Are dark pools good for markets?

Contributor: Robert Rooks

At SunGard’s City Day in Hong Kong, a panel looked at the issue of dark pools 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.  Ned Phillips, CEO of Chi-East, noted that five years ago people were talking vaguely about dark pools and alternative markets, but were either generally skeptical that it would happen or expecting it would take a long time to gain traction. In the last 12 months, across all alternative venues, people are no longer wondering if alternatives would happen, but when and how. That’s the big change.  Indeed, recent developments confirm this. Chi-X Japan and Chi-East were both launched last year, and in recent weeks, Chi-X Australia has finally been granted a license.

During the panel at Hong Kong City Day, competition was a recurrent theme, with all members agreeing that it was a good thing for all investors, both institutional and retail.  Lee Porter, regional head of Liquidnet Asia, pointed to the fact that its clients, who are institutional investors, are representing collectively literally millions and millions of retail investors.  How those funds perform gets passed back onto the retail investor as well.

The effects of competition on the markets were boiled down by Paul Egan, managing director and head of strategy and business development at Citibank Securities Fund Services Asia.  Because monopolies place limitations on pricing, competition offers alternatives and a better, more intuitive pricing environment.

On dark pools befitting the market in general, the panel pointed to a report ITG published some nine months ago, that studied millions of trades in Europe before and after dark pools were introduced.  The report said that after dark pools arrived, only three things can happened:  the execution got better, it stayed the same, or it got worse.  The report used data to prove it did not get worse.  So dark pools have had no negative effect in the markets.

A clear benefit of competition is lower costs for all market participants. As it turns out, Hong Kong, the location of this particular City Day event is one of the most cost effective places to trade in the world. Chris Jenkins, regional head of Tora Trading, said that he believes 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. He went on to conclude that if mergers brought in a new regime of competition, then that would be a great thing for everyone.

A great analogy was used by Phillips to highlight how strange equity markets are in their treatment of institutional investors.  He pointed out that you do not expect McDonald’s to buy hamburgers in the supermarket.  The price would be wrong and the supply would be insufficient.  So they go to wholesale sellers.  He noted that the equity market is one of the only major markets that forces wholesale investors to interact with retail investors.  It’s the wrong economy of scale.  Dark pool venues allow institutional investors to meet up with other institutional investors and trade at the price that’s right.

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