The deepest harbours hold the darkest pools

A sea change is brewing in Victoria Harbour but which way is the tide turning? Mention dark pools to the entirely affable Charles Li and his voice will quiet and grow solemn as he tells you that while not yet a danger to the bourse of which he is chief executive, they could certainly be so in the future and the Hong Kong Stock Exchange (HKEx) must be prepared. At least that’s what Mr Li told me last week when I bumped into him at a press conference at HKEx HQ at One Exchange Square.

The popularity of dark pools is certainly growing in one of Asia’s most mature markets, and vendors report increasing connections among market participants who are executing more and more trades out of the light. But dark pools in Hong Kong hold a curious position. The only type of alternative trading venue allowed in the jurisdiction, post-trade operators must report trades to HKEx, adding a further loop to the process than dark pools in some markets must incur and tying them to the exchange.

Let’s not also forget the HKEx’s monopoly is enshrined in law by the Securities and Futures Ordinance and the bourse was last year excluded from a new Competition Bill. So one would think the exchange quite safe.

Around 20 players already operate alternate liquidity pool in the Special Administrative Region, including Liquidnet, Deutsche Bank and ITG. And while I hear there is one more venue due to be launched in the next couple of weeks, some global players are having a tougher time than expected getting their applications through Hong Kong’s regulator – with forms apparently languishing on some bureaucrat’s desk in Chater House for the past two months. It seems while market participants are increasing their comfort with the venues, the Securities and Futures Commission (SFC) is not.

It’s certainly a confounding situation when liquidity is scarcer than ever and buy-side traders are looking for it wherever they can.

Without exception, brokers I met with in Hong Kong last week expressed a desire to work together with HKEx to help increase liquidity in the market and none of them felt any desire to ‘compete’ with the incumbent bourse. Many decried the coining of the phrase ‘dark pool’ as a complete misnomer and source of much of the confusion over what the venues do.

But the SFC has approved close to 20 dark pools to date so it seems odd the regulator should suddenly get cold feet about the whole concept. One explanation could be that the SFC has had a re-think since ex-CEO Martin Wheatley’s return to London. Another could be that the popularity of off-exchange liquidity is beginning to have a meaningful impact on HKEx volumes. Even on a sunny day, still waters run deep in Victoria Harbour.