It took them six years, but high-frequency traders have finally secured a perfect way to lower brokerage costs in Japan: cut out the middlemen.
Susquehanna International Group and KCG Holdings Inc. both gained “remote membership” at Japanese bourses over the past two months, the first approvals since authorities opened up the possibility in 2009. The distinction -- already common in other developed markets like the U.S. and Singapore -- allows HFTs to place buy and sell orders directly on the exchange.
For traders who rely on speed to extract tiny profits from millions of transactions every day, unfiltered access is making Japan a more attractive market to do business. Brokerages, meanwhile, face exclusion from a growing source of fees in a country where speed traders now comprise the biggest portion of volume on the main stock exchange.
“Whoever had Susquehanna up until now just lost a client,” said Sadakazu Osaki, the Tokyo-based head of research at Nomura Research Institute Ltd., an independent consulting firm that’s part-owned by the nation’s biggest brokerage. “We’ll see more cases like this.”
Susquehanna’s Hong Kong unit was admitted on May 1 as a remote member to Tokyo Stock Exchange, the $23 billion-a-day equity market where HFTs accounted for about 44 percent of transactions last year. KCG became a remote member on the Tokyo Commodity Exchange on June 12, allowing the U.S. firm to place direct orders for oil and rubber futures.
While regulatory and legal hurdles led to a more than two-year application process for Susquehanna, future applications are likely to take less time, according to Takashi Umimoto, an official at the TSE who works on the bourse’s direct access program. He said several other firms have expressed interest, declining to provide details.
“Execution costs and latency are lower when sending orders directly to the exchange rather than involving a broker,” said Umimoto. “Direct access to the exchange could also be attractive for people who don’t want to risk revealing their secrets, such as how their algorithms are constructed.”
The Tokyo bourse’s support for speed trades comes straight from the top.
“I don’t think HFTs are categorically negative,” Akira Kiyota, Japan Exchange Group’s new chief executive officer, said at a press conference last month. “They provide liquidity on the TSE and increase the probability that retail or institutional investors can buy or sell at prices they want.”
Critics say giving HFTs unfettered access to exchanges may leave markets vulnerable. KCG was formed in the aftermath of the near-collapse of Knight Capital Group Inc., which roiled U.S. stock markets with erroneous orders in 2012. America’s securities regulator warned in a report analyzing the incident that the speed of orders by HFTs “can turn an otherwise manageable error into an extreme event with potentially wide-spread impact.”
The traders can’t totally shed their reliance on brokers. Remote members are required to pair up with local partners to clear their trades, giving securities firms a chance to earn settlement fees.
“If the program leads to more clients because it provides a simpler way to connect to Japan and it reduces fees, that’s a boost to both the exchange and us,” said Yoshinobu Nakamura, an executive director at Nissan Century Securities Co., which is partnering with KCG for its trades on the commodities bourse.
Still, Nakamura says that if more of the firm’s existing clients gain direct access, fees may come under pressure. It’s a concern echoed by Daiwa Securities Group Inc., Japan’s second-largest brokerage by market value.
While it’s too early to tell how big an impact the programs will have, brokerages may need to lower commissions to stay competitive if enough traders make the switch, said Shinnosuke Ichii, head of the securities administration group at Daiwa in Tokyo.
“If this becomes more common, it’s possible it will change how people think,” Ichii said. “This program could be a catalyst for more competition in the market.”