The two biggest problems when it comes to trading equities in Asia have been fragmentation and monopolisation. The region is broken into a number of different markets, with their own regulation and structures, and about the only thing they have in common is that trading tends to be monopolised by a single exchange.
The advent of electronic trading and the emergence of alternative trading venues -- first in America, then in Europe -- offers potential solutions to these, but has been seen as a threat by the stock exchanges. As a result, alternative trading venues in Japan, for example, have struggled to get more than 1% of daily turnover.
This week's announcement by Singapore Exchange (SGX) that it is setting up a joint-venture with Chi-X to establish a pan-Asian dark pool could prove a watershed event.
SGX is the smallest of the exchanges in developed Asia-Pacific (compared with Tokyo, Osaka, Sydney and Hong Kong), and has long had ambitions to punch above its weight by promoting itself as a regional hub. Although it has notched some successes in attracting international listings and tradable products (90% of its listed derivative products, for example, are from other countries), it has not been able to convince other markets to have their securities traded in Singapore, or vice versa.
The deal with Chi-X should change this. SGX has cast aside the typical aversion to new forms of electronic trading and embraced them instead, and as a result has furthered the cause of best execution across the region.
"To see Singapore Exchange back a crossing network has to be seen as positive," says Richard Coulstock, regional head of trading at Prudential Asset Management. He and other buy-side traders welcome a platform that, by making itself available to both the buy and sell sides, could help aggregate other dark pools of liquidity.
Other electronic trading networks welcomed the deal. "We like this because it shows alternative trading venues are necessary for the region," says Greg Henry, who runs Liquidnet in Singapore. "What's now important is to get market participants to buy into it."
Danny Lee, Asia director at NYFix in Hong Kong, says the next step is to enable regional crossing on the new dark pool, which requires a central counterparty to clear trades in other markets. If that happens, he says, "The Chi-X and SGX deal should light something up."
SGX is confident the dark pool, once it goes live, can be extended to other markets without too much difficulty.
Chew Sutat, executive vice-president and head of market development at SGX, explains the main hurdle is getting other jurisdictions to amend some regulations. SGX has already received several expressions of interest from entities that could play the central counterparty role. Settlement can be handled by a custodian bank and depository agencies.
SGX is keen to extend the dark pool to onshore markets among other developed markets, with Japan, Australia and Hong Kong the priorities. The technical issues vary among them. For example, the SGX/Chi-X dark pool will be able to handle Japanese securities so long as they are traded among parties outside of Japan; but the dark pool will remain out of bounds to Japan's domestic institutional investors. The JV expects to negotiate with officials in Tokyo to see if this can be changed. Hong Kong and Australia are more open but have regulatory hurdles of their own.
The regulatory side may remain an unknown, but Chew sounds confident that the new JV will attract participants. He says a number of fund managers and brokers have already been in touch, wanting to know when and how they can connect. "We still need to get a license," he says, noting the application to be a recognised market operator is being sent to the Monetary Authority of Singapore.
The parties hope the JV, which has yet to be named, will go live in the first half of 2010. Chew says one reason for the interest is the prospect that such a dark pool will help grow the pie for all trading venues, by attracting more capital to the region.
He adds that SGX decided to partner with Chi-X not just for its technology but because its track record as a pan-European market segued with SGX's ambitions to create a pan-Asian project.
Although dark pools are criticised for splitting up liquidity in already thin markets, the experience in the US and Europe suggests the opposite. Big trades placed on an exchange would have such a big market impact as to make them virtually impossible to do, except if done very slowly. Go into a dark pool -- a Liquidnet, a BlocSec, an Instinet -- and you can see if there's a contra on an anonymous basis. If there is, fine, you can make a trade happen. If not, no harm done. The point is that dark pools should, in theory, make possible trades that would otherwise not occur in the 'lit' market.
Tony Mackay, chairman at Chi-X Global in Hong Kong, says the deal with SGX stemmed from Chi-X's belief that each market should have a market for such block trades. The only way to do so, however, would be to collaborate with stock exchanges, rather than take them head on, and create a means of aggregating various dark pools. "In Asia, there is a real need among fund managers to concentrate liquidity," he says.
He says the breakthrough was when SGX realised that, to be taken seriously as a pan-Asian trading hub, it had to allow others to trade Singapore shares first. The resulting JV should break the ice and encourage other regulators and exchanges to consider similar moves.
Australia is seen as the next likely domino. For years, brokers and institutional investors have agitated for recognised alternative trading venues other than the Australia Stock Exchange (ASX). Chi-X is among a handful of firms requesting such a license. The ASX is trying to build its own dark pool in time to meet what is considered an inevitable break on its monopoly. "We hope this [licensing alternatives] can be done quickly now," says Mackay, adding he hopes Australia, Japan and Hong Kong can be added to the SGX JV dark pool sometime in 2010.
SGX's Chew says the exchange would like to extend the dark pool from just cash equities to other products, including depository receipts and exchange-traded funds, which lend themselves to dark trading. But this is not the priority. "We will focus on where we see demand, which is in top-line blue-chip stocks," he says.