed at the exchange since August 2008, when it began offering so-called direct market access (DMA) to companies looking to quickly implement algorithmic and high-frequency strategies.
Marcio Castro, the exchange's director of information technology and trading systems, told Reuters the exchange sees "huge potential" for growth and plans to double trading volume capacity in 2010 to accommodate the high-frequency surge.
Last month, UBS launched algo trading for non-Brazilian investors wanting to trade on BM&FBovespa, whose benchmark index jumped more than 70 percent this year.
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