Japan Ignoring High-Speed Trading Risks, Liquidnet CEO Says

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As the rest of the world looks for ways to rein in high-frequency trading, Japan is making a mistake by letting it expand unchecked, according to Seth Merrin, head of dark-pool operator Liquidnet Holdings Inc.

“Japan is the only major market in the world that’s not concerned about HFT and has no plans to put any constraints on HFT,” said Merrin, whose firm competes with exchanges as a venue to buy and sell securities. “It doesn’t seem as though they’re interested at all in protecting one constituent over another. And they’re just letting HFT grow as big as they want.”

Seth Merrin

Photographer: Jerome Favre/Bloomberg

High-speed traders were involved in almost half of all stock trades last year on the Tokyo exchange, according to bourse data. That’s up from about 10 percent at the start of 2010, when the exchange unveiled a faster trading system. The world’s other biggest markets are planning stricter rules governing HFT activity, from a proposed registration system in the U.S. to algorithmic trading curbs in China.

“While U.S. and Europe are trying to limit unfairness in trading by setting regulations against HFTs, Japan has not come up with a plan," said Takashi Hiratsuka, in charge of Resona Bank Ltd.’s asset management division in the trading group. “This is one of the reasons why HFTs have a large market share in Japan."

Europe, Australia

European regulators in September ironed out proposals on everything from mandatory systems testing to accountability of market makers, while Australia’s watchdog said last month it would investigate futures trading after conducting a second, detailed review of HFT in its markets.

The operator of Canada’s largest stock exchange this year adopted a speed bump to slow trading on one of its venues, while the U.S. in March proposed requiring HFT traders to register with regulators. China last month said it would increase its oversight of algorithmic traders, including requirements for more disclosure and limits on remote control of trading machines from abroad.

In contrast, Japan’s watchdogs haven’t sought to restrict HFT even as the pace of trading on Tokyo’s exchange got more than 1,000 times faster over the past five years. There are signs that may finally change, with Kiyotaka Sasaki, the secretary general of the Securities and Exchange Surveillance Commission who was appointed this year, saying in September that his agency will watch HFT to see if it leads to unfair transactions.

Illicit Trades

The SESC is monitoring for illicit transactions by high-speed traders and other market participants, and paying attention to HFT given the focus from global authorities, an official said this week, declining to provide a name citing policy. Japan’s Financial Services Agency included algorithmic trading in its annual administration report for the first time this year, and is working to strengthen the agency’s computer systems, another official said.

Japan Exchange Group Inc., the bourse operator, declined to comment. The exchange started operating an upgraded version of its Arrowhead trading system for cash equities in September, which it said will cut order response time to less than 0.5 milliseconds. The benchmark Topix index rose 1 percent as of 2:35 p.m. in Tokyo on Thursday.

Bad Strategies

“Not all HFT is bad, but there are certain strategies that are to the direct detriment of institutional asset managers, which means it is to the direct detriment of all of us that put money into pension plans and mutual funds,” said Merrin.

In some ways, Japan is already ahead of regulation being proposed overseas. Circuit breakers, which the U.S. implemented in the aftermath of the 2010 flash crash, were used in Japan for years before that. Penalties on excessive order placement adopted by Germany in 2013 have been imposed by the TSE since 2005.

Still, that’s little comfort to Norway’s sovereign wealth fund, which said in June it’s worried about the rise of speed trading in Japan and prefers to transact through block orders instead of mingling with algorithms on public exchanges.

Bigger, Slower

Liquidnet, which caters to such bigger, slower trades, says its volumes in Japan have risen about 300 percent since late 2012, outpacing the growth on TSE. Its share of the country’s stock trading is still less than 1 percent, according to Lee Porter, managing director for Liquidnet in Asia.

Merrin is optimistic his venue will continue to attract institutional investors in part thanks to there being no HFT, due to Liquidnet’s minimum order sizes and slower matching speeds.

“They can’t do all of their business on Liquidnet, but certainly they’re looking more and more to a venue that either locks out or protects them” against HFT, said Merrin. “Clearly no one is waiting for regulators to stop or constrain it.”

(A previous version of this story corrected the second-last paragraph to clarify there are no HFT firms in Liquidnet pool.)

— With assistance by Tom Redmond

(Adds Thursday's Topix move in ninth paragraph.)
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