Published November 7, 2008

Stock market rout benefits 'dark pool' operators

Funds struggling to meet redemptions turn to them to exit less liquid stocks

By CHEW XIANG
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LAST month's equity market rout was good for at least one group - operators of 'dark pools' that facilitate big trades by institutional investors.

Mr Klinger: 'Funds that face redemption tend to get rid of the most liquid stocks first, so the liquidity of portfolios is getting quite bad.' Liquidnet saw the most trading in Oct since its debut here last November

They work by electronically connecting fund managers' order books, privately marrying large trades without moving the market.

As funds struggle to meet redemptions, many have turned to dark pools to sell out of less liquid stocks, said David Klinger, managing director of Liquidnet Asia.

Liquidnet, the largest independent operator of dark pools in the US, is one of three that have operations in Asia.

It began trading Hong Kong, Singapore, Korean and Japanese equities in November last year, adding Australian stocks in February this year.

According to Mr Klinger, there has been a surge of interest in dark pools since Asian equities started heading south this year.

'Last month we saw the most trading in Singapore since we started (last November),' he said.

'There has been a lot of interest since the market started going badly. Funds that face redemption tend to get rid of the most liquid stocks first, so the liquidity of portfolios is getting quite bad.'

This is where dark pools can help - by sourcing buyers or sellers without alerting the rest of the market that a big deal is impending.

The average spread in Singapore is about 30 basis points, Mr Klinger said.

And '92 per cent of our trades are at or within the spread, and about 50 per cent at the midpoint', saving clients money as they do not have to cross the spread to trade. Fees are also cheaper than if the trades are conducted through brokers.

'It augments the way exchanges work,' he said.

'Exchanges are great for price discovery - it's the best way to say what is a fair price. Where exchanges don't do such a good job is for volume discovery.'

As well, 'orders can stay on (clients') trade desk (instead of with brokers).

This means that they have more control so there is less volatile trade,' said Greg Henry, who will manage Liquidnet's Singapore office when it opens this month.

Clients now can trade Singapore-listed stocks on Liquidnet's proprietary network - mostly small and mid cap stocks, where liquidity on the Singapore Exchange may be hard to come by, said Mr Henry.

Mr Klinger said the average trade size of Singapore equities last month was $1.7 million, though volume is 'a little spotty'.

'Sometimes we go a couple of days without a trade, and so far there is no consistent flow,' he said.

The Singapore office aims to get more clients - 'about 10 right now, maybe seven more we're bringing in,' Mr Klinger said.

Trading in dark pools and other forms of electronic markets has taken off in developed Western economies, as funds seek to minimise spreads and information leakage.

More than 10 per cent of trade in New York and London takes place in such off-exchange arenas, according to reports.