Published On: Sun, Jan 17th, 2010

Where Do I See An Opportunity In Electronic Trading?

questionmarkI was recently asked where do I see an opportunity in the electronic trading industry here in Asia. Well I thought to myself there are so many opportunities given the changes that have been occurring here of late and the focus the west has been directing in the zone it was difficult to select just one. But if I had to choose it would be in the commodity space. Well hardly an epiphany given the volatility in the commodity markets and the on-going demand driven by the BRICs. But what makes the commodity space so interesting, however, is both the proliferation of commodity exchanges and products but also the cross border arbitrage requiring a currency hedge. Sure one might argue that trading in an increasing commodities base will foster fragmentation, impede price discovery and even lack the necessary liquidity to be successful. But picture a smart order router with multi market access that can quickly arbitrage the underlying, implement an fx hedge and a broker who will finance the clearing house margin. There is both alpha to be generated and commission to be earned.

A study by the Capital Markets Cooperative Research Centre (CMCRC) published last November found that “there is a positive and statistically significant relationship between the turnover of SGX-listed index futures and those of the domestic exchanges.” Granted this study focused on index futures that settle in the same currency but the study found that arbitrage trading and an increase in the investor base were factors supporting the conclusion. If you are interested to read the CMCRC report it can be found here.

There are more than 15 commodity exchanges in Asia (I only counted the bigger ones in India because they will have to consolidate eventually) each offering trading in products that are highly correlated if not deliverable against products on other markets around the world. Most settle in local currency and some are even cash settled. Imagine trading Coffee in Vietnam against Chicago or a triangular arbitrage of TOCOM gold, Globex gold and gold in India. US soybeans against Dalian Commodity Exchange Soybeans settled in Renminbi (I think this is where the HKMEx will shine). What about an FX trader hedging with commodities instead?

Tier 1 banks offering multi asset trading with their own in-house system, undoubtedly needing several onerous approval processes to get it going, are in the best place to take advantage of this opportunity. They have the market access, offer liquid fx pools, have deep pockets to fund margin and can afford the necessary risk systems to mitigate and fuel this kind of trading. Algorithms won’t have to be fast just know where to find the liquidity and offer the foreign exchange hedge at the same time.

With so much going on in the commodity industry in Asia and no unifying currency on the horizon forward thinking brokers should consider this type of business. After all it’s 3 commissions per trade.

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