Japan's Financial Watchdog Queries Brokerages on HFT, Dark Pools

  • Among regulator's requests are sample order and trading data
  • High-speed firms account for half Tokyo Stock Exchange trading

Japan’s financial regulator is finally taking a hard look at high-frequency trading.

QuickTake Trading on Speed

The Securities and Exchange Surveillance Commission began querying brokerages this week about the trading operations of their HFT clients, whose industry has enjoyed more than a half-decade of explosive growth in the nation with little regulatory guidance or scrutiny.

The financial watchdog is asking brokerages about the services they provide, including preferential treatment and differences in fees between HFT and non-HFT customers. The questionnaire dated Monday, obtained by Bloomberg News, also seeks to establish whether high-speed clients have access to dark pools and under what conditions. Brokers are asked to reply by Feb. 12.

“This is the first step,” said Takashi Hiratsuka, in charge of Resona Bank Ltd.’s asset management division in the trading group. “It is an extremely sensitive time for market participants who want to see if the regulators find any problems and, if they do, what rules they will put in place to deal with those problems.”

The move comes after authorities mentioned algorithmic trading in their annual administration report for the first time last year, having been criticized for doing little to police speed traders, who made up more than half of trading as recently as September. In taking these steps, Japan is catching up to other developed markets that have increased their scrutiny over the past year.

The European Union has sought to make electronic traders more accountable, while Australia’s watchdog said in October it would investigate futures trading after conducting a second, detailed review of HFT in its markets.

The operator of Canada’s largest stock exchange last 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 said late last year it planned to increase its oversight of algorithmic traders, including proposals for more disclosure and limits on remote control of trading machines from abroad.

“HFT is under the regulatory microscope around the world,” said Larry Tabb, founder and chief executive officer of research firm Tabb Group LLC. “Greater regulatory transparency will only increase confidence and make the market healthier. That said, the less capitalized and less stable firms will go away and the stronger ones will survive.”

HFT accounted for 53 percent of trades on the Tokyo Stock Exchange on Sept. 7, according to Deutsche Bank AG. That’s up from about 10 percent at the start of 2010, when the exchange switched to a faster trading system.

A spokesman for the financial watchdog said officials couldn’t be reached for comment. Kiyotaka Sasaki, the top bureaucrat at the SESC, said in September his agency is “extremely interested in HFT” and that it was monitoring the industry to see if it led to unfair trading.

Sample Data

In the document, the SESC defines HFT firms as clients who place trading servers at or close to the exchange, who have “fast direct electronic access” to the market, use machines to place orders and who place orders rapidly.

The agency is looking into the strategies run by HFT firms and the questionnaire asks brokers to provide sample order and trading data. Queries on whether brokers check the integrity of orders before sending them and their ability to trigger a “kill switch” for client trading in the case of an emergency are also under examination.

“Regulators would be well served to focus on the behavior of traders as opposed to just the trading tools,” said Bill Harts, the head of Modern Markets Initiative, the HFT industry’s U.S.-based advocacy group. “Japan’s market is very simple in terms of market structure as most trading is done on the TSE. As a result, there are relatively few issues with respect to market structure compared to the U.S.”

Other inquiries include how brokerages manage their own proprietary trading systems hosted at overseas exchanges. Dark-pool scrutiny includes questions about what role HFT firms play in the broker’s internal markets.

“Japan doesn’t have a real regulatory regime for dark pools,” said Andrew Upward, head of market structure for Weeden & Co. in Greenwich, Connecticut. “Japanese regulators are probably looking at the situation and saying, ‘How can we make sure we have the tools to regulate the activity in these venues?”

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