Hong Kong regulator blocks retail investors from dark pools

Hong Kong regulators have decided to block individual investors from participating in private equity trading markets known as dark pools after concerns were raised during a public consultation into the venues.

The Securities and Futures Commission published its findings on Friday evening, more than a year after it first announced proposals for the regulation of alternative liquidity pools.

The SFC's conclusions were largely in line with its original proposals, including the decision to bar individual investors and their family offices from trading in dark pools. Retail investors account for almost a quarter of trading on the Hong Kong equity market, and have guaranteed access to initial public offerings.

However, the regulator chose to amend the wording of its rules to allow "qualified investors" - including companies and partnerships - to use ALPs, providing they have portfolio assets of no less than HK$8m (US$1m) or total assets of at least HK$40m.

Private venues appeal to institutional investors who wish to buy and sell large amounts of shares, thereby limiting big swings in prices against their portfolios. The rise of dark trading also reflects efforts by banks to internally match more of their client trading flow, before pushing orders on to public exchanges.

Regulators across the globe have been taking a closer look at the way dark pools operate since Barclays was accused last year by the New York attorney-general of misleading investors over the prevalence of high-frequency traders using its own unlit trading venue.

Attention was also drawn to the industry by the publication of Flash Boys , a book by journalist Michael Lewis that claimed US equity markets were rigged.

Traditional stock marker operators have meanwhile been fighting back against the success of dark pools, such as reducing minimum order sizes to entice more high-frequency traders and increase liquidity.

However, dark pools have made little headway in Asia. In Australia, one of the few places where dark pools had achieved success, authorities revised rules in 2013, which has reduced share of overall trading volumes being conducted in unlit venues.

In Hong Kong, ALPs accounted for just 0.9 per cent of trading in April this year, down from 2.3 per cent in August 2013. However, the SFC said it was mindful of the example set in the US, where dark pools host up to 15 per cent of total trading.

"The rise of alternative trading venues is one of the key changes affecting global equity markets over the past several years," the SFC report said.

"Although ALPs in Hong Kong operate on a relatively smaller scale and account for a less significant volume of trades, international experience suggests that these trading venues could in time have a huge impact on market functionality."

Dark pool operator Liquidnet said it was unlikely to be affected by the SFC's tweaked regulations due to its existing focus on institutional clients.

"Liquidnet supports measures that will not burden market participants", the company said.

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