High-frequency trading surges across the globe

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.

Bank of America Corp in October began offering a platform for Brazil-based algo traders, adding to similar services in India, Malaysia, Thailand and Singapore. The bank is also eyeing Mexico, where the regulator plans a market overhaul intended to attract high-frequency traders.                                                                                    

Toronto battles "Myths"                                           
In Canada, alternative venues have bloomed in the past few years, leading to more competition for orders. More recently, it has led to a rush of traders seeking rebates the venues offer for trading there.                                           

TMX Group Inc, which runs the Toronto Stock Exchange and Canada's main derivatives market, has been fighting back with more aggressive pricing meant to attract the fast traders -- but it struck a measured tone on the evolving markets.

"One of the myths that we want to overcome is that high-frequency trading is everything to the future. It is a vital component, but the traditional players also have a role in the marketplace," Rob Fotheringham, senior vice president of trading with TSX Markets, said at a Toronto conference.                                           

Paul Wilmott, a leading expert in quantitative finance, said high-frequency trading could be bad for markets. "We should stop and think before we go too far down that route,  simply because when a lot of people are following the same strategies then you get the potential ... for bubbles and crashes, which we don't want," he told Reuters.

The debate has been amplified this year in the US options market, seen as one of the most obvious targets for the high-frequency firms. Options and equities share the same big investors, regulators and exchange operators.                                          

"That's probably the next battleground. But it will probably take a couple years to finalize the structure," said Louis Liu, founder of quantitative trading firm Lotus Capital Management LP, which uses high-frequency strategies.

One trader leads to another                                           
In stocks, even smaller emerging markets see an opportunity to get a lot more liquidity if they make themselves friendly to high-frequency traders.

"We tried to talk to people in Chicago and New York, but attracting their attention when they still have all the Asian market to conquer and some of the European market, looking at Colombia is still small," Juan Pablo Cordoba, president of the Colombia Stock Exchange, said at an event in New York.                                           

"The big question is what can we do to attract one, because if we attract one, maybe we can attract three or four international players. That is a big challenge."