Onerous regulations, harsh tax regimes and a shortage of liquidity in Europe are seeing a growing number of hedge funds and high-frequency traders moving out of the region to set up bases in emerging Asian countries.

With traders in European markets finding profits hard to come by in an extremely competitive environment, the growth and increasing diversity of Asian markets, coupled with inefficiencies and a lack of sophistication in the markets, are seeing many hedge funds flocking to Hong Kong, China and Singapore.

“We are starting to see HFT firms pop up in Asia and also hedge funds who are heading east in search of alpha,” Rob Lane, European business manager, trading solutions, at Interactive Data, a provider of financial market data, told Markets Media.

“In the more traditional markets, of Europe and the U.S., you have a lot of sophisticated traders and algos going up against one another so you’ve got this race, where they start to butt heads, and you start to wonder how much competitive advantage there is there.

“With the way the stock markets are in Europe and the U.S. at the moment, we are seeing a trend emerging of firms establishing trading operations in Asia to gain a foothold and build relationships out there.”

“In the more traditional markets, of Europe and the U.S., you have a lot of sophisticated traders and algos going up against one and other so you’ve got this race, where they start to butt heads, and you start to wonder how much competitive advantage there is there.

“With the way the stock markets are in Europe and the U.S. at the moment, you are seeing a trend emerging of guys moving their trading firms out to Asia to gain a foothold and build relationships out there.”

With a host of regulations in Europe—such as the Alternative Investment Fund Managers Directive (AIFMD), which aims to bring hedge funds and other private equity funds under greater regulatory supervision; an updated Markets in Financial Instrument Directive (MiFID II), which governs European financial markets; and the European Markets Infrastructure Regulation (Emir), which will require all over-the-counter traded derivatives to be processed through clearing houses to mitigate risk—all likely to come into force in the coming months and years that are likely to curtail many current trading practices, some hedge funds are looking to alternative jurisdictions in which to operate.

“We’ve seen a trend of big bank prop traders, who will bear the brunt of the regulation, already physically moving out to various parts of Asia,” one London-based exchange executive told Markets Media.

“What they can do from there is continue to trade in products they are familiar with in the U.S. and Europe but as the telecoms links are much much better now than they were 10 years ago so they can continue to trade in what they are familiar with. Also there is a perception that while they are out there they are physically regulated by a different authority, so they may or may not be subject to Emir. And as the Asian markets start to develop and open up, they may take the opportunity to enter these markets too from out there. I also don’t think the tax regimes in Europe and the U.K. are helping either.”

A crackdown on high-frequency trading by some exchanges in Europe, such as the Italian stock exchange’s plan to charge traders if they send too many orders into its system, is seeing some trading firms looking to exploit less developed Asian venues.

“The regulations are different in Asia,” a market source, based in London, told Markets Media. “These nuances allow people a little more leeway in what they do. So there isn’t yet anything like what the Milan stock exchange has introduced to start blocking orders that aren’t executed. So there is this window of opportunity there.”

Recent figures from Chicago-based Hedge Fund Research illustrated this shift of hedge fund power towards Asia. The number of active Asia-focused hedge funds increased to 1,101 in the first quarter of this year, approaching the record number of 1,107 Asia-focused hedge funds set in the fourth quarter of 2007. The HFRI Emerging Markets Asia ex-Japan Index gained 7.4% in the first quarter of this year, although a volatile 2011 saw total losses of 18.08% last year for the index. Total capital invested in the Asian hedge fund industry increased by over $4.5 billion from the end of 2011 to stand at $86.6 billion at the end of the first quarter this year.

China has continued to emerge as the preferred location for hedge fund firms investing in Asia, with 30% headquartered in China. Globally, China trails only the U.S., U.K. and Switzerland as the preferred location for hedge funds worldwide, ahead of both Canada and France by number of hedge funds. In the Asian region, Singapore is the second most preferred location for Asian-focused funds, with nearly 10% of funds located there, followed by Australia and Japan.

“China will continue to emerge as the capital of the Asian hedge fund industry, representing integral access to specialized local expertise and insight of Asian markets as sophisticated hedge fund strategies evolve to operate in these markets,” said Kenneth J. Heinz, president of Hedge Fund Research. “As this occurs, funds operating in Hong Kong, Shanghai and Singapore will be as relevant and significant to investors as those operating in New York, London and Zurich.

“In a similar manner to the broader global economy, emerging market hedge funds will play a crucial role serving as the growth engine in the expansion of the hedge fund industry by offering sophisticated, transparent investment strategies in emerging economies to a growing audience of global investors.”