HSBC plans to set up 'dark pool' for retail investors

Local regulators are expected to closely scrutinise HSBC's plans for a retail version of a 'dark pool' stock market amid concerns about investor protection and the competitive impact on the city's main bourse. HSBC has already abandoned plans to switch by default thousands of existing securities clients to the 'dark pool' platform, instead the bank will allow investors to choose to sign up for the new service. A 'dark pool' is an electronic trading platform that allows investors to trade a large amount of stock without their identities and the trading volume being revealed. Although it may sound like something from a Star Wars movie, 'dark pools' are becoming increasingly popular with pension funds and asset management companies because of the confidentiality they offer. However, such confidentiality is increasingly posing a threat to the role of the traditional stock exchange and creating new regulatory problems. The US and European regulators have studied tightening regulations on 'dark pools' in recent years. HSBC's trading platform, known as StockMax, has already secured a licence from the Securities and Futures Commission, but is waiting for final endorsement from the SFC before launching. The bank will need to ensure the platform maintains the highest standards of transparency. That is because the government and regulators have concerns about the service that potentially could attract many retail investors, say several senior people in the government and the regulatory agencies. Secretary for Financial Services and the Treasury Professor Chan Ka-keung said regulators had to pay more attention to any platform that involved retail investors. 'Regulators need to be extremely careful and cautious when approving any platform that involves retail trading,' Chan said. He said he would not oppose the development of 'dark pools', but 'they must be properly regulated and must have sufficient transparency'. StockMax will work like the 'dark pools', executing stock trades for its customers on a platform managed by the bank. This will replace the current practice that involves the bank sending orders to be executed on the trading platform of Hong Kong Exchanges and Clearing. A dozen international banks and brokers in Hong Kong have operated 'dark pools' in recent years, but until now they have been tailor-made for sophisticated investors, including insurance companies, pension fund managers and hedge funds. They represent about 3 per cent of the local market. HSBC's StockMax may, however, change the landscape, as it will be the first 'dark pool' in Hong Kong to allow retail investors to trade. HSBC's initial plan to switch all its existing securities services to the 'dark pool' drew fierce criticism from the Consumer Council and legislators for not giving customers a choice. 'We have listened to the concerns of the markets and we have changed our plan accordingly,' said Bruno Lee, head of wealth management for Asia-Pacific at HSBC. 'We will explain the risks and details of the platform to investors and allow them to decide if they want to sign up.' Lee said the bank would fully comply with the requirements of the Securities and Futures Commission and the Hong Kong Monetary Authority. HSBC would only introduce StockMax once it received the final endorsement of regulators. Customers' interests would be protected as the platform would only proceed with trades if the prices matched or if it could offer customers a better price, Lee said. Otherwise, HSBC would send the order to be executed on the HKEx platform. 'We will maintain transparency as we will report all trades to the HKEx after the deals are done,' Lee said. A senior government official said the government was concerned about how the development of retail 'dark pools' would affect the role of the HKEx. 'The regulators have to make sure that retail investors are well protected. In addition, the regulators would also need to ensure that the market would not head in a direction that results in fragmented markets,' the official said. The official said the government would not want to see Hong Kong become like the US or the Europe, where many 'dark pools' or trading platforms directly compete with traditional exchanges. Hong Kong law requires 'dark pool' operators to be members or be linked to a member of the HKEx. This prevents them from acting as an independent exchange in competition with the HKEx. However, if there are an increasing number of trades in 'dark pools' it would still erode HKEx's role as the central market. Lawmaker Chim Pui-chung, who represents the financial services sector, said he would ask the Legislative Council to closely monitor the development of the HSBC 'dark pool' and its impact on the local market. 'The bank is regulated by the HKMA but the platform is licensed and regulated by the SFC. This split regulatory model may create gaps in investor protection,' Chim said. 'Traditionally, 'dark pools' are traded by institutional investors such as pension funds, insurance companies or big corporations and they know what they are doing. But now HSBC has extended the services to retail investors. How can the bank make sure that housewives or pensioners understand such a complicated trading platform?' He said banks are not subject to the same level of rigorous regulation of securities firms by the SFC. Yet HSBC, the biggest bank in Hong Kong, is running a platform and playing the role as an exchange outside the HKEx. 'This is worrying because if anything goes wrong, the retail investors would be hurt and the reputation of the Hong Kong stock market would be seriously undermined.' Kenny Lee, chief executive of First China Securities, said another worry was whether other banks would follow HSBC. He said the platform lacks transparency, as customers would not know if HSBC was matching the order in a fair manner. 'All trades conducted in the HKEx are transparent and fair, as everybody is trading in the same pool. The development of 'dark pools' is turning the market less transparent,' he said. A spokesman for the Financial Services and the Treasury Bureau said the SFC was required to ensure that all 'dark pool' operators function in a fair, efficient, transparent and orderly manner, and that investors were protected. 'The International Organisation of Securities Commissions [IOSCO] is working on the subject and the SFC is a key player in the process. We will monitor the global regulatory environment closely.' The SFC declined to comment. Lee Porter, head of Liquidnet Asia Pacific, a major 'dark pool' operator in Hong Kong and Asia, said StockMax was very different from what Liquidnet offers in Hong Kong. 'We operate a 'dark pool' for large institutional investors, bringing two parties together to trade in a safe, secure and anonymous platform,' Porter said. 'Liquidnet's average execution size is over US$1 million in Hong Kong, which is more than 100 times larger than that of the Hong Kong stock exchange. Liquidnet members can also source liquidity from illiquid stocks and receive meaningful price improvement by trading directly with other institutional investors in our secure environment.' For investors who want to trade in the 'dark pool', Lee said: 'We always encourage investors to better understand the trading process, be they institutional or retail, as greater knowledge promotes increased awareness of an important area of finance.'