Checking in on APAC Equity Market Structure Part II

PETER HAYNES: Welcome to TD Cowen's podcast series Bid Out, a market structure perspective from North of 49. My name is Peter Haynes. And today, for episode 64, we will continue with our review of APAC market structure which we will follow up by coming back to North America for a deep dive into the US with an as-yet unnamed expert in the US market structure. We know who that is, and you'll know about it soon enough. So stay tuned for your local podcast style for that one, as you won't want to miss it.
Back with us for part II on APAC are two regional market experts. John Fildes is a consultant with Bain & Company Sydney office. And George Molina is head of global trading for Templeton Global Investors. Thank you both for coming back to the show. John, I want to move on to Korea now. You mentioned in the previous episode that there's a new marketplace called Nextrade that it will launch, I believe, in 2025. So let's ask the question, are brokers required to connect to this new marketplace?
And again, I think as you've alluded to earlier, a very strange sort of [? BestEx ?] rule whereby the aggressive order, the active order, has to adhere to the best price, whether it be on the primary market or Nextrade. But the passive order can really, at the end of the day, be put on whatever market they think is going to get the trade executed, which, if it's the primary market, 90% of the time, is probably where they're going to rest. Is that how you see the competition fitting in?
JOHN FILDES: It's a really interesting one because Nextrade came out of a consortium put together by KOFIA, which is the sort of broker representation group in Korea. And initially, it was the six largest retail brokers in Korea. Now, that may not sound much. But collectively, those six retail brokers represent about 55% of all trading volume in Korea. So that is not insubstantial.
And since that originally came together, the number of backers of Nextrade has expanded substantially. So it's now well into double digits of brokers who are behind Nextrade. And you shouldn't forget the irony of this because KRX is actually broker-owned. So you've got a mutually owned exchange. And now you've got the largest brokers breaking away to set up a competing platform, which shows, perhaps, or points to this sort of state of the relationship between KRX and the brokers.
In terms of full disclosure, I will say that Bain and I worked for the consortium, on putting together the initial business plan for Nextrade. But I think the critical hurdle for them to get over is building the passive liquidity. As I said, the surveillance model does not favor market makers. And a key element here is whether the market makers will get a sales tax exemption, because, in Korea, there is a sales tax of 30 basis points on the value of every trade on the sell side only, part of which is actually an agricultural tax.
And let's not go down that rabbit hole. But it's unlikely to go away. But there has historically been a waiver for market makers on the KRX. So critical will be whether there is a similar waiver for market makers on Nextrade because that is where you would typically expect to see the passive order book initially built from market makers to create those market data signals to then bring in the aggressive order flow, which has got the best price mandate.
Alternatively, will those retail brokers put their passive order flow on to Nextrade because they believe that putting the passive order flow there will attract the aggressive order flow and therefore make the execution of the orders more definitive on Nextrade than KRX? So it's going to be a very, very interesting one to watch.
PETER HAYNES: And meanwhile, John, the local community in Korea loves to trade. I heard a stat the other day from a friend of mine in the ETF space that 22% of all leveraged ETFs in the US-- and that represents a significant amount of volume-- are traded through two Korean brokerage firms. And they're executed on BOATs. Can you explain where this flow is coming from into US stocks? And why are they using BOATs, ETFs for trading US stocks?
JOHN FILDES: So yeah, I mean a few things here. So yes, Koreans do love to trade. And you see this in the KOSPI options market where there are very active retail investors in the KOSPI index options market. One of the things that we've seen as well is that Koreans love to trade, not just during trading hours. So you've seen, with the listing of the KOSPI options in Eurex in Europe, that the majority of the order flow has actually come from Korean brokers onto Eurex.
And it's a slightly strange way that the options trading on Eurex works is that, it's traded on Eurex during your Eurex hours, but it's actually settled back through KRX, through the domestic broker participant on KRX. So Koreans don't just love to trade during the regular trading day. They love to trade during extended hours.
And what Nextrade is bringing is extended hours in stock trading as well, in that they're going to open 50 minutes earlier at 8 o'clock in the morning. And they're going to continue trading after the close at 3:30 until 8 o'clock at night. So there will be 12 hours of trading availability for Korean stocks on Nextrade.
Now, Blue Ocean has been around quite a long time now. I think Blue Ocean was originally set up in around 2008 and initially, as a way of offering ETF trading in US-listed ETFs during Asian trading hours. But just in the last couple of years, volumes have really exploded. And it's largely been through a couple of Korean brokers, notably Toss Securities as well as some of the Japanese brokers. So it's retail flow into US stocks.
And the Koreans have always liked trading US stocks. I mean, Tesla is actually the most widely held stock in Korea by retail. It's not Samsung; it's Tesla. And so they've been very active in trading US stocks during US trading hours, but that's now extended into the BOATs offering, which is during Asian trading hours as well, but settled into DTCC the following day.
So I think now that the New York Stock Exchange has started talking about 24-hour trading as well, I think what we're likely to see is an uptick in that BOATs volume, other players such as NYSE and potentially NASDAQ coming into the game as well. And I definitely think we're heading towards, if not 24/7, then potentially 23/5 trading in US equities.
PETER HAYNES: John, I totally agree. We're going to get on this podcast a couple of years from now. And every major exchange around the world is going to have 24-hour trading, or 23/5 trading as you said before. We have the 24-hour exchange offering that's going to likely be approved by the SEC, or the expectation is it'll be approved sometime in the year of 2024 run by Dmitri Galinov that was filed, and then pulled, and it's being refiled. And that's just going to lead to all the other major exchange families in the US doing the same thing.
The New York Stock Exchange, as you mentioned, sent a survey around recently about 24-hour trading. So if they're going to lose share, they're going to defend their turf. And if they see it as an opportunity to gain share, they're going to be in. And that definitely will be interesting to see whether or not the institutional community has to change their behavior at all. The initial thought process is, it won't change the institutional community's behaviors. But we're going to have to watch that closely. There's a lot going on right now.
GEORGE MOLINA: Just to add to that, it doesn't have to be limited to five days a week. Don't forget MENA, Middle East, which has become very, very popular as of late. It's very good investment of our own. They trade on Sundays. So most of those markets are open on Sundays. If you're a domestic player, if you're running domestic funds, which Franklin Templeton does-- and we have a license in both Dubai and Saudi-- you need to be there on Sundays. You can't miss out on that liquidity.
JOHN FILDES: I love the fact that George really doesn't like having a weekend anymore.
PETER HAYNES: Yeah. What I was just going to say, guys, was that hearkens back to the building that I work in Toronto here actually has the outside facade of the original Toronto Stock Exchange trading floor where they used to trade on Saturday mornings, as you guys recall. Going back in time before we were in this business, the exchanges were open on Saturday mornings. So it feels like we're going back in that direction, hopefully. Thankfully, I'm on my last lap here, I think, before that happens.
But George, I do want to talk about something in Korea that is not a positive development. Or at least, I don't think it's a positive development. I want your thoughts on it. And that is the short-selling ban that was announced, I think, back in the fall of last year.
And recently, the FSC announced it will extend the short-selling ban to March of 2025, as it's doing more analysis on data to determine whether there is actually an impact of short-selling practices on issuers and share prices. What impact has the ban had on execution quality in Korean stocks, if any? And are there any exceptions to the short-selling ban that allow for market makers or, say, derivative hedging?
GEORGE MOLINA: So Peter, in general, execution quality has not suffered much as the KOSPI average turnover increased by 6%, and market volatility decreased in the six months after the ban. But intraday volatility is much higher, as the price discovery on high momentum stocks specifically has become tougher without the short sellers.
Exception for the registered liquidity providers, market makers, as they say, are allowed, but not allowed for derivatives hedging. Most are resorting to single-stock futures to hedge as the alternative, but not the perfect hedge tool due to the liquidity being quite tight in that space. No liquidity in single-stocks futures have risen with the short-sell banned. And we're hearing that, after March 2025, they will have more robust monitoring system in place and allow for short-selling to come back into the exchange.
PETER HAYNES: OK. Well, I'm glad to hear that they think that this has got a window on it that will end less than a year from now once they sort out the fact that short sellers are not the evildoers. I like to joke that, as long as we have issuers and we have retail investors, there will always be people hating short-selling and people calling for a ban on short-selling.
We all owe it to the market to make sure that we don't allow any of these bans to expand, given how important short-selling is to the grace of the market and the liquidity that we need even to execute long-only transactions. So John, let's move over to T+1. We went through a change in North American markets recently to move to T+1.
We have Gary Gensler pushing the currency markets towards one-day settlement. Europe is under pressure to move to one-day settlement. And I'm curious if Asian markets, other than India, if there's any pressure in these market places to move to T+1.
GEORGE MOLINA: T+1 sort of seems to have gathered some inexorable momentum now. I still think that talking to various institutions from outside the US, they still find it challenging to meet T+1 settlement in the US, in part because of the FX leg, in part because of trade affirmation, and in part because, if you're trying to switch from European stocks to US stocks, you've got this disconnect between the settlement period.
Are you going to wait until your European sell has settled in order to affect your US buy, which potentially means that you're out of the market for a given period of time, or what? So it's definitely introduced a lot of complexity. And so I think there's now a lot of pressure on other markets to move to T+1. There's a bit of a competition between the UK and Europe going on.
We're definitely seeing Hong Kong, which is looking to replace CCASS at some stage in the future, talking about that being a T+1 environment. Given that China is already T+0, and it's been a real struggle for participants on Stock Connect because Stock Connect, obviously, has a T+0 settlement because it's China, whereas, Hong Kong has T+2. So there's definitely a push to move to T+1 there.
And ASX in Australia, despite their challenges with the CHESS replacement, have looked at the new replacement mechanism moving to a T+1 model as well. So inevitably, I think the world will move to T+1. The FX model has to change because CLS with a T+2 settlement is just completely misaligned. And yes, you can get T+1 settlement from your bank. But it's going to cost you more money. And FX is really expensive anyway.
FX often costs more than the underlying stock trade does. So this is overall increasing the frictional cost of trading. So the FX model really has to change in order to facilitate this. But ultimately, are we moving to T+0 model? India is already looking to move to T+0 probably next year. Now, is T+0 real-time gross or end-of-day net?
I don't see how it can work any other way than end-of-day net because real-time gross just is not going to work for institutions, full stop. Because it moves you away from the concept of average pricing across a portfolio to individual clients for the institutional fund manager. But at that stage, are we actually going to see the trigger that brings about the tokenization of securities, atomic settlement, and so on and so forth. There's a lot of changes going on in this space.
PETER HAYNES: That's a long way away. I think a couple of years ago, we would have all said, oh, blockchain is the savior of the settlement world. But I think we're all learning how the complications just moving from T+2 to 1, and then prefunded markets like China, and then what T+0 really means, I think there's a long way to go. That'll be another one of those things, I think, that gets done in the next generation of people that are doing these podcasts in 10 or 20 years.
So George, I want to move across the Atlantic Ocean, still in the Southern hemisphere, though, to Brazil, another of the marketplaces that you trade in. And we'll call us tourists, i.e., people that come and trade in that market once in a while. One of my colleagues dubbed traders that come in and out of the market once in a while as tourists, and I like that term.
What are some of the dos and don'ts about trading in the Brazilian market today and advice you'd have for investors that might be tourists in trading Brazilian stocks? And obviously, that's going to change with all the competition that was discussed earlier. But for now, what are the dos and don'ts?
GEORGE MOLINA: We actually have a trade desk in Brazil. So at Franklin Templeton, we believe, being global yet local brings a big advantage to us. So I do have a trader on the ground, which allows us to speak to domestics and foreign brokers. Despite being the largest market in Latin America, liquidity is concentrated in about 10 to 15 names. And for all of the names, it's really a game of liquidity and a more volatile high beta market.
What we've been successful with in Brazil is, we execute our orders much quicker. What we have found based on our TCA, Trade Cost Analysis, is, the longer you're in the market [? expose, ?] the easier it is to be gained. It's a known fact that, in the emerging markets, the longer you work your order across multiple days, the impact cost is.
You can monitor real-time flow, broker flow and patterns through a system in Bloomberg, which allows for you to see which broker has the market share, which creates a lot of transparency. And you can use that to your advantage or disadvantage. And that becomes a question of, is there too much transparency in the market?
Some of the don'ts we've had and what we've seen is that clients tend to trade on facilitation, so market-making, which is quite often not natural liquidity and causes one to compete with themselves. So that's when they go to a specific broker and ask broker to make a market. The broker decides to make market one, two, three, spreads higher depending on the volume. And then, they're out there in the marketplace competing against you if you have an ongoing, i order to bring down the risk.
What we've also found is that not a lot of traders are using all the liquidity venues made available to them. To give you an example, as of late, what's become very popular in Brazil is RFQs, Requests For Quotes. So we're seeing that being used more often now with brokers. And also the electronic trading-- some investors don't have the electronic systems in order to be able to go into the market directly and anonymous. Well, we do quite a bit of direct market access and algorithm trading now into Brazil.
PETER HAYNES: General question for you, George-- we've talked about certain of these emerging markets where you're dealing with local brokers. I'm curious if you look at the big picture, what percentage of your order flow would be executed by global brokers versus local brokers? Do you feel like you have to rely on these more obtuse markets on local brokers? Or are the global brokers able to satisfy you in those regions as well?
GEORGE MOLINA: So it's going to be market-by-market specific. But if I look at just the mid and small cap space, if you're not speaking to some local brokers, or speaking to the local pension funds and local institutional fund managers, then I think you're going to suffer for liquidity. So what we are finding is we are working probably 65/35.
65 still from a foreign broker perspective because there are some other background issues that we have to deal with just counterparty credit risk, make sure that the brokers have the right systems in place for orders to be secure, making sure they have fixed connections. And with some domestic brokers, we're still not there.
But if we just look at, in India, I mean, Kotak, for example, large Sydney broker, they have something like 13%, 14% market share. So if you're not speaking to Kotak, then you have some trouble. So local brokers have become more prominent for us. We can go and capture some of this local market share through some of the foreign brokers that align with them, or they have JVs in place.
But we want to make sure that we have access to all forms of liquidity across domestic, local, electronic, nonelectronic, capital markets, and making sure we're not limited to any one facet of liquidity.
PETER HAYNES: OK, John. There's two more markets I want to talk about. One, I call the forgotten market, but another one that we kind of bypassed without getting into. And when you look at the weightings in the emerging market, you have China at 25%. I was surprised when I looked at it to see the second-biggest emerging market is actually Taiwan, which you briefly mentioned earlier. John, tell us the 411 about trading in Taiwan before we finish with Australia.
JOHN FILDES: Oh, crikey. I mean, Taiwan is an unusual market. There has been a history of foreign ownership restrictions. So there was an ongoing QFII situation in Taiwan where MSCI kept increasing the weight of Taiwan as long as Taiwan increased the ability of investors to gain more QFII.
And part of this was driven by the fact that Capital International, one of the two founders of MSCI, was the world's largest emerging markets investor at the time-- and I'm going back nearly 30 years now-- and could not get its equal weight because the QFII limit was a dollar value. So even the smallest institutional investor could get as much as capital, or capital could only get as much as the smallest investor. So it's been constrained along those lines. It is dominated by the chip makers, TSMC, USMC, and as those chip makers have grown in value, so the size of the market has grown.
Even when it was very difficult for foreign investors to invest into Taiwan, that was what actually drove the growth of the MSCI Taiwan futures on SIMEX, which is now SGX, Singapore Exchange. Because for investors who couldn't access that market. It was important to be able to equitize through the futures market. And the only futures market that was accessible to international investors was that on the Singapore Exchange.
So that led to the growth of that market, which then Hong Kong Exchange tried to raid when they secured the MSCI franchise for Asia. And SGX responded by moving their Taiwan contract to a FTSE contract where they have actually been able to retain most of that volume. So it's still very much-- the onshore market is still very much reflected by international institutions, a derivatives market that is largely offshore.
PETER HAYNES: So is there one main exchange in Taiwan?
GEORGE MOLINA: Yes, yes, just one exchange.
PETER HAYNES: And is there any influence by the Chinese market, or is it totally separate at this point in time? Despite geopolitical tensions, Taiwan maintains its own market with no influence from China whatsoever.
GEORGE MOLINA: Absolutely. Nothing to do with China whatsoever. But as I say, as you rightly refer to, there's a heightened level of geopolitical tension around the whole mainland versus Taiwan situation.
PETER HAYNES: And the next administration of the United States is going to certainly have to deal with that next four-year term. OK. So John, I do want to finish with what I call the forgotten market, and that's a market that is often compared to Canada, given the minerals and banking focus of it, and that's Australia.
You sit day to day in Sydney. What's new in the Australian market other than CHESS drama every day that our listeners should know about? And do you agree with this notion that it seems Australia might be forgotten by global investors?
JOHN FILDES: Look, I don't think it's forgotten by global investors. It is part of the developed markets benchmarks. It's got a number of substantial companies, such as BHP and Rio, as well as the big banks. As you say, it's very similar to Canada in terms of being made up of financials and mining companies.
Australia also has, I think, the fourth-largest pension fund system in the world, and that's for a country of 25 million people. I mean, it's a phenomenal achievement, but it does mean there's a huge amount of cash going through those superannuation funds, as we call them here. And that represents probably 50% of all investment in the equities market in Australia. But increasingly is a big investor in infrastructure, alternatives, and international investments as well.
The other thing about Australia is it has a pretty liquid derivatives platform, which does trade close to 24/7, ASX 24, which is predominantly the interest rates, the short-term interest rate futures for Australia, as well as the stock index, strangely enough, not that much of a commodities market. Most Australian commodities is seemingly traded in Singapore.
It has had its notable challenges with CHESS replacement. Let's be clear. Post-trade infrastructure replacement is always a bit of a challenge. And you've seen that in Canada as well with the issues that TMX has had with replacing the platform at CDS. Interestingly, a platform provided by the same company that is now being engaged by ASX to replace their post-trade platform, having failed with their proposed blockchain development.
Yes, they have their challenges there, but also, what I'm hearing is that they're in the process of also having to replace their equities trading, their derivatives trading, and their derivatives clearing platform. And I've never yet heard of an exchange that has had four projects in flight at the same time to replace all of their trading platforms and all of their post-trade platforms simultaneously. So it's definitely got some challenges there.
PETER HAYNES: We know how that's going to end, and it's not well. A couple follow-up questions. I'm going to start with the superannuation you referred to earlier having a significant footprint in the local market. Our large Canadian pensions, which are professional, like the superannuations, at one time had a huge footprint in the domestic market and have almost entirely vacated the domestic market in favor of diversification globally. Are the superannuation funds starting to expand their equity footprint outside of Australia to invest in global securities, or are they still severely overweight the local market?
JOHN FILDES: They are investing globally, for sure. I mean, AustralianSuper, which is one of the biggest firms, now has a London trading desk as well as a Melbourne trading desk. They are expanding globally into equities and into unlisteds as well, so into alternatives globally.
But they're not giving up their investment in local firms, because, obviously, their superannuation payment obligations are tied to the local economy. And so, therefore, they have to retain a certain amount of investment that links to the domestic economy as well. So I don't think that they're going to be disinvesting in the domestic markets any time soon.
PETER HAYNES: The final question about Australia is, I have always felt-- I want to make sure I still have this right. I've always felt like Australia actually had best execution figured out. And that is that, for retail investors, you have to honor the market quote. But for institutional-sized orders over a certain notional-- I thought it was $250,000; I can't remember-- you were able to trade at the price that was the best for the institution without having to worry about displacing quotes and potentially leak information as you're executing the trade.
Is that still the case in terms of how the Australian market works? And has Cboe Australia been able to gain any additional share in the last few years?
JOHN FILDES: Peter, you're pretty much bang on about the [? BestEx ?] rules. But one sort of slight amendment to that I would make is that, for retail, it's about total cost of execution. It's not just getting the best price on the share, but it's actually what it costs to place that trade as well that can be taken into account.
And then, for institutions, as you say, it's about the ability to execute and the certainty of execution. So there's a lot more factors that can be taken into account, such as the depth of liquidity on a given market or whatever. Doesn't have to be at best price. It can be aligned with what the institution wants to achieve.
But equally, I think Cboe has kind of plateaued at around the 20% market share. It hasn't managed to break out beyond that. Although, it does have a much higher market share in ETFs, in part, because it is much more accommodating for market-makers. It's built substantial market share there. I think the question is now whether, under Cboe ownership, do they expand into other sectors of the market in Australia.
PETER HAYNES: Yeah. And ETFs don't have that tie to the close. Primary markets win because you want to be on the primary market to participate in that closing auction information, which we know is a substantial portion of every market. And so with that, George, I want the last word to go to you.
If you were to rub your hands together on your crystal ball, what does trading in the APAC market look like in 5 to 10 years? What are the markets that are going to win? What are the potential losers? And are there particular up and comers that you might say, people should be paying attention to?
GEORGE MOLINA: In Asia, I've been here over 20 years, and I've only seen it get better and the markets continue to open up. I think all markets are going to be winners in the Asian region. Yeah, we can't ignore the cyclical nature of supply and demand, the economy, and obviously the geopolitical situations that arise.
What is evident or what has been evident for me, in this last 20 years, is that, in order to have a successful market and in order to compete, you need to have global investors aligned with the domestic investors, a well balanced marketplace, institutional and retail as well. Some can argue in some cases there's too much retail, not enough institutional. But that, I think, will even itself out with time.
You also need a healthy set of capital markets-- the tools, the innovation for exchanges to grow and prosper. And then the accessibility is key. Foreign ownership, taking some of those foreign restrictions off, global best market practices, the ease of capital inflows and outflows, freely tradable currency, the account open documentation, and et cetera.
And of course, as Franklin Templeton sustainability and governance factors are integral to the investment process. And then, as you mentioned earlier, as a long-term active engagement with not only the policy makers, regulators, exchanges, but also with the companies, and making sure the companies from [INAUDIBLE] or unwinding from corporate governance perspective are doing the right thing for our end investors.
PETER HAYNES: If I was to come back 10 years from now and talk to you about APAC, do you think a lot of markets that we define as emerging will, 10 years from now, be what we'll define as developed?
GEORGE MOLINA: Absolutely. I think there's always discussions with both the index providers, MSCI, and FTSE, on Korea. Korea was up for review to move to a developed market status. And then they had some hiccups which have put that off for now. Vietnam-- we like Vietnam. I think Vietnam is going to be a big winner if that market continues to grow. And from a demographics perspective, it's well placed.
Indonesia, Hong Kong, China-- you cannot ignore China. And I can't say this enough. China, the second-biggest economy, China will continue to grow, I think potentially at some point become too big for emerging markets and move on to develop market. So we're quite excited about the region. India's had a fantastic last couple of years. There continues to be demand in India. Our India ETFs specifically is one of the largest ETFs out there in the marketplace now.
So I think we're all winners. I think, as foreigners continue to understand the region better, we're seeing a lot of our competitors, a lot of our peers setting up offices across the region. I think there will be a better understanding for the region as a whole.
PETER HAYNES: Well, both of you have done an incredible job of helping your peer group and the listeners of this podcast, who are market structure nerds, understand better some of the weeds that you traffic in in the APAC region. And for that, I want to thank both you, George and John, for your participation in our podcast series, and for helping shine some light on some of the issues that everybody needs to understand when trafficking in securities in your region.
Thanks for joining us, and appreciate your participation.
JOHN FILDES: Thank you, Peter.

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