Opportunities and Challenges in Equities Trading Industry of India Today

Mihir  Mehta

Country Head

Direct Financial Network India

TradeTech recently interviewed key speakers of TradeTech India 2010 to find out what opportunities they saw in the market and why people should be attending the conference to network and discover international best practices

Q: In your opinion, why is the equities trading industry of India today of so much interest globally?

A: Foreign participation in Indian markets has grown steadily over several years and shows no signs of abating, and regulatory changes mean that domestic brokerage firms are starting to enjoy a larger slice of the business. In the past, foreign buy-side participants that wanted to trade securities in India had to do so via participatory notes-also known as P-notes-which were mostly distributed by international tier-one brokers, who would buy and sell shares on behalf of the foreign player. Typically, international buy-side firms went with international brokers that had offices in Mumbai, and the local brokers didn’t see much benefit from the foreign investment in their country. Thanks to this increasingly sophisticated financial workforce, as well as a generally liberal regulatory policy over the last few years, the Indian capital markets are maturing rapidly. Now, foreign firms have to register an FII then they can go to local brokers as well as international brokers to get access to the market. Indian brokers need FIX connectivity to attract international order flow and many have made significant investments in FIX networks and order management systems (OMSes). In fact, Electronic and algorithmic trading has become part of a mainstream response to buy-side traders' need to move large blocks of shares with minimum market impact in today's complex institutional trading environment.

One-touch DMA, requiring manual intervention from the broker, had already been implemented at many Sell-side players. The Securities and Exchange Board of India (SEBI) announced in April 2008 that it would allow the introduction of direct market access (DMA) for equities, futures and options, and about a dozen brokerages in India launched this service with a few clients. The buy side market in India constitutes over 1,350 foreign and domestic firms. Enthusiasm for DMA is high among the active participants in the market (consisting of about 50 foreign institutional investors and a similar number of domestic institutions). Boston-based research and analysis firm Celent estimates that over 80 domestic and foreign buy side firms will use DMA channels by 2009"2010.

DMA adoption has helped drive down costs, provide better execution quality, better market and liquidity aggregation and better compliance with regulations. Industry insiders expect trading volumes to surge within the next year or two as a result of DMA, and firms and exchanges are working fast to make sure their systems are ready to handle the additional traffic.

DMA traffic accounts for 15 percent to 18 percent of total trading volumes in the US and 8 percent in Europe, and these numbers are growing fast for India also. India is not alone-DMA is also currently being introduced in Brazil, Chile, Mexico and Columbia. This is made possible by the widespread adoption of the FIX protocol over the last two years. Due to DMA, introduction to algos and other emerging technologies Indian exchanges are seeing a huge surge in trading volumes which has increased dramatically over the last few years. Foreign participation, a growing number of DIIS, FIIs, HNIs, ultra HNIs, and retail segment have all played a significant role in increasing volumes.

Q: What opportunities do you see in the industry at present?

A: With electronic trading platforms becoming increasingly sophisticated, more cost effective measures handling larger order flow is becoming a reality. The higher reliance on electronic trading has had profound implications for vendors and users of information and trading products. Broker dealers providing solutions through their products are facing changes in their business models such as: relationships with sell-side customers, relationships with buy-side customers, the importance of broker neutrality, the role of direct market access, and the relationship with prime brokers. Greater control, faster execution and error reduction will be the primary drivers of DMA adoption in India. Front running of orders and high latency of execution are serious issues in the market today. Buy side firms in India described the frequency of front running in India as "moderate." DMA can curtail front running since the clients can now place their order directly on the market. Also, the time taken between a trade order by end customers of the buy side firms and its actual fulfillment can sometimes be as high as one to two days. In addition, errors in order fulfillment are also known to occur. Celent estimates that three to four errors per month for a client are common. The institutional buy side believes in DMA technology's ability to solve these issues.

Algorithm trading, or program trading, common in the US and Europe, has swiftly gained ground in India over the past year, as volumes picked up after the crunch. Algorithmic trading uses strategies that exploit short-lived market opportunities and depend highly on execution speed. Essentially, set software program decide when, how and where to trade, without the need for human intervention. Algo trading eliminates any opportunity loss that arises if the same actions are to be performed manually. Sell-side players are Members to execute strategies for Proprietary Trades or on behalf of their clients and they also run multiple strategies in a single application.

Algo trading in India is not as advanced as in the US, where buying or selling through software is pegged to movements in currency and commodities markets and even other corporate news. The commonly-used strategies in India include selling of stock futures quoting at a premium to the spot, and buying the shares, thereby locking in the difference. Another strategy is to sell shares on the exchange where the price is higher and simultaneously buy back when prices fall, or vice-versa. Indian Exchanges have started providing co-location facility to their member brokers, whereby they can place their trading servers close to the exchange’s engine on a first-come-first-served basis. Co-location saves crucial milliseconds from the time it takes to place an order and its receipt at the other end. The broker with his server next to the exchange engine gets a price feed that is updated every three-four milliseconds, while a broker at a remote place will get this feed updated every 30-40 milliseconds.

Q: What are the challenges that you see at the moment that the industry needs to address?

A: Algorithmic trading services are the latest innovation to be promoted by broker-dealers. Increasing competition in the algorithmic trading space and prospective phenomenal growth in Direct Market Access (DMA) have led to several challenges for the broker-dealers. After analysing the situation from various perspectives, it is interesting to observe the disparity in interests and perceptions of the industry. The biggest challenge is to provide improved means of ensuring that trading process is effectively and efficiently managed, including the ability to exploit micro-trends in price movements or optimizing order execution costs.

For Algo trading, the market data latency in India is a big concern. Hence, the so-called real-time information fed into Algos will actually be stale market data (by at least a couple of seconds). Since electronic trading began to dominate the capital markets, low latency has become one of the main concerns for financial organizations, and a crucial weapon in the battle for competitive edge. Increasing demand has given rise to a noticeable gap between what the market expects and what vendors can deliver and this is widening all the time. Cleaned data (market data, broadcast, etc.) should be available to play back through the test system, for the purpose of testing the Algos. This is not currently available from the exchange

There is still work to be done before the full potential of direct market access (DMA) trading in India can be realised. Sell-side technology needs to advance further to allow companies to take full advantage of DMA in India. The baseline capabilities are there, but the sell-side has not yet developed all the tools and technology platforms required to support electronic execution. There are also regulatory hurdles that need to be cleared before traders can make the most of DMA in India. India has regulated direct market access flow as if it were regular retail flow, which means that it is not quite as simple as in certain other markets. A bigger problem may be the delays that can occur in regulatory approval process before firms can offer DMA services in India.

Q: In your opinion, why is participating in this conference of so much importance?

A: Being one of the Prime sponsors, our core focus is to position our Solution Suite to the key of buy side & sell side institutional players. Trade tech is one of the world’s largest and most coveted electronic trading conferences. Affiliating with them, we will be able to further our company’s visibility and brand recognition.