Hong Kong Stock Exchange

Dark pools aren't unfair competition to HKEx, Ron

PUBLISHED : Sunday, 18 December, 2011, 12:00am
UPDATED : Sunday, 18 December, 2011, 12:00am


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'Dark pools face far less regulation than traditional exchanges like the Hong Kong stock market. Allowing them to compete directly with Hong Kong Exchanges and Clearing under such circumstances would allow regulatory arbitrage. This is unfair competition ...'

Ronald Arculli, HKEx chairman, SCMP, December 12

Years ago a friend and I set up a small institutional brokerage that was indirectly majority owned by a Middle Eastern oil sheikhdom. We did quite well. There was a distinct panache to our backing. But occasionally when we went up on the boards as buyers of a blue chip a rumour would start up - 'the sheikh's in the market' - and then all the sellers would vanish and line up under us as buyers.

To get around it our dealer would have one his friends go up as a buyer while we went up on the offer side of the board. As soon as our dealer thought he had enough sellers behind him, he would tell his friend to scoop all the offers off the board and pull down his own bid. The man would then turn the stock over to our dealer and they would have a slap-up dinner at our expense.

We couldn't do it all the time. The market would get wise. But it worked reasonably well in keeping the minnow seat-holders guessing as to who was behind our trades. It was a nuisance, however. We would have preferred to keep those front-running rat-traders away from feeding off our order flow.

And if we felt this way as a boutique broker in just one market, think how a big investment-management house with hundreds of billions under management must feel about the parasites it faces every time it shows its hand on an exchange. There are 516 of these 'market participants' on the HKEx, of which 500 by my guess do little more than keep a beady eye on the big players in hopes of jumping in first. The big boys have therefore decided to go dark. They deal with each other on privately arranged internet platforms and no one can be sure how much they have traded or at what price.

Ron hates them. Unfair competition, he says.

I don't agree. In the first place, who says the general public always has the right to know how strong the market is in any stock? This is valuable information for real buyers and sellers of that stock to share. If you want it you pay for it.

If you call a trader to ask for a price and he gives you his bid/offer spread, he is entitled to believe that you will indeed buy or sell if you like the price, all the more so if you then ask him in what size he will deal. Hang up too often after doing no more than getting answers and the trader will not talk you again. He has no time for frivolous small time speculators looking to get a cheap edge on the market.

Transparency is not always a virtue. You don't show your hand as soon as the cards are dealt in poker. Your opponent pays to see your cards. Likewise the stock market. To know how it's moving you have to put your money down and join the play. The more that regulators say you have to show everything to everyone, the more likely you are to go elsewhere. This is what the big boys have done with dark pools.

And there is a lesson here for Ron. When dealing through HKEx you also pay seven different tariffs, fees and charges on each trade, eight if they should start up the investor-compensation levy again.

This is ridiculous in a modern context where an exchange need be no more than sophisticated computer software. There is definitely a value in having a formal registry to guarantee legal title to the securities you buy, but again it need be little more than software hooked to a printer if you really must have something for the vault.

And it's pointless to complain about regulatory arbitrage. The big players in dark pools have voted with their feet to say they do not set much store by the regulatory protection they forgo. In fact they are fleeing exchanges precisely because regulation cannot keep parasite speculators off their backs.

If Ron thinks he can resist developments in the evolution of securities trading he will eventually find himself swamped by dark pools.