An industry colleague pointed me towards an interesting YouTube video the other day that helps illustrate the importance of tick size in the global battle between primary and alternative trading venues. The video is from an alternative venue (or PTS) in Japan called SBI Japannext which, together with Chi-X Japan, is continuing to grow its market share of the Nikkei 225. The two combined now account for around 6% in this index.
The video shows end of day trading in Mizuho stock on 26th September 2011 and you can clearly see that SBI trades inside the TSE spread nearly all the time. The benefit is that price improvement is delivered nearly 80% of the time for both sides of the trade and, in this case, was around 10-11 bps.
Tick sizes in Japan vary considerably between the incumbent (1 to 100,000 JPY) and the PTS folks which begin at 0.1 and are capped at 10 and 100 at Chi-X and SBI respectively. Smaller tick sizes are only part of the game, though, as alternative venues need to provide low latency platforms and other incentives so as to encourage liquidity providers to step up and make prices in these smaller increments. And, for their part, these providers need to operate at sufficient frequency on and between venues so as to achieve an acceptable balance of profit and risk. The resultant liquidity, typified by smaller trade sizes and narrower spreads, isn’t always good news for institutional investors that want to trade in larger size. But, then again, maybe that’s what dark liquidity is supposed to be all about.
The Japanese situation can be contrasted with Europe where combatants have grudgingly agreed a scheduled process for tick size reductions, and with the US and Australia where tick sizes are standardised. It’s not all peaches and cream for alternative Japanese venues, however. Until recently they have had to contend with prohibition of maker taker pricing and a unilateral short selling ban.
Anyway, this all got me thinking about what the right ingredients really are for alternative venues to prosper and I thought it would make an interesting topic for the first poll of 2012. As always, I’d be interested to hear your views.
Thanks to everyone for their comments on the last blog and thanks to Chuck Chon of SBI Japannext for pointing me to the video in the first place.
Whilst the spread cost improvement cannot be ignored, SBI JapanNext also illustrate the other costs associated with tick size changes… namely the IT projects. In the Dec’11 publication of “The TRADE Asia guide to: Algorithmic trading & the search for liquidity in Asia” say the decimalisation of tick sizes required a high level of investment and the allocation of significant resources to retrofit system to handle it. Some projects took up to 6 months and in some cases incurred costs of half a million dollars. They claim the vast majority of mid- to small-sized local brokerages and online securities firms are unable to handle decimal numbers.