HK's stock exchange faces challenges closer to home

PUBLISHED : Tuesday, 18 May, 2010, 12:00am
UPDATED : Tuesday, 18 May, 2010, 12:00am

Despite the strong [HKEx] earnings figures, chairman Ronald Arculli warned of challenging times ahead. 'While global economies are recuperating at varying paces, potential mounting protectionism to help revive economies and apprehension over inflation in various countries creates uncertainties in the bumpy road to recovery ...'

SCMP, May 13

There followed more big-picture stuff to provide the necessary background of cautious optimism to the news that the stock exchange's profits for the first quarter came to HK$1.13 billion.

Stop me. Did I actually use that meaningless phrase 'cautious optimism' just now? My sincere apologies. I grovel.

Anyway, what we had here was Ron scanning the far horizon with his binoculars for any threat to the good ship HKEx while entirely overlooking the much nearer track of the torpedo aimed directly at it.

I refer, of course, to that alternative system of securities trading commonly given the name 'dark pools'. These are internet-based platforms that allow big institutions to deal with each other in large size out of sight of all other players on the market.

Ron hates dark pools. They eat away an increasing share of the exchange's business. Taking the opposite view, I think that they may point us to the way of the future and that our exchange would do best to adapt itself to them.

But what really counts here is what the big investment institutions think. Their view is increasingly that stock exchanges are made for tiny stocks that no serious investor wants, anyway, and for itty-bitty single-seat traders who make their money by front-running other people's orders or trying to guess what the institutions are doing.

In their view, a true small investor only rarely deals directly in stocks. He mostly buys into investment funds run by institutions. These may charge him fees, but they spread his risks better, do not steal from him as his brokers do (well, not quite so badly, anyway) and lift off his back the burden of administering his portfolio.

The small player on stock exchanges, they say, is really nothing but a short-term speculator hoping for crumbs of inside information, and from trading anomalies, that fall off the tables of the big boys.

So why should big institutions show their hands on stock exchanges when they can deal with each other out of sight in dark pools and still get prices just as good or better? Why should they give any of the 467 full seat holders on the Hong Kong exchange a tip-off to what they are doing when, to change the metaphor, a good 400 of those seat holders subsist only by riding on the backs of other, larger investors who make the mistake of showing themselves there?

There are other good reasons for institutions to stay away from the exchange. For one, every time you deal there you have to pay seven different fees and charges, ranging all the way from brokerage to transfer deed stamp duty (separate from transaction stamp duty).

The most pointless of them is the transaction levy. It is only 0.004 per cent, but all of it goes to the Securities and Futures Commission, which now has an accumulated surplus of HK$5.7 billion from this source, equivalent to more than eight years of running costs.

But will the SFC admit that this is enough and call it quits? Good question. Address your concerns to Santa Claus, c/o the North Pole.

And speaking of the SFC, doing your trades in dark pools also reduces the threat of ignorant regulators deeming you a miscreant because you believed a rumour, when only stock exchange notices are considered to be in the public domain. Don't laugh. I know people whose lives have been ruined this way.

Our stock exchange has become a confused beast of mixed species and parentage over the years.

First it was made a branch of the civil service 25 years ago, then it became a listed company on its own boards and now it mostly lists stocks that have no business in Hong Kong and over which we have no real supervision.

The only constants through all this have been a growing bureaucracy (that civil service) and a lip-smacking concentration on earnings (that listing). This is not a lean and agile beast fit to meet a hungrier future.

I am not saying there is no role for it. The weakness of dark pools is that they cannot give buyers the level of security provided by exchange-traded instruments.

But this only suggests there is a role for the exchange as a glorified form of notary public in its clearing arrangements. It does not say we need an exchange to transact actual business in securities.

Your danger does not lie in Greece or Spain, Ron. Stop talking that big-picture stuff. You know you have problems at home.