Published August 27, 2009

SGX as Asian Gateway - but at what price?

By CHEW XIANG
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A MONOPOLY faces two choices when a new competitor comes knocking: to fight or to cooperate. The Singapore Exchange (SGX) has chosen to cooperate. Two weeks ago, it signed a deal with New York-based exchange operator Chi-X to set up a dark pool trading Singapore, Hong Kong, Australia and Japan equities.

Chi-X had wanted to set up an alternative exchange here directly competing with SGX for trading revenue; that threat has evidently made the two parties bedfellows.

It was a deal that 'made so much sense on so many levels', says an industry insider. SGX keeps its monopoly on trading of Singapore-listed stocks. It also keeps a half-share of all the trades that leak into dark pools, a breed of specialised exchange that electronically matches big trades. And, subject to regulatory approval, it gets a foothold in foreign markets - something it has been trying to do ever since Clob International became as good as dead and a trading link with the Australian Securities Exchange (ASX) set up in 2001 was severed five years later.

Perhaps most importantly, it gets to keep its regulatory functions, which it would have had to lose before new entrants could enter. A rule proposed earlier this year to increase minimum order size requirements was seen by some as anti-competitive. And a slew of measures to improve corporate governance announced last Saturday could be seen by the cynical as a way to head off yet more (admittedly not always fair) criticism that SGX can't balance its commercial and supervisory goals.

This week, ASX was told it has to fight. On Monday, it lost its supervision of financial market trading to an independent government regulator. It used to regulate itself, and critics hit out at the obvious conflict of interest. So long as ASX regulated itself, other market operators couldn't enter. And why, they demanded, should ASX shareholders pay A$16 million (S$19.3 million) a year for supervision, even though that is in the public interest?

Chris Bowen, the Australian minister for financial services, superannuation and corporate law, agreed that ASX should not also look after its competitors. 'It will not be possible for (them) to enter the market and actually operate until the supervision of Australia's financial markets has been centralised under the one agency,' Mr Bowen said. Three operators - Liquidnet, Chi-X and AXE, a unit of the New Zealand Stock Exchange - have been waiting for years for their exchange licences from Canberra.

ASX will continue to enforce its own listing rules, so it won't be totally toothless. And even if the three operators are granted licences (which they have not yet obtained), ASX still retains a monopoly on clearing - a major cash cow for them, as it is for SGX.

So it's not all doom and gloom, and the Australians will have deep pockets going into any battle. ASX reported pre-tax annual profit of A$445 million on sales of A$538 million, compared with SGX's operating profit of S$367 million on turnover of S$595 million. (With margins between 60 and 80 per cent, you can't deny being a monopoly is hugely profitable.)

But what if SGX had been forced to fight? What if the Monetary Authority of Singapore (MAS) had taken over its regulatory powers and then allowed Chi-X - and anyone else who wanted - into the country? Not merely as a dark pool, but as a fully functional electronic exchange trading SGX-listed stocks?

Investors may benefit if operators slash trading costs. Reports say spreads in Singapore are among the highest in the region, so there's fat to trim. And if it gets cheaper to trade, liquidity should improve, along with valuations, which should help attract new listings, in turn drawing even more liquidity into Singapore. And if others were allowed into securities clearing too, that could open up space for a true Asia-wide clearing house.

On the other hand, there are some regulatory issues to sort out first (although the Australians are leading the way with their solution for this one). And the traditional excuse - sorry, reason - that Singapore is just too small a market could actually be true. Asians could also be culturally less disposed to work with newfangled innovations like dark pools, alternative trading systems, or multilateral trading facilities. Entrants may find it hard to break into long-held relationships between brokers and their clients.

Is this the case? The problem is, we don't know - and now that Chi-X is in a happy partnership with the exchange, we may never know. The deal, if it's successful, should position SGX well as the Asian Gateway it wants to become. But is that worth sacrificing domestic competition for?