Global HFT bigwigs are taking local route to play Indian derivatives

FPIs shore-up exposure to F&O route

Some of Wall Street’s largest trading firms are setting up shop in India through local brokerage licences to trade more aggressively in the Indian derivatives market, which continues to see a huge surge in volumes.

According to recent regulatory filings, Citadel Securities, Tower Research, IMC Financial Markets and Jump Trading are among those to have high-frequency trading (HFT) desks.

These firms have registered with the Indian market regulator the Securities and Exchange Board of India (Sebi) as stockbrokers, though, for now, they will focus on proprietary trading, sources said. A few will also provide broking services to other smaller foreign proprietary traders, the sources said.

A detailed email questionnaire sent to these firms remained unanswered.

Global HFT firms typically operate in emerging markets from regional financial hubs such as Singapore. India’s derivative market, however, has become one of the leading markets globally, both in terms of volumes and liquidity, prompting these Wall Street firms to take bigger bets through a local presence, the sources said.

Experts say being a domestic brokerage provides foreign players with greater freedom in derivative markets, especially while taking short positions. On the other side, being a domestic brokerage increases the tax burden significantly.

“If the same traders come as foreign portfolio investors (FPIs) through jurisdictions like Mauritius, their derivatives income will be tax exempt. Despite this, the HFT firms have chosen to open shops as local members,” said one of the sources cited above.

“Until now, the trend was that most global firms traded in India from Singapore or Hong Kong but the retail frenzy in Indian derivatives is taking the volumes to new highs and global firms are taking notice of the same.”

For instance, global HFT trading firm IMC, which draws an annual revenue of 1.2 billion euros, has said in its management commentary that the Indian options market was an exceptional performer.

“IMC performed relatively well by recent historical standards, although volatility and trading volumes did not reach the exceptional levels witnessed in 2021 and 2022.

“India and the US options market were notable outperformers. Both continued to experience high trading activity in line with 2022, though the impact of tight spreads and intense competition constrained market maker profit margins,” the management said in the 2023 annual report.

Shrinking FPI volumes and rising proprietary volumes

Generally, the large FPIs focusing on derivatives do not set up shop in every market and trade through regional hubs. Several FPIs trade in Indian derivatives from the Singapore Exchange (SGX). But with Indian derivative markets becoming more lucrative, some of these HFT traders are now opening shops in India.

While there is no official data published on how many foreign HFTs have come in, industry estimates suggest about two dozen global players have taken the local breakage route.

FPIs accounted for nearly 20 percent of the derivative market volumes pre-covid but their market share has now come down to just 6 percent, Sebi data showed.

On the other hand, the share of proprietary trades has gone up from 33 percent pre-pandemic to 60 percent in FY24, data showed.

Individual traders including retail and high net worth individuals (HNIs) accounted for 34 percent of the turnover in equity derivatives in FY24 compared to 47 percent in FY20, data showed.

“Large FPIs also use derivatives to hedge their equity portfolio and such funds continue to trade from off-shore jurisdictions but their trading is limited to the two most popular products: Nifty options and Bank Nifty,” said another source. To be sure, even the trades made by the smaller domestic brokers also fall in the category of proprietary trades but their contribution to the pie is far lower than the global firms, which make big-ticket trades, sources said.

Dollar inflows into derivatives

Most of the global HFT firms are pumping millions of dollars into Indian derivative trading desks and have also developed data-driven models centered on Indian markets, say experts. The ongoing lawsuit between Jane Street – a UK-based proprietary trader with $62 billion worth of assets – and Millennium Management which was filed a couple of months back in the US drew attention towards these HFT firms.

According to a Bloomberg report, Jane Street made profits amounting to $1 billion in 2023 alone. These firms have developed India-specific trading models based on big data and use such models to execute derivative strategies.