In the not too distant past, Asia was thought to have a lower quality infrastructure than developed nations in North America and Europe. However, widespread government investment in infrastructure projects in the region has seen significant improvements in core underlying infrastructure critical to stable trading platforms.
[Before you continue, you might want to read Part 1 of this contribution, coverering business drivers and growth.]
Whilst countries such as Korea, Japan, Singapore and Hong Kong have led the world in terms of Internet connectivity for a number of years, their international connectivity did not keep pace with this expansion, both in terms of capacity, concentration risk and price. Three major earthquakes since 2006 on the ‘Pacific Ring of Fire’ have highlighted these problems.
Much of the concentration risk was historical, with the majority of international links being submarine routes that avoided Russia and China. Together with the changing economic and political climate in the region, this drove the installation of several overland cables linking Asia with Europe, often using the Trans-Siberian route from Hong Kong, through China, Mongolia, and Russia. A side effect of particular interest to financial trading is that these new connections are shorter and thus have lower latency than the traditional subsea routes from Asia to Europe. Carriers have taken advantage of this and offer these shorter lower latency connections at premium rates.
Links from Asia to the U.S. were traditionally routed via Taiwan and Japan, but additional new cable routes have been laid further south to reduce concentration risk. An advantage of these new connections is that more direct, lower latency circuits are available between Singapore, Japan and North America. Again, carriers are offering these routes at premium rates.
Prices for international capacity in the region have dropped significantly in the last five years but still remain well above prices in the U.S. or U.K. While prices have dropped by about 50% in Hong Kong over the period, this has only brought pricing to the levels seen in London and New York in 2006. In the same time period, London and New York have seen prices drop by around 60%.
When all cost factors are considered, measuring the return on investment (ROI) on co-location or low latency infrastructures is difficult. In Asia, this is particularly difficult due to:
· Local settlement costs
· Expense of network links
· Limited competition for venues and matching engines
· Limited off exchange crossing
· Fragmentation with each country or venue having unique infrastructure requirements and regulations
· Lack of a third party vendor community
A single venue for a particular market may make sense, for example in Tokyo. However, even leading HFT firms state that low latency infrastructures are not cost effective in many jurisdictions where the post-trade costs in Asia are high. Japan and Australia are the only two markets in Asia that have attracted a significant amount of HFT trading in equities, with the Indian market the only other experiencing progress. For other exchanges the back-office costs often do not justify the investment.
Technology Is a Differentiator for Exchanges
The exchange industry has moved from being technology-enabled to being technology-centric, and thus technology is a key differentiator for exchanges.
Asia has a small number of ATSs in comparison with the U.S. or Europe, although the number is gradually increasing. Regulations can significantly hamper the process of obtaining a license, and the incumbent exchanges often take advantage of this delay to update their systems. The adoption of e-trading and FIX is also increasing, especially in the leading markets.
In Japan, ATSs are classed as Proprietary Trading Systems (PTSs), and their leadership in the region is expected to continue. Dark pool facilities are allowed in Japan, Hong Kong, Singapore and Australia. Less than 2% of trading in Asia is through dark pools, compared to around 5% in Europe and 17% in the U.S.
There has been a surge in technology investment from 2009 onwards in response to the inception of alternative venues, not just in the leading markets of Japan, Hong Kong, Singapore and Australia, but also in the emerging markets so that they may remain competitive.
These changes include:
· Exchange trading system upgrades for capacity and speed
· Extension of trading hours outside of the traditional short morning and afternoon sessions
· Widespread adoption of standard technology offerings from NYSE and Nasdaq
· Introduction of Direct Market Access (DMA)
· Announcement and/or introduction of co-location facilities (of varying standard) and
· Enhanced risk management
Japan currently leads the way with these changes, but Singapore and Australia are trying to use technology to make them more attractive as trading locations. The upgrades to trading systems will force U.S. and European firms to locate hardware and applications closer to the matching engines to remain competitive. There is still some way to go though. Asian HFT stands at 10%, mostly due to 30% in Japan, which is low when compared with 40% in Europe and 60% in U.S.
As competition increases and exchanges see threats to their existing revenue streams, co-location and proximity hosting provide a convenient, stable, alternative revenue stream, both for the data centre business and for preserving liquidity.
However, while an increasing number of exchanges and venues are supplying co-location facilities that offer reduced latency, there is a lack of consistency in latency measurement and a fairly loose definition for co-location when comparing various offerings. Venues that push their technology offerings as world class and comparable to the best in the U.S. and Europe, such as the Singapore Exchange, provide transparency around their co-location design and latency measurements. For example, they define the door-to-door latency metrics for the exchange to receive, process and acknowledge the order, and from the points in their infrastructure where the measurements are taken. They also provide figures for using their proprietary APIs versus using FIX. Some of the smaller exchanges, whilst offering co-location, are not yet open and transparent about their facilities’ performance.
At the moment, 61% of exchanges in the region offer co-location services and 39% offer proximity hosting.
Related Research from GreySpark Partners
· The full report that contains discussion of low latency in Asia-Pacific, with an analysis of the technology offering – Low Latency in Asia-Pacific: an Infrastructure View, GreySpark 2012.
· Detailed discussion around the low latency benchmarking, technology stack or latency and jitter measurement – covered in Low Latency: Faster than Light, GreySpark 2012.
· Consideration of the trade-off between operating and capital expense – covered by Infrastructure Investment: Are Banks Penny-wise and Pound-foolish?, GreySpark 2012.