UBS to Boost China Computer Trading on Institutional Demand

UBS AG (UBSN)'s China venture plans to offer more computerized-trading services as it bets on a surge in demand from institutional money managers in the biggest emerging market.

Stock-trading volumes from institutional investors will more than double within five years, spurred by regulators' efforts to reduce market volatility and reform capital markets, Qu Hongjie, executive director of China equities at UBS Securities Co., a venture of Switzerland's largest lender, said in a Nov. 8 interview from Shanghai.

"We foresee in the next 3 to 5 years institutional trading flows will increase from the current 20 percent to over 50 percent," Qu said. "As institutional investors have higher demands for better execution services, more powerful and sophisticated electronic trading platforms will become a key factor for brokerage firms to win market share."

The government is targeting more capital from both large domestic and foreign investors to revive a stock market that has been among the world's worst performers over the past three years. The Shanghai Composite Index has fallen 36 percent since the start of 2010.

Communist leaders are holding a four-day gathering that ends today to map out an economic blueprint to sustain growth. The plenum is likely to release structural and financial reform plans, including capital account liberalization and increases in the size of investment schemes for foreigners, Zhang Zhiwei, Nomura Holdings Inc.'s China economist, wrote on Nov. 7. China almost doubled investment quotas for the qualified foreign institutional investors program to $150 billion in July.

Price, Anonymity

Institutional investors account for 60 to 70 percent of trading volumes in developed markets, Qu said. In China, that's only about 20 percent, he said.

China will continue expanding the types of contracts traded on local exchanges, Qu said. The China Financial Futures Exchange started mock trading of options on CSI 300 stock-index contracts on Nov. 8. The options will help improve price discovery and market efficiency, according to the exchange.

Some local brokers are also testing the use of stock options with the exchange that would allow investors to hedge their holdings in specific companies, Qu said.

Institutional clients are moving away from traditional brokerages to electronic-trading platforms because they are cheaper and allow for more anonymous trading, Qu said. UBS currently provides algorithmic-trading services, or "passive" strategies where the client sets up rules in advance and then lets the computer trade, Qu said. The firm wants to start quantitative trading services, where computers identify trading opportunities for clients, he said.

High-Frequency Trading

While UBS has the technologies for high-frequency trading, barriers prevent their use in the Chinese market, Qu said. These include a stamp duty on stock sales and prohibitions on buying and selling the same stock on the same day, or the "T+1" rule.

High-frequency trading, which allows hedge funds and institutional investors to use computers to execute orders in milliseconds, has come under scrutiny by regulators in the U.S. Disruptions in electronic markets have garnered increased attention since the May 2010 flash crash, when the Dow Jones Industrial Average fell almost 1,000 points in minutes before rebounding.

In China, faulty trading software used by Everbright Securities Co.'s proprietary-trading desk, which specializes in high-frequency trades, sent 26,082 unintended buy orders in just two seconds on Aug. 16. The mistake, which the securities regulator characterized as unprecedented in China, led the Shanghai Composite to swing more than 6 percent.

"In bad market conditions, people tend to look for alternative ways to invest for stable returns and lower risks," Qu said. "This can be a good opportunity for us to step up and provide well-established quant trading models for our clients."