High-frequency futures traders in China face growing challenges due to rising costs that threaten the profitability of their algorithmic strategies (para. 1)Some traders were set up by reputable foreign firms as commodity trading companies to circumvent restrictions on foreign investment in the commodity futures market and operated in a regulatory grey area (para. 2)These firms have made significant profits through sophisticated algorithms capable of executing large transactions quickly. In 2019, profits of about 5 billion yuan ($725 million) were generated, 60% of which came from foreign firms. (para. 4)However, the low-cost conditions that made these gains possible are now declining (para. 5).
Newer guidelines exclude high-frequency traders from receiving commission rebates and allow futures exchanges to charge additional fees based on order submissions and cancellations. (para. 6)As a result, trading costs have skyrocketed, undermining the advantage of high-frequency strategies and causing some companies to consider layoffs (para. 7). To consolidate their regulatory position, some foreign traders tried to register as mutual fund managers in China, but many failed (para. 8).
Earlier this year, futures exchanges introduced new rules on commission rebates and eliminated rebates for trades executed via computer programs, which directly affected high-frequency traders who previously benefited from such rebates. (para. 10)(para. 11). The strategies of these traders, which involve frequent order submissions and cancellations, are very sensitive to changes in transaction fees (para. 12)As a result, some transaction costs have increased tenfold (para. 13)which led many traders to abandon their strategies in China (para. 14).
Although leading institutions can still make profits, they will face significantly lower returns, and mid-sized traders may exit the market entirely. (para. 15)High operating costs may prompt some companies to look for high-frequency trading opportunities elsewhere, such as India. (para. 16)Previous regulatory measures such as additional fees for excessive order submissions and daily trading limits have already weakened the profitability of high-frequency trading in China. (para. 17)(para. 18)While these measures may reduce overall trading volume, industry experts believe they will ultimately stabilize the market by forcing out firms that are overly reliant on high-frequency trading clients. (para. 19).
To legally invest in the Chinese futures market, foreign institutions must trade approved commodity contracts or qualify as a qualified foreign institutional investor (QFII). (para. 21)Some traders circumvent these requirements by setting up commodity trading companies, such as Yue Shen Industrial, which is controlled by the Jump Trading Group and conducts large-scale financial market transactions under the guise of commodity trading. (para. 25). Yue Shen reported significant capital gains with minimal tax contributions due to tax refunds and value added tax (VAT) avoidance. (para. 28).
Authorities have been scrutinising Yue Shen’s tax practices and found that shifting investment profits overseas as royalties reduces China’s corporate tax revenue, even though the practice is technically compliant. (para. 29)To make matters more complicated, other investors accuse high-frequency traders of inflating trading volumes without increasing market liquidity because orders are frequently canceled. (para. 31).
Under pressure from regulators, some foreign high-frequency traders have attempted to transform themselves into private investment fund management companies (para. 34)However, these attempts mostly failed due to inadequate compliance with the requirements for raising funds (para. 35)(para. 39)For example, Optiver Private Fund Management’s registration was revoked because it had failed to register fund products within the prescribed time limit, even though it had attempted to launch a product funded by its parent company. (para. 36)(para. 37). Applications from companies supported by Jump Trading and Hudson River Trading were also rejected (para. 42).
Foreign traders attempting to comply face regulatory uncertainty. Some are shifting their focus to spot trading to align with the regulations, but concerns remain about potential future regulatory changes that could retroactively impact past transactions. (para. 45).
Reporter Zhang Yukun and editors Lin Jinbing and Joshua Dummer can be contacted for further details. (para. 47).
AI generated, for reference purposes only
