Alternative Venues:Going from Strength to Strength

 
SBI Japannext’s Chuck Chon discusses the growth of Proprietary Trading Systems (PTS) in Japan.
FIXGlobal: What has enabled PTS to succeed in an illiquid environment?
Chuck Chon, SBI Japannext: The Japanese market isn’t necessarily an illiquid environment – it used to be the second largest market in the world. Success has not been easy for PTS in Japan; nevertheless, both Chi-X Japan and SBI Japannext have been able to chip away at the incumbent exchanges’ market shares.
While I wouldn’t necessarily call our growth rate comparable with our counterparts in Europe or the US, the PTS business model is a proven business model in the US and Europe. Hence, the model’s success in Japan should be no exception.
All PTS venue members, including mega Japanese investment houses, do understand PTS – they are the first mainstream users of PTS in Japan. Fierce competition among PTS in Japan has brought out the best of both, resulting in an increased market share.
FG: What advantages do PTS in Japan enjoy that the incumbent exchanges do not?
CC: PTS enjoy great support from the global investment market and Japanese mega investment houses who understand the value of market fragmentation in the US and Europe. They are also supported by the leading buy-side firms that understand the value PTS brings in terms of cost savings.
In addition, they receive support from retail on-line brokers as well as global liquidity providers, proprietary trading houses, hedge funds, etc. that benefited from market fragmentation and competition in the US and Europe.
The single most important difference that all PTS market participants appreciate is the tick size differences between incumbent exchanges and PTS. PTS have smaller tick sizes (one tenth) compared to incumbent exchanges. The spread for Nikkei 225 Index stocks at the incumbent exchange is around 24 bps compared to around 12 bps at a PTS. About 50% compression in the spread makes it extremely attractive for market participants.
Another advantage enjoyed by PTS is simplicity of order types (limit, IOC and FOK), which enables systems to be much faster than incumbent exchanges.
FG: What will it take for PTS to experience further growth in Japan?
CC: The Japanese market is the most advanced in Asia in terms of regulatory framework and fees associated with trading. Having said that, it would be unfair to compare the Japanese market to other Asian markets, which still lag far behind Japan. However, compared to US and European counterparts, it needs to improve.
There are three major factors that hamper the growth of PTS volume. Firstly, the 5% Tender Offer to Buy (TOB ) regulation. This presents a risk for large institutional buy-side firms to accidentally over purchase more than 5% of outstanding shares through PTS. Many buy-side participants are reluctant to deal with PTS in Japan because of this regulation. According to some experts, if PTS are exempt from this 5% TOB restriction, then their market share could grow by as much as 10% in a short time period.
The second factor is margin trading restrictions for PTS. This rule prevents retail investors from fully participating in best executions. Many retail on-line brokers have indicated to us that unless margin trading restrictions are removed for PTS, they are reluctant to participate in PTS venues. A large majority of retail end investors are currently unable to access best executions via PTS due to margin trading restrictions.
The third restricting factor is the 10% limit for PTS market share. In a nutshell, if a PTS’ six month daily average volume exceeds 10% market share of total equities traded in Japan, a PTS must apply to become an exchange. This restriction has two flaws that need addressing:
• The transition from PTS to an exchange is easier said than done. Flexible timing is needed for transition to an exchange since additional capital resources will be required to relist hundreds of companies onto a newly created exchange.
• The 10% limit is a psychological barrier for PTS market participants and many PTS venue participants have voiced this concern.