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AseanAffairs Magazine January - February 2011



With the growth of the Asean economies, David Swartzentruber reports on the entry of Dark Pool electronic trading platforms into the region.

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Dark pools which have spawned some controversy in western markets are how headed for Asia. What will be their impact?

Dark pools are a relatively new way of trading stocks. They are platforms where electronic trading is done off of an exchange to obtain a better price while leaving the price unmoved if a large block of stock is being traded.

A major attraction of trading in dark pools is that the stock trades are hidden from the public and other brokers before and during trading. After the trade, the information appears on the consolidated tape of the exchange. Dark pools have been traditionally used by institutional traders, who use them to execute large stock transactions without moving the market against themselves. This secrecy is a major factor that draws skeptics.

As Shayne Heffernan pointed out in the previous issue of Asean Affairs magazine, there are 33 institutions, mainly banks and trading houses, in the dark pool business and five dark pool aggregators. The aggregators attempt to offer institutional investors a one-stop shop linked to other dark pools, much the same role as Internet search engines play.

At the present time, volumes of trade generated through dark pools are 13 percent of the total of U.S. stock markets, 3 percent of the European markets and an estimated 1-4 percent of Asian markets. However, in December 2010 Dark Pools accounted for a record 33 percent of U.S. stock trades, Heffernan reports.

The share of Japanese stocks traded on the Tokyo bourse’s trading network Tostnet rose to 10 percent in November 2010 from 7 percent in March, when regulators first required dark pools to connect to the system, the bourse said.

Nevertheless, dark pools, up to now virtually unregulated, have attracted the interest of the U.S. regulator, the Securities and Exchange Commission. On Oct. 21, 2009 the commission noted that the number of dark pools had tripled since 2002 and proposed three concerns for comment:

>> Dark pools have been traditionally used by institutional traders, who use them to execute large stock transactions without moving the market against them selves. But dark pools have evolved to give retail investors and smaller orders a crack at price improvement and better liquidity. <<

When investors place an order to buy or sell a stock on an exchange, the order is normally displayed for the public to view. With some dark pools, investors can signal their interest in buying or selling a stock but that indication of interest (IOI) is communicated only to a group of market participants.

The second proposal would lower the trading volume threshold applicable to alternative trading systems (ATS) for displaying best-priced orders. Currently, if an ATS displays orders to more than one person, it must display its best-priced orders to the public when its trading volume for a stock is 5 percent or more. The proposal lowers the volume to 0.25 percent for ATSs, including dark pools that use actionable IOIs.

The third proposal would create the same level of post-trade transparency for dark pools and other ATSs - as for registered exchanges. Specifically, the proposal would amend existing rules to require real-time disclosure of the identity of the dark pool that executed the trade.

In Europe the dark pool issue appears to have been more hysteria than anything else.

In September 2009 The Federation of European Exchanges claimed that 40 percent of the order flow in European markets “may be processed by broker-dealers in unregulated opaque crossing networks”. This claim was later modified as the 40 percent figure referred to all over-the-counter equity markets.

The Committee of European Securities Regulators (CESR) launched a study of the issue, as its chairman, Eddy Wymeersch, expressed frustration at “wild figures” published in the press about the extent of the dark pools.

The UK’s Financial Services Authority then held a meeting with the six banks responsible for the “crossing networks,” as dark pools are called in Europe, and the banks told the authority that dark pools collectively accounted for only 1.25 p

In the wake of the meeting, Nomura became the first bank to convert its crossing network into a Multilateral Trading Facility, anticipating any steps on dark pools that regulators might take.

The start of. Chi-East dark pool operations in Singapore coincided with the period when European Union (EU) lawmakers were discussing ways of imposing tougher regulations on dark pools and high-frequency share trading.

There is no question that dark pools are finding a home in Asia, particularly in the Singapore Exchange (SGX) with Chi-East being the major player. Chi-East is a joint venture between Chi-X Global and the Singapore Stock Exchange. It plans to provide sell side institutions a crossing platform for block trades of shares listed in the SGX, Hong Kong Exchanges and Clearing, Tokyo Stock Exchange and Australian Stock Exchange.

Chi-East is tagged to become the major portal for dark pool trading in the Asean region as Singapore becomes a global financial center.

Other dark pools in Asia are: Chi-X Japan, ITG launched its dark pool for Asia named POSITS Marketplace, Bloc Sec which is owned by CLSA; Crosspoint run by Tora Trading; DBAT which is owned by Deutsche Bank; Japan Crossing by Instinet Japan; Korea Cross which is jointly owned by Instinet and Samsung Securities; Liquidnet; Sigma X by Goldman Sachs, Credit Suisse and brokers such as LiquidNet and Instinet, owned by Nomura Holdings of Japan.

Citigroup, Inc the # 3 US bank announced that it will begin dark pool electronic trading in Singapore early in 2011 to meet growing demand in Asia. The bank is expanding its regional footprint after its off- exchange trading in Australia increased to a record Au$1.5B (US$1.3B) in June 2010 from about Au$700 million to Au$800 million a year earlier, according to Citigroup’s Asia Pacific head of execution services.

Examples of aggregators operating in Asia are TORA Crosspoint, initially launched in Japan and now linked to around half a dozen Japanese pools, as well as ITG’s POSIT Marketplace, which went live in Hong Kong in March 2010 and will soon be available in Australia

In Asia low levels of liquidity in dark pools appear to have led the push towards aggregation, while in the US the opposite occurred. The large number of dark pools pushed brokers to find ways of bringing the various sources of dark liquidity together.

Electronic trading is the key component of dark pool trading and it employs algorithms. An algorithm is a set of instructions, sometimes called a procedure or a function used to perform a certain task.

Mark Palmer, vice president and general manager at software house Progress Apama, says: “The role of algorithms comes about precisely because of the dynamic behavior and changing prices – as they change instantaneously, you need very sophisticated algorithms.”

However, Credit Suisse has seen a shift to so-called “dark algorithms”, such as “Sniper” and “Guerrilla”. Traders are turning to algorithms which do not display anything to the market. They look for and identify liquidity opportunities and then go in and capture and trade extremely aggressively.

A major issue that exists in Asia and not in the US or the EU is that there is no common regulator. Each country has its own bourse with its own rules and there is no pan-Asian regulator. It’s highly unlikely there will be any major changes in the regulatory environment in Asia in the near future as most countries are quite protective of their national exchanges.

This and other issues have brought some detractors to address the dark pool invasion of Asia, primarily basing arguments on the track records of dark pools in the West.



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