Today, we interview Seth Friedman, the Co-Founder of Shiroyama Consulting in Tokyo. It is a Financial Services Technology, Consulting, and Representative Agent Services firm. Their clients are primarily overseas based DMA algo & high frequency trading firms within the equities space as well as sell-side firms in Japan and overseas. It is also working on some exciting Fintech applications utilizing Blockchain, customized hardware, and custom configurable integrated circuits for global trading IT systems.
1) When did you start Shiroyama Consulting? Why did you choose to start your firm in Tokyo, Japan? What is your main business and current state of operations?
Shiroyama Consulting is an outgrowth and extension of the work that each of the 3 partners has been involved in for many years; collectively, the 3 partners have more than 65 years of relevant professional experience. We’ve taken our accumulated knowledge and experience and packaged it as a unified set of products and services. We are focused on operating in the fields of Financial Services Technology, more popularly known as FinTech, and the intersection of FinTech and Regulatory Environments. We've formalized our organization with the legal formation of a US-based LLC and Japan-based KK earlier in 2017.
2) There has been a lot of talk about “HFT Regulation” in Japan, could you explain what this is all about?
The financial services environment in Japan is on the verge of significant change with the impending introduction of a vastly revised Financial Instruments and Exchange Act (FIEA) which was submitted to the Diet by the Cabinet Office on March 3, 2017. The revised regulatory framework will bring a host of technical, organizational, disclosure, record-keeping, and educational challenges. The revised FIEA focusses on three main areas, 1. High-Speed-Trading Regulations (what has been described somewhat ominously as HFT Regulation and includes more than 20 new Articles); 2. Exchange Groups; and 3. Information Disclosure. These proposed regulations are publically available on Japanese Government websites but currently are officially only available in Japanese.
The regulatory changes in the area of high-speed-trading will impact a relatively small segment of the automated-trading and quantitative investor community generally described by non-practitioners as High Frequency Trading (HFT); the exact number of impacted firms cannot be determined (most likely between 18 and 60+ firms) until the Cabinet Office and FSA defines what it describes as HFT Conduct. As a result, there is enormous uncertainty as to what technology techniques, investment strategies, and firms will be impacted. Once a definition is created, a firm that falls within the definition will be officially categorized as an HFT Operator.
Once judged an HFT Operator, a firm will have to establish an onshore presence, either by opening an office themselves or utilizing the services of a representative agent; a firm could also respond by changing their infrastructure setup and trading behavior to no longer be an HFT Operator, or cease activity in Japan all-together. The short-term and long-term impact to trading and overall liquidity could be unpredictable, sudden, and inconsistent. Certainly there will be unintended and unforeseen consequences.
While small in number (relatively speaking) HFT Operators represent a very large proportion of activity on venues. With slightly less than 50% of traded volume and more than 65% of submitted orders originating from TSE Co-Location an enormous percentage of liquidity is potentially affected by how HFT Operators respond to the new regulations. The corresponding uncertainty concerns not only HFT Operators, but others who fear the potential impact if a significant percentage of liquidity is affected.
3) Where do you see the opportunity for your firm to grow? What key advantage do you have today in Japan?
We have two main long-term business streams 1. Financial Services Technology; and 2. Consulting and Representative Agent Services. We see an immediate regulatory-driven opportunity in the Japanese environment with longer-term opportunities in other Asia-Pacific, EMEA, and American environments. The short-term opportunities in Japan are driven by the FIEA, the forthcoming definition of HFT Conduct, and detailed rules regarding registration requirements. Depending on the final form of these it is possible that anywhere from 18 to 60+ firms could be directly impacted. Registration requirements, which include the need to describe strategy details, could become extraordinarily complicated. Will firms be required to document the high-level firm strategy, or individual investment strategies at a sub-firm, pm, or asset class level? We won’t know until Cabinet Office Orders are issued at some point after the revised FIEA is passed by the Diet. No matter the outcome, we’ll be able to help firms understand the regulations, the processes and procedures of registration, and adhering to record-keeping requirements.
Our experience and expertise is aligned to deliver significant value to all stakeholders; buy-side, sell-side, venue, and regulatory. Our team has vast experience from previous sell-side and buy-side roles from a number of perspectives including extensive interaction with regulators and venues not only in Asia, but particularly in Japan, design and implementation of sub-microsecond automated execution strategies, and conceptualizing and bringing to market paradigm-shifting capabilities such as US patented network-based packet analysis tools for regulatory compliance and microwave communication networks to significantly reduce data transmission latencies. We deeply understand trading systems and environments, the buy-side quantitative hedge fund space including in-depth experience with the HFT segment, and the buy-side real-money asset manager environment.
The new regulations are targeted at an investor community which is largely offshore to Japan. We see a strong need to help these investors understand, adapt, and conform to the new regulatory environment in a country that many find challenging to navigate. Further, in an environment where the FSA seemingly perceives venues and sell-side firms as biased in a certain direction, we believe our objectively un-biased stance, which is informed by many years of sell-side and multi-faceted buy-side experience, will be extremely beneficial to the overall environment including the formulation of feasible regulations.
We will strive to advise and assist offshore clients in their direct relationship with the FSA and to assist the FSA in its effort to understand and maintain up-to-date awareness of the organization, staffing, technology, trading, legal, and funding structures which are utilized by HFT Operators.
4) Tell us about your Fintech and Blockchain initiatives for trading services in future.
Our second phase of business operation will involve leveraging our in-depth experience conceptualizing, developing, evangelizing, and implementing ultra-performant infrastructure and trading systems on a global scale. We are well underway in the design of future-view systems and have been looking at ways to push the envelope to achieve even higher performance, efficiency, transparency than exists today. These initiatives embrace many factors types of technologies, ranging from optimization of functions in hardware to revised data transmission paths, and include technologies such as blockchain and customized integrated circuits.
It is undeniable the current environment will evolve. The sell-side economics of creating and maintaining high-quality electronic-trading environments have been challenged for a number of years. These challenges will grow even more significant as MiFID II drives commission unbundling and traditionally non-quantitative investors implement quantitative methods with the corresponding demand for broader access to ultra-performant-trading and ever lower commission levels. Our services and products are crafted to deliver the performance demanded by sophisticated organizations with an underlying economic model which will ease the cost pressures experienced by buy-side and sell-side.
5) Have trading opportunities in Japan, changed in any way due to government actions or new technologies?
Absolutely! The Japanese environment has seen tectonic change over the past ten years. The introduction of Arrowhead brought real-time order matching where previously orders were matched in three-second cycles, exchange co-location, unfettered access to full order-book market data, broad acceptance of alternative venues, big-data analytics, and reduced bid/offer spreads. These changes occurred hand-in-hand with the introduction of new technologies which collectively allowed for, and created, exponentially increased order volume as well as sell-side, exchange, and clearinghouse capability to successfully support such volumes.
Looking to the future, as described earlier, the revised FIEA will implement a new framework specifically targeted at HFT Operators, this new framework, its implementation and ongoing operation, known knowns, known unknowns, and the law of unintended consequences will no doubt create broad street-wide challenges. Hopefully these choppy waters will be smoothly navigated without negative impact to the environment.
Separate from the regulatory framework, we see an increasing number of traditionally non-quantitative investors implementing quantitative methods and introducing new types of data sets into their investment process. The trading process and methods of these organizations will evolve as well and we expect the demand for ultra-performant trading capabilities (sub-microsecond venue interaction) to expand. We believe that with these changes, combined with the effects of MiFID II, a new round of commission compression in agency business is on the horizon. These changes will bring even more pressure upon sell-side organizations to rationalize the portions of their platforms which serve as payment channels for their core business of content and capital. In response, we see broader sell-side acceptance of outsourcing non-differentiating functions to firms or consortiums; as we have seen with Project Symphony1 and Project Scalpel2.
6) Are there gaps in overseas trading abilities via the TSE that overseas investors do not fully understand that Shiroyama Consulting try and fill?
The biggest challenge we currently see for overseas investors isn’t a trading issue per se, but rather the seemingly incomplete awareness of the proposed revisions to the FIEA by large segments of the sell-side and buy-side community and the consequent lack of engagement with the FSA or Cabinet Office over potentially problematic regulations. The buy-side, particularly the offshore buy-side, relies upon the FSA, TSE, and sell-side organizations for information. Unfortunately the buy-side seems to have only a high level understanding of the proposed changes to the FIEA. The details are publically available but essentially inaccessible as the revised FIEA itself is as yet untranslated.
The FSA, TSE, and sell-side have broadly communicated to the buy-side that some form of registration and “proper risk management” will be required. The devil is of course in the details, and there is seemingly little awareness of the details. For example, at the moment “proper risk management” is not defined in detail and there is inconsistent understanding among a number of entities as to its exact meaning. Is Naked Access allowed or not allowed? Different entities have different perspectives.
We’ve gone through the Japanese text of the proposed regulations and have identified no less than 21 specific issues which are either open to broad interpretation or are cause for specific concern. We’re worried as to the direct impact but more so we fear the law of unintended consequences will reign supreme. We’re already engaging venues, regulators, sell-side, and offshore investors to provide more details, highlight issues, and encourage participation in the process.
7) Where do you see your firm growing the most in the next 2-3 years? Will this continue within the Blockchain or Fintech space? Are you seeking investors for new projects or service offerings?
We see significant growth in Consulting and Representative Agent Services resulting from the revised FIEA and its requirements, particularly that HFT Operators must maintain an onshore Japan presence. This requirement can be satisfied two ways, either by establishing an office or by contracting with a representative agent. We don’t anticipate offshore HFT Operators actually opening their own offices in Japan, with the attendant cost and complexity of running a people-center in Japan; we anticipate most will utilize the services of a representative agent.
We see a significant global opportunity for our Financial Services Technology efforts. We believe a fundamental reckoning in the client-directed-trading space is on the not-too-distant-horizon where a number of factors – non-differentiated products, many years of commission compression, evolving buy-side demand, MiFID and unbundling, a new round of commission compression, and Brexit, – will force the sell-side to undertake a radical rethink of the traditional model in much the same way as firms have embraced Project Symphony and Project Scalpel. In Japan, the challenge will be exacerbated by the already painful and inevitably increasing experience of a shortage of appropriately skilled staff brought about by a declining and rapidly aging population.
As far as investment, yes, we are actively engaged with a number of potential partners and welcome others to join the discussion. Just as the environment has changed dramatically over the past ten years, not just in Japan but around the world, so too will the global environment change over the next ten years. We hope to create a group of like-minded visionary organizations to lead the next wave in the evolution of performance, efficiency, and risk management.
Those desiring to learn more about our products and services and the proposed revisions to the FIEA can request information by visiting www.shiroyamaconsulting.com and completing the request form. We can also be contacted directly on LinkedIn.
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