SINGAPORE (Nov 11): Singapore has been trying hard to reinvigorate its stock market, following the 2013 penny stock saga. Various measures mooted include a dual-class share structure, private-market platforms to build the IPO pipeline and cross-border partnerships. Unfortunately, the trading volume of securities continues to be listless. A growing list of delistings did not help either.
A recent MAS staff paper by the Monetary Authority of Singapore on dark trading could be worth pondering in the light of efforts to rejuvenate the local stock market.
Dark trading refers to trades that are executed off-exchange without the pre-trade transparency of the price and quantity of the orders placed — an example is a married deal. In contrast, normal trades are lit orders submitted to a limit order book of a stock exchange that are visible in terms of price and quantity (pre-trade information) and in real time to all market participants. For dark orders, the pre-trade information is known only to the party originating the order and, depending on the matching method, potentially the counterparty as well.
According to the white paper, dark trading can improve on-exchange liquidity, especially for illiquid, and small- and mid-cap stocks. This is because, for one, the presence of dark or alternative venues encourages the entry of investors, who would otherwise not be willing to trade on traditional exchanges, owing to the price impact of their large trades.
Secondly, “liquidity begets liquidity”. “Market participants will thus become aware that there is trading interest in those securities, and such increased trading volume may generate further trading interest,” the paper says.
However, there are limits to this positive effect on liquidity. Stocks with smaller market cap size, on average, see larger increases in on-exchange liquidity than those with a larger market cap as dark trading increases. This is mainly because the positive effect of dark trading is likely to be masked by the latter’s existing high liquidity, but amplified by the former’s already-low liquidity, the paper says.
Dark trading’s positive effect on liquidity is also constrained by a certain threshold — after which the on-exchange liquidity would be cannibalised instead of enhanced. According to the paper, the spread widens more, in the range of 3.70% to 23.0%, once the proportion of dark trading to overall trading reaches the inflexion point of 25%.
The level of dark trading in Singapore is well below the 25% threshold at 8%. The volume of married trades for the first nine months of this year was 6.72 billion shares, or merely 3% of the total securities market. In terms of value, married trades over the same period amounted to $12.96 billion, or 7% of the total securities market. By comparison, the dark trading levels observed in the US, UK and Australia are 20% to 28%.
So, how can dark trading help reinvigorate Singapore’s stock market? From a policy perspective, there is “room” for a more “calibrated and differentiated approach” to dark trading, according to the paper.
For one, the limits on block volume could be calibrated to be based on the liquidity profile or market capitalisation of individual stocks. Under the Singapore Exchange’s trading rule, a block trade, or married deal, can be executed only if it exceeds the threshold of at least 50,000 units, or $150,000 in terms of value. Secondly, a monitoring framework can keep tabs on liquidity changes and fragmentation, if any. This is for the specific purpose of providing feedback inputs during the periodic reviews on block trade limits.
In response to the paper, SGX says the study provides a “welcome” and “useful” model-based research on market structure. “The complementary provision of screen and OTC [over-the-counter] liquidity promotes greater investment opportunities and risk-management access for all participants, while avoiding excessive fragmentation and loss of transparency. The growth of our FX, commodities and equity derivatives volumes exemplifies this,” it says.
However, the bourse operator appears vague on whether it will accept the suggestions. “Small- to mid-cap companies can benefit from on-exchange price discovery, supported by investment research. We continually engage our intermediary partners to identify new ways to enhance our markets for investors and issuers,” it says.
Market participants, on the other hand, are receptive to the idea of tweaking existing rules on dark trading. “If the report’s conclusions lead to a change in policy, we believe any resulting improvement in transparency and liquidity could benefit the full spectrum of Singapore market investors,” says Jason Yates, managing director and head of Asia execution services at Morgan Stanley.
Still, the commercial viability of solely operating a dark trading platform in Singapore could be a concern. Dark pool operator Chi-East, which offered trading in shares of companies in Singapore, Australia, Hong Kong and Japan, closed down in 2012 after just two years in operations. The company was backed by big names such as Goldman Sachs, Morgan Stanley and SGX. Ned Phillips, the then CEO of Chi-East, said the company shut down because of “commercial considerations” and expectations of continued relatively weak business prospects.
