ANALYSIS-Regulation may dim growth of ‘dark pools’ in Asia

By Reuters Staff
August 17, 2010

By Kevin Lim and Adrian Bathgate

SINGAPORE/WELLINGTON, Aug 17 (Reuters) – “Dark pools” and other alternative trading systems are not as big a threat to Asia’s bourses as they are for their western counterparts, given regulators’ reluctance to grant them a free reign and due to structural differences in markets.

Dark pools, so named because they represent large pools of “buy” and “sell” orders not visible to regular investors, operate relatively freely and match billions of dollars in stock transactions each day in the west.

But in Asia, where stock exchanges are often seen as national assets, regulators are likely to curb their activities to protect incumbents as well as ensure markets remain wholly transparent.

“Emerging market regulators have bad memories about the Asian financial crisis and are concerned about speculators,” said Richard Kang, CIO at New York-based Emerging Global Advisors, who manages about $120 million in exchange-traded funds.

“Liquidity pools, dark pools, alternative trading systems etc are still relatively new…they (Asian regulators) will wait for cues from the U.S. to see if dark pools are beneficial or a burden to their capital markets.”

Dark-pool operators acknowledge Asian markets will be harder to crack, but they remain keen to expand in the region where they account for just 1-3 percent of trades in the larger, more liquid markets and close to zero in smaller bourses.

Chi-X, a unit of Nomura and the biggest dark pool operator in Europe, last month launched a service in Japan and has plans to do the same in Singapore and Australia. Tora, a trading technology firm part-owned by Goldman Sachs, recently announced plans to set up a pan-Asian dark pool.

CHI-X says it hopes to gain 5-10 percent share of the Japanese market.

Bourse operators such as Hong Kong Exchanges and Clearing and Singapore Exchange also benefit from market structures that make it difficult for dark pools to bypass them when clearing trades, ensuring they will continue to earn fees regardless of how orders are matched.

Even in Australia, where the government has decided to expose ASX <ASX.AX> to competition from as early as next year, dark pools can expect strong resistance from the incumbent operator.

To fend off competition, the ASX has taken steps, including lowering fees for matching and settling stocks trades and the creation of its own dark-pool facility that traders can use to key in orders worth more than A$1 million ($913,200).

“You may not see the same impact in this market as you have in other markets,” said Shane Delphine, an investment manager at Karara Capital in Melbourne, referring to the dark pools.

MATCHED TRADES

Dark pools let brokers and fund managers place and match large orders anonymously to avoid influencing the share price. Matched trades are subsequently shown on the stock exchange while unmet orders remain invisible to other investors.

In the United States, dark pools and other alternative platforms account for about 22 percent of all shares traded. And in the UK, the London Stock Exchange has lost more than a quarter of the market to alternative platforms, in particular Chi-X.

NYSE, LSE and many western exchanges have since set up their own dark pools to fend off competition.

Chi-X has secured a provisional licence to operate in Australia once the rules regulating new entrants are ready.

ASX shares have fallen 16 percent since the start of 2010 on concerns margins will fall and that it would lose market share to new entrants, underperforming the around 10 percent decline in SGX and 8 percent fall in HKEx, which have both lost ground amid the global drop in stock trading volumes.

Most analysts regard ASX and the Tokyo Stock Exchange, which is unlisted, as the two Asian bourses that are most vulnerable to competition from dark pools because of their high trading volumes and relatively liberal regulatory environments.

Celent, a financial services consultancy, estimates dark pools could, in the next 3-4 years, grow their market share in these markets to as much as 5 percent from the current 1 percent, well below the 30 percent levels in some European markets.

Richard Murphy, ASX’s general manager for equity markets, said regulators will not allow dark pools to make similar inroads in Australia as they did in North America and Europe.

“I don’t see dark pools per se being a threat to ASX because it’s too much of a threat to the concept of displayed, centralised markets for regulators to let them get out of hand.”

The Australian Securities and Investment Commission (ASIC) declined to comment.

Dark-pool operators also face obstacles in Hong Kong, where operators of alternative trading services are required by law to report and clear their trades through HKEx, and in Singapore where shares of listed companies are held by a central depositary owned and managed by SGX.

This means that while dark pools can earn fees from matching orders, they cannot make money from clearing and settling trades either directly or by outsourcing the service to third parties.

“In Europe, there is competition among different clearing houses unlike in Asia where the clearing houses are linked to the exchanges,” said Lee Porter, Hong Kong-based CEO for Asia at Liquidnet, a large U.S.-based dark pool operator.

For smaller Asian bourses such as Bursa Malaysia, their relatively thin trading volumes and Asia’s fragmented stock markets may actually insulate them from competition.

“Asia is still 12-13 different markets with different rules, different regulations and different currencies. The market structure here does not allow one to trade all of Asia at once,” said Ned Phillips, CEO of Chi-East, a venture of Chi-X and SGX.

“In Europe, charges for alternative trading systems are already below a basis point so you need to do a lot of liquidity. It would be challenging for dark pools to enter a smaller market.”

($1=1.095 Australian Dollar)

(Editing by Muralikumar Anantharaman) ((kevin.lim@thomsonreuters.com; +65 6403 5663; Reuters Messaging: kevin.lim.reuters.com@reuters.net))

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