Now that the pending merger of the Tokyo (TSE) and Osaka (OSE) stock exchanges has been announced I will give you a breakdown of the challenges the two bourses are facing from a behind the scenes point of view.
Who am I??
I am a system engineer working on the most recent release of the Osaka Stock Exchange. OSE has recently went live with a new derivatives and cash/spot market (J-GATE) using the Nasdaq OMX market (from Sweden – Nasdaq bought the Swedish market).
The reason OSE has decided to get in bed with Nasdaq OMX (henceforth, OMX) is because Japan has not yet adopted international standards for market access to the markets. Nor have they created their own standard. Essentially, OSE was forced by the Japanese government to adopt a global exchange back-end vendor to internationalize markets in Japan and create more liquidity into their markets. The result being that OSE has adopted and fully integrated the non-native OMX system from Sweden into some of their hottest markets.
The OMX solution includes many supposed benefits for international and domestic traders/securities firms:
- API Interface for external trading applications to access the market.
(In REAL LIFE, no firms are using the OMX API, preferring to use the FIX protocol)
- CIBOIS Trade XT – A native trading platform/tool which can be used to trade on OMX markets and exchanges.
(so far none of the Japanese securities firms are using this software platform)
(So far none of the foriegn capitalized firms/investment banks are using this either)
- SPEED – The OMX trading platform has offers the advantage of speed over
domestically developed Japanese exchange systems.
The introduction of this system comes about as the Tokyo Commodities Exchange (TOCOM) has implemented the OMX system across all its commodities markets and has been operating this for over two years now with no significant glitches.
ALTHOUGH,,, there have been no major glitches, TOCOM has lost significantly in terms of market participation following the implementation of OMX software. More specifically in the areas of volume, liquidity and market share. Some explanations as to why this reduction has taken place are:
- Non-Native Platform – OMX essentially refuses to implement a Japanese language localized trading platform for their software (but they still want to be in the Japan market — WTF!?)
- Shifting Gears is difficult for Japanese securities firms that are used to automatic transmissions. Japanese securities firms have a significant disadvantage as all of the documentation for the CLICK XT system (CLICK), the backend exchange management system developed by Nasdaq OMX.
- CIBOIS Trade XT the OMX trading platform also has not been localized and there is no comprehensive documentation available in Japanese.
- Growth of unofficial Dark Pools and Crossing Networks (ECNs)– This is the real reason for the exchange merger mania, A massive growth in the use of Dark Pools, privately owned Electronic Communication Networks (ECN markets), Proprietary Trading Systems (PTS), Multilateral Trading Systems (MTF), and Alternative Trading Systems (ATS). Their growth has sent the official stock exchange market (RM, or Regular Market) into a tailspin. More about this later.
While TOCOM and OSE’s integration of OMX software was successful (technically speaking) (integrated by NTT Data Corp., my boss).
In contrast, the TSE system was developed domestically in Japan by Fujitsu Corp. and introduced last year with several failures and was defective for several months into its release. The Fujitsu system for TSE has been labelled as the Arrowhead system and TSE is trying to promote it globally. Currently they are bidding to be the software vendor for the Malaysia Stock Exchange (but it is widely considered overpriced and costly for the size and scale of the Malaysian market).
1. Why Merge: Merger Mania in the Exchange industry?
Whoops!! Where did my market go?
Recently, a severe case of merger-mania has swept over the exchange industry. Globally, all Regular Market exchanges (RMs) have suffered a vacuum syndrome as trades are happening in Alternative Trading systems. That leaves the markets with less liquidity, and less volume, and fewer Trading Participants (TP) (otherwise know as Participants or Members).
Securities firms and Private markets, etc. have created these non-listed market/exchanges where the big boys (global investment banks offloading massive quantities of stocks) can play together in secret. ATSs also serve to allow the small fry private investor to trade by just going to your local securities firm and opening an account (you get your own software to trade your own stocks).
This loss of market share has put RM exchanges under pressure. Why they don’t create their own secondary markets themselves is beyond me, but so far there is only a little momentum in this direction. They all just seem to want to merge and acquire the competition — typical Wall Street Mania?!
2. OMG!! Standards!? WTF are standards??
Japan has long suffered in any standards war. The cellphone industry, once the cellphone global leader, now relinquished to iPhone and Android or DVD or whatever…
It is called the Galapagos syndrome and it comes from a lack of collaboration amongst Japanese companies and is also attributable to the business culture of customization in Japan. Customization that conflicts with the creation of standards.
And then there is the Osaka vs. Tokyo rivalry…
3. Long Time RIVALRY!!
Osaka has long had an inferiority complex with Tokyo. As the Osaka area (aka, Kansai) is the cradle of traditional Japanese culture, Edo culture of Tokyo has been dominant for over a hundred years.
However, this does not really work the other way around. Tokyo has no (few?) issues with its lesser rival. So as the name suggests, there is an inherent provincialism in the exchange industry as well where the mercantile culture of Osaka just wants to best its Tokyo brother.
4. What does TSE bring to the table?
The TSE markets are less dynamic but more established. They have not shown to be very fast nor responsive to market demand. However, they do have most of the biggest companies listed and these big listings are where most people’s eyes stay focused. Thus the focus of OSE’s envy.
On the back-end, TSE runs a system called Arrowhead that has had several problems in its original implementation.
5. What does OSE bring to the table?
OSE compared to TSE is a less bureaucratic and better performing exchange. The market and products (instruments) for sale there are more of the start-up genre and overall a more dynamic marketplace.
OSE back end is either powered by OMX (Derivatives, Spot, Futures/Options) or by an older but reliable engine developed domestically by Hitachi.
6. What NEEDS to be done!!
If they merge, what challenges do they face? Here are some of the most obvious challenges I see:
- Increase Liquidity – There is not enough money in the market to attract more people.
- Increase Participation – Both TSE and OSE (and TOCOM, who will probably be sucked into this acquisition my a matter of inertia) are loosing Trading Participants (TPs).
Crossing Networks and ATPs are stealing away both the small and big investor. While…
- High Frequency Traders (HTF) are robbing the traditional and small time investor blind in major markets. This is a deterrent to anyone looking to make money via trading and investment.
- Increase Volume – Although HTFs increase volume in markets, they literally take liquid cash out of the market. Liquidity is the lifeblood of any market/exchange. No life exists without blood. And if HTFs continue to suck off liquidity — like a leech, market activity will enter a downard spiral creating a dilemma for exchanges, Volume in exchange for Liquidity.
How do you increase volume while growing your liquidity?
- Attract Foreign Capitol – The most important goal of introducing OMX software to the OSE exchange was to increase foreign participation. They feel that the introduction of a foreign standard will bring more investment from abroad (however, the TOCOM example proves this is not necessarily so).
- Merging the Back-End Systems – A massive task using systems that are vastly different. The OMX system is a VERY turnkey system that OMX refuses to localize, and the Japanese integrators are showing incapable of doing (a simple case of a single-track mind Japanese business). The TSE Arrowhead system was rushed to market with obvious oversights in Software Quality Assurance (SQA). But, has started showing to have sufficient throughput and speed.
Nonetheless, I doubt that OSE and TOCOM are going to give up their $15m investment in the OMX system standard just to merge. For that reason, I suspect that this “merger” may be of a more unfriendly variety of big brother, TSE, taking over little bro, OSE, and small fry, TOCOM by hostile takeover — but dont quote me.
- Tackle High Fees and Regulation – The official RM exchanges are more expensive, slower and less accessible all due to REGULATION (i.e. supervision, or government regulation).
In the official marketplace is subject to government scrutiny and therefore market supervision. The regulations and reporting restrictions create an operating and cost overhead for the RM exchanges, like TSE/OSE/TOCOM. This overhead is translated into higher fees and as a result less volume, less liquidity, fewer participants and so on.
7. Will a merger, or takeover, result in a solution to any of these challenges?
I say NO, not in itself. market share will go its merry way and continue to slip.
The Japanese market is slow and it takes forever to force it to change in my experience.
What they can do though is, acquire or create Multilateral Trading Platforms that have listings (financial instruments) that are consistent with their official markets. These financial instruments (products) will somehow pegged to an actual series (or stock) in the regulated market (or somehow be a by-product of it).
If they have an MTF without Market Supervision they can lower the fees and create even faster systems.
An added advantage of creating an MTF on their own is they can create an alternative trading platform that trades on the MTF, but can also trade on the RM at the same time, if the user chooses to do so because he/she either sees an opportunity, or just wants to increase his odds.
The trading platform/software market is currently in a hypercompetitive mode. as algorithmic trading is skyrocketing and everyone is trying to keep up. It would be easy to buy one of these trading platforms and insert cross-market functionality. Although cross-market functionality is already out there, a few unexplored opportunities do exist:
- A Proprietary Trading Platform localized for the Japanese market
- Japanese Style Horizontal Order Pane
- ZARABA specific tools
- A Collaboration Feature – so that individual investors can combine forces to equalize the advantage of the big investment banks or HFTs
- A more graphical UI
- Be able to trade and ping in a dark pool while trading and dealing in a MTF or RM marketplace seamlessly and simultaneously
There is a multitude of options in trading software that are not being offered currently.
Another advantage in an MTF offering by the RMs is that many MTF/ATSs hustle their own products in their own markets. Sooner or later this will be regulated and stopped, but only god knows when. Furthermore, often these products are not based in reality (with no actual underlying security). They even use Market Makers to prop up the market to get you to buy.
The operator is selling you crap, running the numbers, and making money hand over fist in his own private gambling zone.
An MTF run by an RM would be the perfect way to counter this pending legislation and making it safe for the real investor.
On a final note, I recommend against the use of any Nasdaq OMX product. They are extremely unprofessional, poorly managed, do not honor their own SLAs (Service Level Agreements) and just plain rude. They are introducing a new system that is a combination of the faster NASDAQ (NY) system and the configurable OMX (Sweden) system. This system is already in place in Austrailia (ASX) and Singapore (SES) and having some problems/outages. But in my personal opinion, as developers the quality of OMX software is low to begin with, and they don’t like to issue customizations even if you are ready to pay for them.
I hope this has offered some insight to the mentioned merger and the exchange market in general for those of you who, like myself, initially had no idea how markets work.
If you enjoyed this and want to explore opportunities in MTFs together please do not hesitate to contact me.