Published July 20, 2009

SGX retains monopoly for now

By CHEW XIANG

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THE Singapore Exchange is probably one of the few monopolies listed on, well, the Singapore Exchange. (Another popularly regarded as one is Singapore Press Holdings, which owns this newspaper). If you want to list a company in Singapore, the only place is on the SGX. If you want to trade a stock listed on the SGX, you can do so only through one of the SGX's member firms, and the exchange charges 0.75 basis points for the privilege.

In most other developed financial markets, that kind of monopoly power, once wielded so profitably, has vanished. In Europe, traditional exchanges have been hurting since the Markets in Financial Instruments Directive (MiFID) was passed in late 2007. MiFID allowed firms to send their orders to brokers and exchanges that offered the best terms. In doing so it created a market for so-called multilateral trading facilities (MTF), essentially computerised exchanges that boast much cheaper and faster trading of listed stocks between their members. In the first four months of this year, about 15 per cent of all European equity orders were traded on MTFs, and that will increase to 20 per cent by the end of this year, according to a report from Aite Group.

In the US, the NYSE Euronext executed just 30 per cent of trades in May. Nasdaq has just a 20 per cent share of the trading of stocks it lists. Both have been fighting - and losing - a decade-long war against upstart electronic exchanges such as BATS Exchange and Direct Edge.

SGX's shareholders should not panic - yet. These innovations have to a large extent been kept at bay. For now, 'existing and disparate regulations across the different major Asian financial centres continue to be a major barrier to entry,' said a June report by Aite.

So far in Singapore, only so-called dark pools have been allowed in. These are a sort of limited and specialised version of the electronic exchanges wreaking such havoc in the West. They facilitate quick and anonymous trades of blocks of shares so big that if placed in the normal way would certainly move markets and cause leakage of information. Two dark pools, Liquidnet and BlocSec, began operations last year and both are reporting healthy growth. In fact, June was a record month for Liquidnet in Singapore, said its Asia chief executive officer Lee Porter in a recent interview with BT.

Likewise, BlocSec has signed up over 80 clients here and liquidity in its system is growing steadily, according to Phillip Van Dine, its head of sales. UBS launched a dark pool to match orders among its clients in Hong Kong in May, and is keen to bring the system to Singapore.

Even then, trades executed through dark pools have to be reported to the SGX, which will take its cut of trading and clearing fees. That means that the exchange does not lose out, not financially at least, though it does lost market share and visibility of trades.

That could be why it has moved to curb such off-exchange trades, or direct business trades, as it calls them. In January, it invited public consultation over revised requirements for direct business trades that if carried through would hurt such off-exchange trading venues. In effect, the proposed rules meant that only trades of at least 500,000 units, or worth at least $500,000, could be taken off-exchange. (The previous limits were 50,000 units and $150,000.)

The SGX's official stance is that the initiative 'would enhance the transparency of trades, as well as improve exchange regulation over trades'. 'This, in turn, would provide investors with more confidence regarding the integrity of the marketplace.' With the reduction of minimum bid sizes in December 2007 and a new trading engine introduced last July, the increased efficiency of trading on-exchange should mean less need for direct business trades, the SGX said.

Yet average spreads - one measure of efficiency - are at 37 basis points in Singapore among the highest in the region, according to reports. Japan, Korea, and Hong Kong boast spreads of between 22 and 25 basis points. In Australia, spreads are just 16 basis points. Dark pool operators say that they can improve this by more efficiently matching big orders. Yet the new regulations would drive order flow away from dark pools. BlocSec, for instance, has minimum trade sizes of either US$250,000 or 20 per cent of average daily volume.

The new regulations, if passed, may or may not have anything to do with the fact that SGX is, according to one report, considering whether to set up its own dark pool. That is a route that embattled exchanges overseas have taken. The London Stock Exchange for instance has won regulatory approval for Baikal, its own dark pool which is being launched in phases.

But as long as trades have to be reported to SGX, and it retains a monopoly on trading fees, it will not be financially hurt. But its role as a regulator will come under pressure. It will have to ensure that the new trading systems benefit all, not just big players with big pockets. It will have to find a way to retain oversight of the anonymous trades conducted within the dark pools. Regulators in the US and Europe are already taking alarm. 'Given the emerging risks posed by dark pools, the commission will be taking a serious look at what regulatory actions may be warranted in order to respond to the potential investor protection and market integrity concerns raised by dark pools,' US Securities and Exchange Commission chairman Mary Schapiro said in a speech in June.

It's not clear how serious a threat dark pools are here. The SGX refused to provide details of the volume and value of direct business trades here. But there are bigger worries. MTFs are coming to Asia.

Unlike dark pools, MTFs don't limit themselves to big market moving orders; they compete with traditional exchanges directly. Three of them have applied for exchange licenses in nearby Australia (though their applications have so far stalled as the government dithers over whether it should allow the competition). One of the applicants, Chi-X, is also keen on running its own exchange in Singapore. If the Monetary Authority of Singapore opens the door, funds and money managers here will celebrate. SGX's shareholders will not.