The panel at SunGard’s City Day in Hong Kong late last week looked at the issue of dark pool and how they can impact the wider market. Were they good for all investors? And how has the picture in Asia changed in recent years?
There has been great change over the past five years in this area. Ned Phillips, CEO of Chi-East, noted that five years ago people were talking vaguely about dark pools and alternative markets, but were generally skeptical that it would happen, or at least that it would take a long time. “Two years ago, people were saying I think this might happen and were generally more accepting. What we’ve found in the last 12 months, across all alternative venues, is that people are no longer wondering would alternatives happen, but when and how. And that’s the big change we’ve seen,” said Philips.
Indeed, recent developments bear that out. Chi-X Japan and Chi-East were both launched last year, and also the news in recent weeks that Chi-X Australia has finally been granted license.
When discussing whether High Frequency Trading is additional quality liquidity for an institutional investor, panelists agreed that HFT is important for market making on lit pools, “but it does not make sense to have HF Traders in a dark pool because it defeats a lot of the objects of a dark pool”, commented Chris Jenkins, regional head of Tora Trading. “The vast majority of what dark pools and HFT do is increase liquidity, and improve execution. But HFT and clearing go hand in hand, continued Phillips. The cost of clearing is so high in certain markets that you would not see HFT liquidity there; you have to look at the whole cost of a trade. In Europe, clearing costs have fallen dramatically, which is better for the broker, the retail and the institutional investors”.
Another factor that is brought in when alternative venues exist is smart order routing. More markets, or venues, mean brokers have options, and their portfolio managers will want them to get the best price. This change will come in the form of best execution policies. Smart order routing is the result of these policies. In Europe, with 20 dark pools, this is already in place, but in Asia the picture is more mixed. When there is a single market, as in many markets, such as Hong Kong and in Singapore, there is no need. However, in Japan and Australia there is. To add the list of markets with multiple venues, Thailand has recently announced it will allow alternative venues. We have yet to see any of the providers enter that market though.
“There is obviously a much bigger push in the US around best execution, and not just by the brokers, but also in the investment houses themselves, be it their own internal mandated policies, they have to prove to their management and their PMs that they are seeking the best price and best liquidity that they possibly can,” noted Phillips.
On dark pools benefiting the market in general the panel pointed out a report by ITG done some nine months ago, that studied millions of trades in Europe over the time before dark pools were introduced and the time after. The report said that after dark pools arrived only three things can happen, the execution gets better, it stays the same or it gets worse. All that report did, through data, was prove it did not get worse. They are now working to show if it got better or not. So the benefit of dark pools, or at least that they do no harm, has been shown in markets.
Competition was a recurrent theme during the panel, with all members agreeing that it was a good thing, for all investors, both institutional and retail. And a clear benefit of competition is lower costs for all market participants. This was particularly highlighted given the location of the CityDay, Hong Kong, which was pointed out as not the cheapest place to trade in the world. “I think there would be a benefit if it broke potential monopolies and if it allowed, specifically on the clearing side, for the cost of clearing to be lowered. An execution only business is a low margin business and high clearing costs can destroy that. So if mergers brought in a new regime of competition, that would be a great thing for everyone,” said Chris Jenkins, regional head of Tora Trading.
A great analogy was used by Philips to highlight how strange equity markets are in their treatment of institutional investors. He pointed out that you do not expect MacDonald’s to buy hamburgers in the supermarket. The price would be wrong and the supply would be insufficient. So they go to wholesale sellers. “The equity market is one of the only major markets out there where you are forcing wholesale investors to interact with retail investors. It’s the wrong economy of scale. Venues like ours allow the institutional guy to meet up with the institutional guy and trade at the price that’s right,” he noted.