On November 11, Chi-East, a dark pool aimed at providing a new venue for traders to cross shares away from the public, was launched. This was no ordinary dark pool, in contrast to a slew of others that have sprouted across the region – either sponsored by broker-dealers keen to leverage their internal crossing networks or by independent outfits riding on a unique technology.
It is actually the love child of the Singapore Exchange (SGX) and Chi-X, the alternative trading platform that had shaken the European markets to the core and challenged the dominance of, what were then, powerful national exchanges by siphoning nearly a quarter of the trading volume of securities traded at the London Stock Exchange and the entire European market.
Whether Chi-East will be as successful in Asia as Chi-X has been in Europe remains to be seen, but the spread of alternative trading systems that offer a more efficient execution of trades at cheaper prices has been viewed as a mortal threat to brick-and - mortar national exchanges.
The rise of dark pools across the globe and now in the Asia-Pacific region continues to divide opinions. Critics say that by removing price-moving transactions from the spotlight, dark pools have given major market players (and especially the bulge-bracket banks) an unfair advantage over smaller players. Their proponents argue that they help stabilize market conditions by reducing information leakage when large blocks of shares come to the market.
Chi-East targets to provide sellside 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’s kick-off happens in a climate where the regulatory mood elsewhere has grown testier with dark pools and the high-frequency traders to whom they cater.
It came just eight days after a decisive move from the US Securities and Exchange Commission (SEC) to ban naked trading where broker-dealers allow their customers unfiltered or naked access to a trading venue, whether this be a regular brick-and-mortal exchanges or an alternative trading platform such as dark pools. The move targets high-frequency traders who are blamed for the ‘flash crash’ incident in May this year that saw the Dow Jones Industrial Average lose 700 points in a matter of minutes.
Pool apprehension
The week Chi-East started operating coincided with the period when European Union (EU) lawmakers were discussing ways of imposing tougher regulations on dark pools and high-frequency share trading. Their deliberations were aimed at reshaping the EU securities laws aimed at curtailing market abuses that have been spawned by Europe’s headlong rush in the last 10 years to modernize its markets.
Dark pools and other crossing networks have been directly blamed for a sharp reduction of transparency in European stockmarkets. By allowing anonymous trading, so the lawmakers charged, the dark pools have been unfair to other market participants that have less information to price assets.
In a surreal turn in Asia, Chi-East CEO Ned Phillips described the birth of the newest dark pool in Asia as complementing the existing marketplace and as supporting a more dynamic trading environment in the region.
Two to three years ago, when the public’s fascination with dark pools was at its pitch, such sugar-coating would have been easier to swallow, but the public’s mood for dark pools and high-frequency trading has clearly changed since the May ‘flash crash’ incident.
For now, regulators in the Asia-Pacific region are still in a catch-up mode as far as dark pools and high-frequency traders go. Of course, they have much less to be worried about than their Western counterparts since electronic trading remains a very small part of trading activity in the regions. Trading restrictions remain tight hampering a host of high-frequency traders from deploying sophisticated algorithms to get in and out of markets.
Chi-East’s launch in the region follows that of Chi-X Japan’s in the middle of this year. In March, ITG launched its dark pool for Asia named POSITS Marketplace.
Other dark pools operating in the region at the moment include Bloc Sec which is owned by CLSA; DBAT which is owned by Deutsche Bank; Japan Crossing by Instinet Japan; Korea Cross which is jointly owned by Instinet and Samsung Securities; Liquidnet; and Sigma X by Goldman Sachs.
No one knows exactly how much revenue the dark pools bring to their operators. Most operators claim that their dark pools have 10% crossing rates but there are no solid statistics to back that up. Considering how liquidity dried up this year after the ‘flash crash’ in May, the average cross rates most probably went south.
Success not a given
It will be interesting to see how alternative trading systems such as Chi-East are embraced in Asia. The region is so completely different that the possibility of their success remains up in the air.
The political environment in the region means that exchanges in certain countries are partly owned by the government and shielded from the competition. The experience of Chi-East is instructive in this regard – it took a long time to get it up and running.
In an October report for consulting firm Celent, Anashuman Jaswal argues that dark pool adoptions in Asia will take longer to develop than in the US and Europe, because of regulatory restrictions and significant retail trading that will remain the key barrier for their growth in Asia. While Jaswal expects a growth in the utilization of advanced order types and trading tools (such as algorithmic trading and smart orders), he predicts that they will not flourish to the extent that they have in the US and European markets.
Chi-East is keen, however, to highlight the significant innovation it is bringing to the region with its operation. It believes it offers the first central counterparty clearing (CCP) model for selected securities. Gan Seow Ann, SGX president and Chi-East chairman, says the strategy of the new dark pool is to attract new types of market participants and cater to the changing demands of customers. Among the sellside brokers that have committed to bring their liquidity to the platform are Instinet, Deutsche Bank, Morgan Stanley, Nomura and UBS.
Zach Tuckwell, head of electronic execution and programme distribution in Asia at Morgan Stanley, is positive the platform will stimulate the flow of liquidity in the region.
Yang Xia, head of Asia-Pacific direct execution at UBS, says clients of the bank’s global equities businesses can execute trades directly on i-East. The platform, he adds, will reduce the potential for information leakage and minimizes price impact risks.
Completely Asia-focussed
Ian Lombard, the COO of Tora Trading, says dark pools have a role to play in Asia. “We are still at the beginning of the process and we will be seeing more of them in the region.” Tora itself runs a dark pool in the region called Crosspoint, which was launched in February this year. Lombard feels there is still plenty of room for more dark pools to come into Asia, adding that their number in the region is nowhere near the 40 plus pools believed to be operating in the US. In view of the specific challenges posed by the region, he is not sure what number of dark pools could operate successfully here.
“It is certain that not everybody will succeed and in fact there may well be consolidation,” he remarks, adding that it is going to be tougher for pools that rely mostly on external sources of liquidity. Dark pools can play a strong complement to the primary exchange, according to Lombard. “There are ample data in the US that illustrate that the advent of pools leads to a net increase in liquidity and this is the reason why numerous exchanges around the world are collaborating or partnering with dark pools.”
Lombard holds that dark pools should not be blamed for the purported fragmentation of markets in the US and Europe. “The fragmentation in those markets was not primarily caused by dark pools, but by the presence of other exchanges.
In the US for instance you can trade in New York and other regulated exchanges. It is the fragmentation in lit markets that has been the cause of the problems facing those markets.” It is his belief that the presence of dark pools is especially beneficial in Asia where trading spreads remain wide and transfers are desperate to cut execution costs.
In the US, those spreads have been reduced to 4 or 5bp, while in Japan they are 22bp; 24bp in Hong Kong and 37bp or 38bp in Singapore. “Through alternative exchanges, one can trade at mid-price and so save half of that spread. That is a material saving for a lot of traders in the market.”
All dark pools continue to evolve their platform, notes Lombard. “Our business model closely resembles that of dark pool provider ITG. Fully 100% of the technology driving our platform has been developed in-house. It was not something cobbled together from various product providers. We are constantly enhancing our smart order routing algorithm so that it becomes a better technology. It is about making sure that we are connected to all the venues that happen to have the volume.”
“We are completely Asia focussed, he continues. “The region now accounts for 99% of liquidity flowing into the pool.” The group which employs 175 people maintains an office in Tokyo, Hong Kong, Sydney, Singapore and a development team in Europe. He expects to launch the Hong Kong crossing platform later this year or early next year.
Briefly speaking
Swift start to Asia’s latest dark pool
Ned Phillips, the CEO of Chi-East, answers questions about the region’s newest dark pool
At what time was the platform made available to clients?
The Chi-East platform was officially launched on November 11 2010.
Did liquidity immediately flow? What is the cross rate?
Yes. We enjoyed strong support from leading brokers such as Instinet, Deutsche Bank, Morgan Stanley, Nomura and UBS. We have seen a good level of interest from clients wishing to trade on our platform. As end users become familiar with the benefits that our platform brings such as lower market impact and increased liquidity, we are confident that trading volumes will continue to increase.
How different is Chi-East from Chi-X in terms of technology and structure and what were the challenges in bringing the platform to the region?
Chi-East utilizes the same low latency, innovative trading technology as Chi-X. The main difference is in the operating structure. Chi-East is the first independent exchange-backed platform which supports the non-displayed trading of stocks across Asia in Singapore, Hong Kong, Japan and Australia on one single platform. The initial challenge is to provide an efficient clearing and settlement system across all of the markets on our platform.
What is your day-to-day role in running Chi-East?
I oversee overall business strategy and development, as well as interaction with our participants and other stakeholders.
This was published in the November 2010 issue of The Asset
The Asset website is at http://www.theasset.com
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