Dark pools move further into Hong Kong spotlight

It seems dark liquidity concerns are still prominent in people’s minds in Hong Kong, where the issue was brought up in the Legislative Council last week and again discussed among market participants.

On Wednesday, member of the council, the Honourable Kenneth Leung, questioned Professor K C Chan, the Secretary for Financial Services and the Treasury, on the government’s policies towards alternative venues and trading in the dark.

Leung quoted Securities and Futures Commission of Hong Kong (SFC) figures suggesting trades executed in dark pools accounted for around 1.5% of the total turnover on the Hong Kong securities market from February 2011 to February 2012.

Concerned about a potential rise in dark pool activity, he asked the government if it had taken an official stance on whether dark pool trading should be prohibited, regulated, or encouraged and whether it would consider introducing legislation to regulate dark pool trading with a view to increasing its transparency, preserving the integrity of the local stock market and giving better protection to retail investors.

Chan explained dark liquidity existed for market participants to execute trades faster at better execution prices and to minimise market impact.

“In recent years, the handling of dark liquidity has been made more efficient by the advent of new technology. This has promoted the growth in electronic trading venues that do not provide any pre-trade transparency regarding the orders that are received by or reside in the trading venues,” said Chan, adding dark trading in Asia was still small compared with the US and Europe – according to Chan, reported dark trading in Hong Kong accounted for about 2.2% of total market turnover in October, versus around 8.5% in Europe according to Thomson Reuters.

Under Hong Kong’s regulatory system, dark pool operators – which primarily comprise brokers that run internal crossing systems – are licenced by the SFC. To better monitor dark pool activities, on 1 February 2011, Hong Kong Exchanges and Clearing introduced a voluntary reporting requirement that enabled exchange participants to flag all dark pool transactions. Since 3 October 2012 these rules have been mandatory.

“We note that regulators in the US and Europe as well as the international regulatory bodies such as the International Organization of Securities Commissions have been keeping a close watch on the development of dark pools,” said Chan, adding he would “continue to monitor international developments to ensure Hong Kong’s regulatory regime is on par with international standards”.

Certainly the appetite for dark liquidity isn’t sated in Hong Kong, so regulators will be likely to monitor the situation even more closely. The TRADE's managing editor Chris Hall and I were in town last week for our inaugural The TRADE Asia Algorithmic Trading Awards, and dark pools were a heavy focus in many discussions.

In a Dark Pool Trade-off debate at the awards evening between Instinet, ITG, Liquidnet and UBS, venue operators agreed a thirst for dark liquidity was increasing in a world where on-exchange liquidity was scarce. Yet dark pools needed to be increasingly innovative with offerings if they were to attract a greater number of more discerning participants, all the contestants agreed.

One thing seems clear, as the hunt for liquidity becomes increasingly more difficult, the role of dark pools is moving further into the spotlight.