Chinese finance high-speeds into unknown territory

by Qian Han/ 31 Jully 2017 / EAF

On 23 June 2017, a court in Shanghai charged the international trading company Eastern Dragon with market manipulation in the Chinese futures markets during the 2015 stock market crash. Eastern Dragon was slammed with a US$101 million fine and two of its traders were handed out suspended prison sentences. This sets an important precedent as the first time a Chinese court has ruled on foreign high frequency trading in China.

Unlike their Western counterparts, the Chinese futures markets publish price quotes just twice a second. This means that a high frequency trader — who uses algorithms to buy and sell shares at high speeds — is not supposed to know what is going on in the market between these half-second intervals. But this restriction does not technically apply to high frequency traders with a ‘direct connection’, or who trade directly in the market rather than through a brokerage firm. This direct connection method is illegal in China.

But this is exactly the method that Eastern Dragon used in 2015, meaning that it could observe the real-time quotes and transactions of all other trading accounts in the same futures broker with which it opened its accounts. This gave Eastern Dragon an informational advantage over other firms, and from June–July 2015 this advantage also yielded Eastern Dragon about US$100 million in profits.

The government regulator’s handling of Eastern Dragon weighs heavily on the future of other foreign high frequency traders in China. For instance, in 2016 Citadel and IMC were also investigated for high frequency trading misconduct in the Chinese stock-futures markets in 2015. Both cases are now awaiting sentences.

Over the past few years, many foreign high frequency traders have been attracted by the huge potential profits in Chinese derivatives markets. Most of these high frequency traders disguise themselves as international trade or IT companies, which helps them circumvent Chinese regulations. International high frequency traders like Citadel, Tower Research, IMC and Optiver are some of the major traders in China, predominantly trading in Chinese commodity futures markets. Their success has encouraged other high frequency traders — such as Virtu and Teza — to follow suit.

While Eastern Dragon’s sentence initially generated some panic in the market, a longer run retreat of foreign high frequency traders from the Chinese markets is unlikely given the enormous amount of money on the table. Many companies are completely undeterred. Optiver, for example, has stepped up its efforts to circumvent regulations through joint ventures with domestic futures brokers. More foreign high frequency traders will likely follow suit if this venture turns out well. Read more…

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