March 20, 2015
While the rest of the world continues to be caught up in the fervor surrounding the March 2014 release of Michael Lewis’ Flash Boys, trade desks in Asia are grappling with issues related to the lack of regional market maturity. Many of the more advanced technologies that traders in the US and Europe take for granted are finally being introduced to Asia. In addition, the lack of competition with regards to alternative trading venues makes many local exchanges monopolies for the governments that back them.
The evolving state of the regional marketplace and varied market structures makes transaction cost analysis (TCA) a must, and any such analysis must be done with the relevant microstructure in mind. In the paragraphs that follow, we review trends in transactions costs in the context of a few of the significant market events that occurred in Asia over the course of 2014.
We start our analysis with the comparison of the developed Asian countries of Australia, Singapore, Hong Kong and New Zealand to the developing Asian markets of the Philippines, Taiwan, South Korea, Thailand, Indonesia, China and Vietnam. Based on its size in the marketplace, Japan is analyzed seperately. The introduction and expansion of electronic trading tools in Emerging Asian countries coincides with a 30% decrease in transaction costs between Q2 2013 and Q4 2014. Additionally, both cost and volatility for the developed countries has also declined over this time period as these markets continue to modernize and become more efficient. Despite the fact that costs have been trending downward for the past two years, trading in Asia Pacific markets remains more expensive than trading in the US market.
Aggregating costs in the region somewhat hides the noisiness of the country-level quarter-over-quarter costs, especially in relation to the US. For example, costs in Indonesia are almost 120bps more expensive than the US in Q3 and Q4 of 2013.
Bid-ask spreads provide an even more simplistic and perhaps straightforward measure of market efficiency. Average spreads in Emerging Asia markets drop significantly in 2014, driven mainly by tightening spreads in Thailand, the Philippines and Indonesia.
Stock connect was all of the buzz on the trading conference circuit last year, but appears to have some more work to do to attract additional participants. Of the 200 clients in ITG’s Peer Group Universe, less than 5% participated in Stock Connect in Q4 2014. It is hard to comment on overall performance for Stock Connect with less than 2 months of data being captured, but what is interesting is the overall decrease in transaction costs in China over the last two years. A combination of decreasing volatility and tightening spreads results in a transaction cost drop in China ex-Stock Connect from over 60bps in Q1 2013 to 28bps in Q4 2014
Japanese Tick Size Reduction
The Tokyo Stock Exchange (TSE) announced in late 2013 a plan to reduce overall tick sizes for TOPIX 100 constituents, splitting reductions into two phases based on stock price with a final phase to review the outcome of Phases 1 and 2. Phase 1 was initially applied on January 14th to stocks in the TOPIX 100 that were priced above JPY 3,000 while the second phase that was rolled out on July 22nd applied a reduction to stocks priced less than 3,000, and a further reduction to stocks priced less than 5,000. The outcome of the tick size reduction plan appears to be lower transaction costs, but variability in costs observed towards the end of 2014 implies that it is too early to tell if this is permanent or temporary. It should be noted that the TSE did suspend any further tick size reductions and will roll back the tick changes made to stocks priced between 3,000 and 5,000 Yen.
CHINESE NEW YEAR
Trading Analytics are not isolated to the review of market impact costs alone, and as such, we take a look at the effect of Asian market holidays on opening and closing auction participation in the region. We observe a large spike in opening auction participation in Hong Kong following a multiday market closure due to an Asian-specific holiday such as Chinese New Year. Global Portfolio Managers continue to enter orders while the market is closed which leads to built up demand when the market reopens. There is not a significant impact on costs though; sometimes a liquidity event is just a liquidity event.
AUSTRALIAN TRANSACTION COSTS
The Australian market avoided any significant market structure events, but cost trends in 2014 are worth mentioning. Overall volumes in Q4 decrease to an 8 quarter low with volumes in December being 40% less than levels seen earlier in the year. The drop in trading volumes and overall liquidity in addition to a dip in market level returns drove transaction costs to a 4 year high in December 2014.
THOUGHTS ON 2015
We expect to see continued market efficiency improvements over the course of 2015 and 2016 as portfolio managers and traders alike adopt advanced trading tools. While there is currently no explicit regulatory mandate across Asia for TCA, it’s clear that analytics can help identify opportunities for process improvement. As the markets modernize and become more efficient, TCA and trading analytics can offer transparency and process improvement to help trading desks stay ahead of the curve.
ASK US A QUESTION:
ITG’s Trading Analytics team invites you to ask us a question about the Asia markets that could help improve your trading. Using the ITG Peer Database and a wide range of market data and analytics tools, we provide evidence and data-driven insights that can be acted upon to improve trading outcomes.
Email: firstname.lastname@example.org with your questions