HFT Comes to Japan

Terry Flanagan

The advent of high-frequency trading has caught the attention of regulators and market participants.

The HFT ratio, or the percentage of orders sent from co-location facilities to total orders, of the Tokyo Stock Exchange has risen since the introduction of Arrowhead, its high-speed trading system, in 2010.

“The HFT ration of TSE was recorded at above 50% in September 2012, reach to the level close that that of the U.S. (60-70%) and Europe (40-50%),” said Ko Nakayama, director of the financial markets department at the Bank of Japan, on a presentation last month.

Chi-X Japan and other alternative exchanges in Japan scored a major coup in 2012, receiving an exemption from the country’s regulator, the Financial Services Agency, from the takeover bid (TOB) rule.

The Tokyo-Osaka merger provides the impetus for regulators to increase competition. By exempting Japan’s two PTSs—Chi-X Japan and SBI Japannext—from the TOB rule, the FSA is supporting market fragmentation and more foreign order flow to be directed into the PTSs.

The TOB rule requires investors who approach a five per cent stake in a company’s outstanding shares to launch a tender offer if they are trading off-exchange, causing many participants to have concerns for inadvertently breaching the rule when trading on a proprietary trading system (PTS), as alternative trading venues are known in Japan.

In an effort to drive competition due to the pending merger between the Tokyo and Osaka stock exchanges, Japan’s FSA announced the abolishment of the 5% TOB rule applicable for PTSs.

“This is ultimately seen creating a groundswell that portends sweeping change, and the 2012 deregulation of the PTS market and margin trading can be considered a template,” said Celent research analyst Eiichiro Yanagawa, in a report on capital market trends in Japan.

Interview with market participants conducted in late 2012 for the Celent report highlighted areas that system innovation and combative relationships will fuel the changing trading environment.

According to the head of a major overseas securities firm in Japan: “For Tokyo to become the hub market of Asia, we need to reconsider anew what is required and then execute based on this. Today we find ourselves in a situation where many of the foreign traders have fled the Tokyo market for Hong Kong and Singapore.”

HFT is generally defined as a computer-driven trading strategy that emphasizes rapid rule-based automated buying and selling.

HFT is characterized by the use of computer systems to generate, route, and execute orders, the use of col-location and proximity services, short timeframes for establishing and liquidating positions, submission of numerous orders that are canceled shortly thereafter, and ending the day in a neutral overall position.

“HFT has had the positive effects of providing liquidity, restraining volatility, and reducing trading costs,” said Nakamaya.

However, HFT also produces some negative effects, such as market disturbance arising from programming errors, and one-sided pricing.

“HFT programs and parameters might become similar as a result of seeking marginal and slight profit chance under almost the same information set,” said Nakamaya.

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