Wall Street’s fastest traders are using their tech to improve how big investors trade foreign companies like Nintendo and Rolls Royce
Stock trading has always remained on the cutting edge of Wall Street’s tech innovation. From the use of laser beams for sending orders to smarter, one-size-fits-all algorithms, there’s never been a shortage of shiny new toys for banks and investors to use when trading equities.
However, one small — albeit important — portion of stock trading is still working to catch up with the rest of its brethren.
Over-the-counter equities, commonly referred to as pink sheets, are traded off exchanges where automation is limited. While many associate pink sheets to penny stocks — the small companies The Wolf of Wall Street’s Jordan Belfort infamously dealt shares in — some large foreign companies’ stocks are traded by US investors in the OTC market as well.
In recent years some of the most sophisticated market makers on Wall Street have pushed into the space as they look to improve how trades are done and tap into a market that has a daily notional value of roughly $3 billion. And with US foreign policies in flux, the space has the potential to grow even larger as their is a high value in providing a seamless way to invest in foreign companies, experts say.
“These are some of the biggest companies in the world and yet they’re trading in an OTC marketplace that is still point and click,” Andrew Brown, head of ADR trading at Citadel Securities, told Business Insider. “The lack of automation up until now has resulted in wider spreads than currently seen in the listed equity market, and we are trying to change that.”
From Nintendo to Nestle
American depository receipts (ADRs) are derivatives of foreign stocks listed in dollars and tradable in the US in the OTC market. ADRs serve to benefit both US and foreign companies, as the former doesn’t need to set up trading operations outside the US and the latter avoids the costly and laborious process of listing on a US exchange.
Japanese gaming company Nintendo, Chinese conglomerate Tencent, and German automaker Volkswagen are among the companies that trade off exchange as ADRs in the US.
But the process of trading ADRs isn’t an easy one. Brokers tasked with dealing ADRs for clients have to perform a series of complex tasks manually to fill the order.
A client order for shares of Swiss-based Nestle would require a broker to book the actual ADR trade while also performing foreign exchange transactions to hedge the risk between currencies and then buy and sell actual shares of the stock on the local market.
“It’s a lot of work. It’s very manual, and it’s prone to errors,” Brown said.
That’s starting to change thanks to efforts by some of Wall Streets most sophisticated players applying technology to the outdated market. Citadel Securities, Virtu Financial, Jane Street, and GTS ranked in the top five in ADR trading for notional amount and number of trades in July on OTC Markets’ alternative trading system. G1 Execution Services, a subsidiary of Susquehanna, fell just outside the top five for both categories.
There is no doubt about the opportunity in the market. ADRs pricing spreads can often be much wider than listed stocks as brokers account for the risk that comes with conducting the labor-intensive trades. As a result, some investors choose to steer clear of ADRs entirely, or trade sparingly, despite interest in the companies.
“The liquidity profiles of the same foreign shares in the US versus the ordinary shares in the foreign market can differ significantly,” Brown said. “Even though it’s the exact same company it’s going to be more difficult to trade in the US, simply because the US OTC market is less efficient than the foreign market.”
Citadel Securities is one industry player hoping to evolve how ADRs are traded. The market maker founded by Ken Griffin is already one of the largest liquidit