"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.