Hong Kong’s securities regulator says it is “moving forwards” with approving applications from prospective operators of dark pools that could open more of these unlit alternative trading venues to professional investors.
The Securities and Futures Commission (SFC) has not approved any such applications for some time due to outstanding issues and debates about retail investor protection, says SFC chief executive Ashley Alder, although he expects pending applications to be higher priorities this year.
Speaking at the Asia-Pacific Trading Summit in Hong Kong yesterday, he also raises issues such as high-frequency trading.
Today, the 15 licensed dark pool operators in Hong Kong account for 2% of total equities market turnover, a figure almost unchanged from a year ago and dwarfed by the 30% total equities volume traded both across dark pools and over-the-counter in the US.
SFC’s brief suspension of new licensing follows HSBC’s application last year to set up a retail-targeted dark pool, StockMax, which is widely viewed as a potential game-changer by alternative venue operators. The bank was forced to pull the plug on the launch following the SFC restricting the platform to professional investors.
“We are moving forward with those discussions, while ensuring that the licensing conditions for alternative trading systems [ATS] ensure a level playing field, and yet recognise that each venue is different,” says Alder, but he did not give more detail on pending applications.
A commonly touted selling point of dark pools has been that they offer “best execution”, one way to enable crossings at mid-spread and hence generate savings for investors who trade on traditional exchanges. These are traditionally operated in Hong Kong either by agency brokers or investment banks’ internal crossing engines (or “internalisers”).
Asset managers and other large institutional investors like the anonymity of trading in dark venues, as they often need to trade in large block sizes and therefore want to minimise market impact.
However, since close to a quarter of the Hong Kong equity market volume is accounted for by retail investors, says Alder, the SFC regards investor protection as a top priority when supervising these alternative trading venues.
“The debate we have had with the industry about internal trading systems is on whether these venues should be limited to professional investors… and the difficulties of accessing data within these internalisers of the banks’ [own] trading desks,” he notes. “This leads to another subject: the disclosure related to how orders are handled as best execution.”
Broker-dealers’ internalisers have long attracted criticism that their clients’ order flows would be mixed with the bank’s internal proprietary flows and therefore may conflict with clients’ interests.
Meanwhile, Alder notes that the SFC will this year also issue draft guidelines on electronic trading, which will cover algorithmic trading execution and algo connectivity technology such as direct market access and internet trading.
It will also propose rules for electronic trading platform operators in terms of their system requirements, and risk management issues such as their pre- and post-trade controls when offering these algorithmic means of access to exchanges to clients.
On high-frequency trading, Alder says Hong Kong Exchanges and Clearing has seen “a style of trading very closed to high-frequency trading strategy” in the warrants market. In fact, last year roughly 28% of market turnover in listed warrants in Hong Kong was done as high-frequency trades. HFT is still rare in Hong Kong’s cash market mainly due to stamp duty, which is not imposed on warrants.
Institutional investors and proprietary traders view Hong Kong’s stamp duty as a major cost deterrent that discourages them from trading cash equities on a low-latency basis. But Alder did not specify whether the SFC or HKEx would address such issues.
The city’s regulators are more concerned about the systemic risk issue related with HFT. Local regulators are still discussing whether HFT would crowd out less sophisticated investors from the market and create risk management issues for exchanges due to the sheer number of orders and cancellations. “The costs that regulators face on surveillance would be enormous,” he says.