Webb: HKEx chairman is anti-competition

David Webb, a prominent activist investor in Hong Kong, has accused Ronald Arculli of undermining any competition to Hong Kong Exchanges and Clearing (HKEx), to the detriment of investors and, ultimately, Hong Kong's position as a financial centre.

The office of Arculli, who is the government-appointed director and chairman of HKEx and a member of the government's Executive Council, as well as the office of Lawrence Fok Kwong-Man, its chief marketing officer, declined to respond to requests for comment.

What prompted Webb's ire was a speech given by Arculli in Shanghai on July 21 regarding the role of exchanges in the new economic order.

Arculli's views are not new: AsianInvestor reported his opposition to dark pools last year. But now Webb is concerned these comments represent the opening moves of a campaign to have HKEx exempted from a new competition bill currently before Hong Kong's Legislative Council.

Webb notes that competition is what has led to narrower bid/offer spreads and lower transaction costs at other stock exchanges.

HKEx, because of its quasi-monopoly, is enormously profitable: it booked a pre-tax profit of 78.8% from its total revenue in 2009, and the stock trades at a pricy 29x 2009 earnings. The government is also a shareholder, which creates a conflict of interest, as it has an incentive not to allow competition.

Says Webb, displaying comfort with the royal 'we': "If that isn't a monopolistic profit margin, then we don't know what is... Don't expect those profit margins to last forever."

Under the current Securities and Futures Ordinance, only the Hong Kong Stock Exchange (a unit of HKEx) may function as a stock market. Automated trading services (ATSs) are allowed so long as they don't serve the general public, meaning brokers can use internal crossing networks so long as no retail brokers participate. Moreover, ATS trades must be reported to the Stock Exchange of Hong Kong and cleared through its affiliated systems, which delivers fees to HKEx.

Under a competition law, ATSs would not necessarily have to pay a fee for trades, if they arrange their own clearing and settlement. But to do so would require some kind of interface with the HKEx-owned clearing system (the Central Clearing and Automated Settlement System or CCASS).

Webb's broadside concerns his allegation that Arculli doesn't understand how competition works, or obfuscates it. For example, Arculli's speech says ATSs 'conceal' price discovery by taking a portion of demand and supply off the exchange. Fragmentation leads to opacity, in other words.

This is a position not shared by many buy-side traders, who argue that alternative venues tend to work best for trades that would never get done in the first place, due to concerns about leakage and front-running. This is why dark pools are often favoured for block trades: ping for a counterparty, and trade if there's a bid or offer; if not, do nothing. The benefit of alternative venues is usually anonymity.

This works in markets such as the United States, where there's a consolidated tape that provides see-through pricing among all exchanges and alternative venues.

Arculli's speech also used the May 6 'flash crash' in New York as evidence that newer trading methods can lead to more frequent and more severe swings in volatility. Yet Webb questions whether there is in fact a link between such crashes and a monopoly versus a competitive landscape. For example, he says HKEx had a 'flash crash' of its own in 2009, when on March 9, HSBC stocks fell 12.5% in the final five minutes of trading, only to rebound by 13.9% the next day.

Then there's the argument that high-frequency trading (HFT) is not about ownership of companies and nor is it bad for corporate governance. Webb says HFT will have no impact on how shares are voted because the traders don't hold onto them, and therefore it is irrelevant.

He goes on to tackle other aspects of Arculli's arguments, including those regarding listing regulations, capital raising and clearing and settlement. You can read Webb's missive here and Arculli's original speech here.