"Broker anonymity" or "What do you have to hide?"

I addressed the World Federation of Exchanges Town Hall Meeting in Hong Kong today Wednesday 26 March 2008.

Dominant institutional brokers are demanding that exchanges move towards broker anonymity i.e. not display brokers' ids on the trading screens. What do they have to hide? For a start, many trade on their own book and they want to disguise their trades from clients. If you are advising a listed company, you certainly don't want the company to know that you are selling their shares on the open market.

Many also use their own capital to buy a block of shares which a client wants to sell. They then "slice and dice" the block and re-sell on the market, at a profit of course. How would you feel if you jsut sold a block to your broker and then see him seeing the same shares at a higher price.

Finally, clients like to monitor the execution of their trades, and without broker ids' on the trading screens, this is impossible to do.

The following is the text of my speech.

WFE Hong Kong Town Hall Meeting
26 March 2008
Panel 3: Market Quality – Changing the Competitive Environment

Good morning ladies and gentlemen.
The topic is very timely as exchanges compete for market share with each other and with trading venues such as ECN’s, ATS, etc. It is only natural that exchanges look at the “micro trading mechanisms” of these alternative venues and consider changes to your own market structures to compete effectively.

Recently, we have seen a move towards what is commonly known as “broker anonymity”. The demand appears to come from dominant brokerage houses which find it difficult to complete large client orders and attribute this to “front running” by other market participants. Let’s get this straight. “Front running” is used to describe the illegal behavior of a broker buying or selling ahead of a client order so as to profit from the subsequent movement in the market. There is nothing illegal for a broker to trade ahead of another broker because he thinks that other broker may be acting for a big client with a large order that may move the market.

Let me quote you a passage from a report supporting “broker anonymity” --- “Transparency invites market manipulation, increases volatility, distorts pricing and ultimately reduces liquidity”. Sounds counter intuitive doesn’t it?

“Market transparency” is the ability of market participants to observe information in the trading process. Pre-trading market transparency provides a level playing field for all stakeholders in a market and is a key component of price discovery. “Post trading transparency” is only sufficient as an audit trail to guard against market abuses. It is not a substitute for real time price discovery which tends to stablise prices, increase liquidity and lower transactional costs.

There are a number of stakeholders in a market, each with their own interests and agendas. We have the government representing public interests, the regulators who are there to protect the investing public, the issuers who need a properly functioning market for fund raising, investors (both institutional and retail), and intermediaries. Ultimately, the market is for issuers and investors, and the regulators and intermediaries are there to facilitate trading and to guard against abuses.

For investors and issuers, market quality is measured in terms of a level playing field, price stability, risk management, information flow, liquidity, and trading volumes. “Broker anonymity” tilts the playing field in favour of those in the know i.e. information on trade flows will be concentrated at the trading desks of the dominant brokerages, and available only to their favoured clients.

Investors and fund managers are overwhelmingly in favour of full transparency in trading and disclosure of broker identification on trading screens. This allows them to properly monitor the execution of their orders. Broker anonymity reduces the transparency in a market and makes it difficult for fund manager, who have a fiduciary duty to their clients to ensure that there is best execution, to monitor the execution of their orders.

As a matter of fact, there has been a trend towards more transparency in all aspects of the market. For example, price discovery is facilitated through pre-opening auction sessions. “Broker anonymity”, therefore, appears to be a step back to opaque markets where only the brokers know who is buying and who is selling.

As operators of exchanges, you have a fiduciary duty to your stockholders to maximize returns, and certainly increasing turnover and trade flow must be at the very top of your list of priorities. However, in every financial market, there are a number of stakeholders whose interests must be safeguarded.

Markets and trading venues developed and evolved to fill a need. Their trading structures are very much a product of their history, and development. To a large extent, there is no one market structure that fits all exchanges or even all stocks traded on a single exchange.

In HK, public interest is enshrined in the law that created the HKEx. Public consultations are conducted prior to the introduction of major new initiatives, and new products and trading practices are vetted by the SFC which takes a balanced approach and ensures that the interests of all stakeholders are considered.

In HK, our trading system is automatic order matching and therefore there is no partiality as brokers cannot choose their counterparty. Also, we can negotiate block trades off market, but these are required to be reported to the exchange to ensure transparency.

The market in HK is not as concentrated in the hands of a small number of brokers as in other market. The top 14 brokers account for 55% of the turnover, while the next 50 account for 30%. In the Australian market for example, the top 10 brokers account for 72% of turnover while the top 4 account for 37%.

In contrast to some markets where real time information is only available to brokers, institutional and retail investors in HK have always had access to the same information as brokerages. Moreover, HK does not have trade practices which restrict the flow of information from brokers to investors. We enjoy a very level playing field indeed.

Retail investors in HK account for some 37% of the turnover while institutional investors account for 56%. Proprietary trading only accounts for 7%. In overseas markets, proprietary trading account for a much higher percentage as brokers often take client positions onto their own books and then re-distribute into the market. This is another reason why large brokerage houses would prefer to hide their trading from the prying eyes of clients who may feel aggrieved.

HK does not have competing local exchanges, and that makes life “less interesting” for our exchange operator. However, many HK issues are traded on other exchanges, and we do want to bring that liquidity back onshore.

Overall market quality and integrity is what ultimately drives investors’ interests, and liquidity and turnover will gravitate towards quality markets. “Broker anonymity” is a short–term fix at the expense of market transparency and will detract from the attractiveness of a market to investors.

For exchanges with broker anonymity, I encourage you to provide more trading information to your ultimate clients, the investors, instead of less. The HKEx has made a business out of this and derives 8% of revenues from information services, and most of this drop directly to the bottom line.

We have the best practice in HK and there is no need to regress to a less transparent model.

Fed intervenes in the US Market!

There is market intervention, and there is market intervention. But when it's done by the Fed, it's called saving the economy.

In 1998, currency speculators attacked the Thai Baht, and then went the rounds of other Asian countries bringing down the value of the local currencies and making a huge profit in the process. Shades of George Soros attacking the UK pound sterling.

The HK Governemnt instigated a series of controls limiting the ability of speculators to borrow HK dollars for short selling. Unlike the other Asian countries, HK did not have any external debt denominated in foreign currencies that could be called in. The speculators decided then to use the HK stock market as a proxy and borrowed HK stocks instead. They sold the HK stocks for HK dollars and then sold the HK dollars for US dollars, hoping to drive down both the HK dollar and HK stocks, and doubling up their winnings.

The HK governemnt spent HK$120 billion of our foreign currencies reserves buying up blue chips in the HK stock market, and was successful in halting the slide from 16,000 on the Hang seng Index to around 6,000. HK was facing a financial abyss. If the government had not intervened, the stock market would have collapsed first, and then followed by the housing market, and the rest of the economy.

The HK Government was roundly castigated for intervening in the free operation of the market by "international community" i.e. those had the most to gain by a collapse of the HK dollar and the HK stock market, and by academics in their ivory towers. As it turned out, the stock market rebounded, and the HK governemnt put the majority of the shares purchased into an exchange trade fund which is still the largest ETF in the world. By the way, the HK residents were given a discount when the ETF was floated on the HK stock market, and those who held on for 2 years were given bonus shares.

I personally believe that the Fed has a duty to defend the economy from a financial meltdown. In fact, I had pointed out earlier that the Fed's action was too late and too timid. Until now. But this begs the question of why is it ok for the Fed to intervene in a commercial transaction? The point is the Fed is lending US$30 billion to a commercial enterprise (JP Morgan) to take over another commercial enterprise (Bear Stearns). And this is a non-recourse loan. Of course, if the value of the bonds subsequently recover, the Fed will be make a profit. I hope that the Fed will consider putting this into a listed vehicle and letting the US taxpayers benefit because after all it is their money at risk.

The Asia Era: Challenges and Opportunities After The Subprime Mess

The year 2007 marked a major turning point in the financial world order. The market capitalization of the Americas (USD22.5 trillion), Europe Middle East (USD20.3 trillion) and Asia Pacific (USD19.7 trillion) were roughly equal. Over the next decade, the Asian markets are expected to continue their phenomenal growth with the expansion of the economies of China and the Indian sub continent as the new engines of growth.

Of the top 5 growth markets in 2007, the top 4 were in the 2 most populous countries China and India. Shanghai and Shenzhen grew at 303% and 244%, and Bombay and NSE grew at 122% and 115%. Except for Japan, all Asian markets enjoyed double digit growth.

During 2007, the NYSE and LSE each grew at a paltry rate of 1.5%. The US and European markets will be pre-occupied with dealing with the aftermath of the subprime debacle. New regulations expected to be put in place to prevent similar problems will handcuff the principal US and European markets in the same way that Sarbanes-Oxley inhibited US market growth in the wake of WorldCom and Enron.

The ASF is the annual gathering of the representatives of the securities industries in the Asia Pacific region. The objective of the ASF is to allow delegates to share experience and to explore opportunities in co-operation. Currently, markets represented on the ASF include Japan, Korea, China, Chinese Taiwan, Hong Kong, Thailand, Malaysia, Philippines, Indonesia, Australia, India, and Vietnam. The ASF 2008 in Hong Kong will be the 13^th in the series of annual meetings.

The ASF will consist of market reports by representatives of each market, followed by panel discussions lead by well known market professionals. This year, the panels will focus on Risk Management and what we can learn from the subprime crisis, and How to Take Advantage of Opportunities in Asia.