J.P. Morgan Markets
Do. More.

Market Matters | Data Assets & Alpha Group: APAC Equity Market Structure & the Liquidity Landscape

 

[MUSIC]

 

Eloise Goulder: Hi, I'm Eloise Goulder, head of the Data Assets and Alpha Group here at J.P. Morgan. And today, I'm really delighted to be joined by Claire Witts, who is head of Market Structure for APAC and based in Hong Kong. So, Claire, it's brilliant to see you face to face for once here in London.

 

Claire Witts: Hi, Eloise. It's great to be here and speaking to you in person, given the very interesting conversations that we normally have over Zoom.

 

Eloise Goulder: Absolutely. So, Claire, can we start with the turnover question? Here in Europe, turnover ratios have been declining for a decade now. We've discussed this at length on this podcast series with your mere counterpart, Chris Andrew. But in APAC, I know we've seen the opposite trend. We've seen turnover ratios increasing. So what do you think is driving this?

 

Claire Witts: Yeah, it's a great question. Just to give some context first, I think for equity trading, we look at over 16 different markets in what we call APAC. And that ranges from large developed markets, like Japan, through to frontier markets, like Vietnam and Pakistan. And they're all at really different stages of their capital market development. They have very different political priorities, lots of different trading rules. And each one has a different mix of types of investors. If we look back over the past decade, I think the APAC growth story, just the evolution in general, has been huge. So average daily trading volume for the region has more than doubled since this time 10 years ago. And when we look at that, just in terms of volumes, one of the biggest drivers has been the creation of Stock Connect, which is the cross-border trading program. It connects the China and Hong Kong exchanges. And it's enabled international investors to trade into China from offshore. And we quickly forget, but that market in practical terms barely existed eight years ago. Now, northbound connect trading is over $21 billion USD a day.

I know China's not the most popular market for many global investors at the moment, but we shouldn't lose sight of the fact that the rate of change to access for international investors and, actually, the medium to long-term growth of trading volumes on China Connect is really phenomenal. But if we look at some of the hot markets right now where there's real growth in terms of activity, Japan trading volumes are at nearly decade highs. The Nikkei is regularly reaching new levels, and that's a very interesting market for many of our clients. Then India, trading volumes are up 77% year on year. Korea and Taiwan also big growth stories of positive performance in AI and semiconductors.

 

Eloise Goulder: It's fascinating and such a contrast to what's going on in Europe, where turnover ratios are falling. So coming to the drivers of this, I mean, you mentioned Stock Connect, the creation of that, obviously, driving volumes in China, but outside of that market, what do you think is really driving this growth in turnover and liquidity?

 

Claire Witts: Yeah, thinking about why there's been this growth, actually, for me the answer lies in who is trading. A really big driver for this increased rate of trading in the APAC markets has been a very significant growth in systematic trading in the past five years or so. And one of the reasons is that this has been enabled by a lot of improvements in the exchange's trading infrastructure and latency. And also, there's been quite a lot more clarity from regulators across the APAC region around their expectations of market making and quant and high frequency trading. So that's meant there's a lot clearer guidance on what sort of trading behaviors are considered to be abnormal or disruptive. And that clarity, I think, has helped to provide confidence and institutionalize some of those systematic trading activities in Asia.

And then the other key players in the APAC turnover story are retail traders. And unlike what you've seen in much of the rest of the world, this is not just a COVID era phenomenon. In the career market, over 65% of the turnover is from retail trading. Onshore in China, it's 60% to 65%. Taiwan is up close to 60%, and India is 35% to 40%. Even Japan, off the back of the recent rally, we've seen retail volumes rising to 30% of the overall market. And another point to mention, these stats are weighted for the total market. If you go and look at midcap and smallcap trading boards around the Asia region, retail trading just totally dominates.

 

Eloise Goulder: Thank you, Claire. And it's worth noting that those stats you've given in terms of the retail share of volumes, 55% to 65% mark across onshore China, Korea, and Taiwan, that is way higher than the retail share of volumes we see, even in the US, which is probably about half of that, and then in Europe, where the share of volumes is much smaller. So Claire, what would you say is driving this retail impulse in those specific markets?

 

Claire Witts: For a start, many of the Asia emerging markets like China and India haven't had a mature pension fund system for people to put their money in, so direct investing into equities has been a much more common way for the person on the street to try and get returns on their savings. And this has driven the high retail activity in these markets for a long time. But I find there's also a big dose of psychology at play and very different cultural range of impacts. So in Korea, retail traders, they're often called the ant army, and trading on leverage is really common. There's a hugely active social media focus on investing. And there's strong parallels with what you may have observed in the US. Much has been written about, faced with high cost of living challenges to get into the housing market. A lot of younger Korean retail investors are looking to play the stock market in the hope of quick and high returns. But on the flip side, Taiwan, it's interesting to see that the largest group of retail investors that have accounts are actually the 61 and overs.

 

Eloise Goulder: It's fascinating the way this is so cultural, in a way, but also so different across the various markets.

 

Claire Witts: Yeah, I think the retail trading trend is very deeply entrenched in Asia. And maybe we'll see some dilution of that in terms of the percentage of the market turnover in China and India, as their domestic pension fund industries evolve. By that, I mean some of what's currently direct investing of retail money may become indirect through mutual funds and ETFs. But in the foreseeable future, I really think the retail investor will remain a key component of Asia liquidity. And everyone trading the market will do better by understanding how those retail traders work.

 

Eloise Goulder: Definitely, and actually, we, as a data driven team, frequently receive client requests on gauging the Asian retail investor. If it's not retail investor flows, then it's retail investor sentiment as measured from social media platforms, for example. There's certainly a huge amount of investor appetite out there to better understand this cohort. But it is interesting to hear that there's one force in China and India which will actually potentially lead to a reduction in the retail share of volumes, and that's the evolution of the domestic pension fund industries, because if you contrast that with the US and markets in Europe, it's a one-way bet. The retail investor may be starting from a lower base in terms of their share of volumes, but it is going up and up. I mean, when you think about these APAC markets, are there counterbalancing trends here? So the evolution of the pension market is leading to a reduction in retail share of volumes, but other factors are leading to an increase?

 

Claire Witts: Yes, I think one market that's an excellent example of that is India. And the trend there is somewhat different to China and Korea and Taiwan, which have had high retail participation for a really long time. In India, there's been an absolute explosion of interest among retail investors over the past three years. And JP Morgan recently hosted a conversation with the National Stock Exchange of India, talking about this. They provided a lot of stats for us. So they've seen growth in retail investor trading accounts, growing over 600% in the past 10 years in cash equities and 800% in the futures and options market, which is a big part of how people trade India. But one stat that stuck with me is that there's now over 85 million retail trading accounts registered with the National Stock Exchange of India. But they went from 70 million to 80 million accounts in just eight months of last year.

 

Eloise Goulder: That is an incredible stat. And what do you think is driving this? I mean, I imagine that strong equity returns has been part of this.

 

Claire Witts: Yes, definitely. I think the main trigger has been technology. So, now, in India, biometric mapping can be used for approving account opening in minutes. So suddenly, anyone, anywhere, in India could open an equity trading account. And in fact, the biggest growth of new accounts has come from states that are outside the financial hubs and big cities. So lots of people that have never previously been involved in investing have entered the stock market. There's also a central bank-backed instant payments platform, and that can be used to link bank accounts and share trading accounts, so it's really easy for people to get up and running quickly. And then, to your point, Eloise, India market performance has been on a strong rising trend, and there's very high domestic confidence at the moment about future growth. So a lot of household savings are channeling into direct equity investing, and many Indian retail traders want to benefit quickly from that positive momentum.

 

Eloise Goulder: Yep, that totally makes sense. And it's definitely true to say that in the US, we've seen a positive correlation between stock market returns and retail investor participation, especially post-COVID. And obviously, the direction of causality is to weigh in that better stock returns draw in retail investors, but equally, retail investor participation and net buying boosts stock returns. So it's obviously a two-way relationship, but it is fascinating to hear that you're seeing similar dynamics in India with various structural changes also boosting the retail share of volumes there. So, Claire, coming back to market structure, what would you say has been the impact of the rise in retail participation on market structure in these various APAC markets?

 

Claire Witts: Yeah, I find it fascinating because it has impact in a whole range of ways. So, as an example, we can see from the data that APAC markets with lots of retail trading have more activity at the start of the day and less at the close, where a lot of the institutional trading is done. So, a lot of retail traders will come in the morning, and they'll put their orders on, or they'll have their ideas overnight, and they'll be placing those orders either directly via apps or via their brokers.

But one of the most interesting impacts of the high retail participation from a macro perspective is how the regulators and the policy makers need to respond to the demands of retail. So we see retail investors having much more influence on policy and regulation than perhaps, we see in other parts of the world.

 

Eloise Goulder: Can you give me some examples of that?

 

Claire Witts: Yes, a great example at the moment is the Indian regulator, Sebi's, recent proposal to allow optional T0 and instant settlement. So as you know from I think most institutional investors experience of the US, moving to T+1, there's many challenges to move that sort of infrastructure. And certainly, institutional investors don't necessarily want to move to a same day, or instant trade settlement model. This could present some challenges. But the regulators have been clear that actually, this is initially targeted at retail investors. And one of the reasons is to retain them in the cash equity markets in the face of growing retail investment in crypto. So the idea is that if equities are also settled instantly, and retail investors get their money back into their pockets straight away, then this removes one of the differentiators of investing in digital assets. So I think it's a great example of how regulators are creating a really unique market structure, largely, for the demands of retail investors.

Other examples from the Asia region also include how Korean regulators are incorporating the retail investor view into discussions on the current short sale ban. So recently, there was a public forum that included individual investors held to debate the topic of short selling. And even at a market microstructure level, we've got a number of stock exchanges around the Asia region that are changing their tick sizes as part of efforts to reduce spreads. And although the small and micro caps are a very small part of the overall market turnover, there's been a lot of thought put into the decisions on tick size changes for those stocks, given their outsized impact on retail investors who are actually the majority of the ownership base.

 

Eloise Goulder: That's all so interesting. And I guess it all speaks to the fact that the regulators are acting on behalf of the general public, and hence, their interest in listening to the retail investors concerns.

 

Claire Witts: Yes, exactly.

 

Eloise Goulder: So coming back to the rise in turnover across various APAC countries, Claire, how much do you think this is linked to market structure changes rather than fundamental participant appetite to invest in certain markets?

 

Claire Witts: I love this topic, Eloise. I know you've spoken about it in other podcasts in the past as well. And I think this idea of structural changes versus cyclical changes is a topic we could debate for a long time. But to my mind, this relates to time frames, because generally, in my experience, there are very few market structure changes that instantly or quickly change the liquidity profile, or the turnover of a market, and certainly not if it's in conflict with a prevailing investment trend. So if I think back to last year when they cut stamp or trading fees last year in Hong Kong and China, didn't really boost volumes given the overall market sentiment. But on the flip side, somewhat against expectations, the short sale ban in Korea hasn't yet reduced volumes, or even hedge fund positioning as your data shows. The current market rally that's driven by the Korea value up program seems to be reason enough for hedge funds to put their money there at the moment, despite the ban.

But what I think market structure can do is create floors or remove ceilings on the amount of investment that can flow in and out. And that directly affects liquidity over the medium and the long-term as investment sentiment ebbs and flows. So if we think about fees, high fees, or very onerous trading regulations, they can disincentivize opportunistic investing. They can disincentivize the Quant trading that can be really valuable for liquidity. Or if we think about what that does to the participant mix of a market, markets that don't have a diverse mixture of different trading types, different investors all interacting with each other, tend to be the ones that are hit worst when sentiment turns, and then that liquidity evaporates. We've seen that to a certain extent in the Hong Kong market this year. And I think that's a big risk for markets where for example, there isn't short selling, or where rules create a barrier to entry for investors like global institutions. And on the flip side, it's one of the reasons we've seen frontier markets like Vietnam working really hard on changing some of their fundamental market structures, like the requirement to pre-fund trades. So they're trying to address some of those barriers that put a cap on institutional trading, even though their market performance has been really strong recently. International investors just haven't had the access to be able to get in.

So in my view, reactive market structure changes that are done in response to some of these investment trends or these cyclical trends can actually add to volatility and liquidity risk. But on the other hand, if you've got good market structure, if you've got well-considered changes, they nudge long-term behavior. And that supports market quality. And over the long-term that stabilizes some of these ups and downs as the investment flows ebb.

 

Eloise Goulder: That's such an interesting way of looking at it. And I guess for various strongly performing APAC countries, including Japan and India, they've had the best of both worlds recently in the sense that market structure has been in general supportive. You referred earlier to the presence and the rise of the retail investor, but also the rise in systematic trading in the region. But on top of that, there have obviously been very strong fundamental tailwinds for those regions, GDP growth earnings, growth, et cetera, which have undoubtedly supported those countries.

 

Claire Witts: Yes, I'd agree. But equally, we see both those markets are still making ongoing changes. And I think that's what keeps it interesting in APAC. Things are always in flux.

 

Eloise Goulder: Yeah. So looking ahead now to the rest of this year, what are the top APAC market structure themes you think we should be watching?

 

Claire Witts: I'll give you three ideas on this. And they're all slightly different. So the first is a thematic. And I think I can describe it as trading with momentum. So on the equity trading side, we're actually seeing a lot of same way institutional trading in Asian markets, particularly those ones you just mentioned, Eloise, like Japan and India. And the microstructure data is actually showing up that in many cases, this is pushing the costs of trading up. And with many managers concentrating their positions in the same stocks, we're hearing from a lot of our clients trading desks that finding liquidity is getting harder and harder. So in Japan, they also cut tick sizes for the topix 400 last year, a microstructure change that had quite a lot of impact. We see that spreads have narrowed, but we've also seen liquidity on the order book get thinner. So we're doing a lot of work on helping traders manage not just the general market structure, but also the specifics of getting into and out of crowded or popular positions in this more momentum-driven environment. A lot of clients are interested in how they can adapt to this new microstructure, perhaps, by accessing more dark liquidity, using liquidity seeking algos, or thinking about how they change when and how they trade through the day.

The second topic I wanted to flag is close auctions. So again, something that often comes up in microstructure discussions, we've got Japan overhauling their closed auction in November. Australia is likely to introduce a post-closed session. There are some early stage discussions about whether India should introduce a closed auction. Other markets are considering whether they're closed auction mechanisms are optimal. So nowadays, the close is such a significant liquidity event in so many markets. And we are starting to see those closed volumes across the APAC region rise, in the same way that we've seen happen in Europe. And I think that from a microstructure perspective, getting the close right is perhaps the most important mechanical decision for stock exchanges. And there's going to be a lot of change in Asia on that front as we go through to next year. And then finally, elections, much as I hate to say it given my comments earlier about reactive market structures changes, I think that we will see more frequency of policy and regulatory change in Asia this year. There are some significant regional elections. I'm sure the US elections are going to have impact on geopolitics on fund flows and on volatility. So from that perspective, Asian policymakers, and regulators, and the stock exchanges I'm sure will be making more changes as this happens.

 

Eloise Goulder: Thank you so much, Claire. Well, three major topics for us to be watching there, the momentum trade, which we know so well here in Europe and in the US as well, close auctions, again, as you say, growing in other parts of the world, and certainly, growing in terms of share of volumes in Europe. And then elections, all things that we need to be watching. So Claire, it's so helpful to hear your perspectives on market structure in APAC and the causes of this rise in turnover ratios in so many of your markets. And as you said at the outset, you're looking at more than 16 different markets ranging from very large developed markets through to those frontier markets. So I'm always struck by how much complexity there is in APAC. And thank you therefore for explaining these high level themes so clearly.

 

Claire Witts: Thank you, Eloise. It's a pleasure.

 

Eloise Goulder: Thank you also to our listeners for tuning in to this bi-weekly podcast series from our group. If you have feedback or if you'd like to be put in contact with Claire, then please do reach out to your sales representative, or do go to our website at JPmorgan.com/market data intelligence. And with that, we'll close. Thank you.

 

[END OF EPISODE]