Korea is the new beach head in the growing war between the world's established stock exchanges and the new, technology-savvy electronic communication networks (ECNs). Island ECN went on the offensive last week with the announcement that it had moved into the Korean securities market through a joint venture with Uclick, a financial portal and technology provider.
ECNs are a form of alternate trading systems that facilitate off-market auction matching of customers' buy and sell orders. Like most of the exchanges in the Asia-Pacific region, ECNs capture order flow and match prices electronically. But they generally have much lower operating costs than traditional exchanges and can avoid a lot of the regulatory responsibilities. They are also free to choose the most actively traded stocks and ignore those that offer smaller turnover and less revenue.
A recent paper by the Australian Stock Exchange argues that despite the advantages that have seen ECNs in the US capture 33% of Nasdaq trading volume, there is no real future for the networks in Asia. This is because most markets in the region use an electronic limit-order book that establishes the market depth of all bid and ask limit orders and automatically executes when the orders meet at the same price. In the US, the Nasdaq (a dispersed dealer market), and the NYSE (a specialist market) do not offer the same openness and efficiency, and this has allowed the ECNs to compete.
But Chris Concannon, associate general counsel at Island ECN, says there are many more areas in which ECNs can prove effective. "The reason we've been successful is not the concept of electronic limit-order books, it's the concept of technology that tackles particular inefficiencies in a market," he says. "One point to establishing ourselves overseas is the network ... bringing together markets in other parts of the world."
Concannon points out that some Korean brokers are offering online trading of Nasdaq stocks, but are very inefficient. "They're basically phoning in their orders," he says.
Pending South Korean regulatory approval, the joint venture between Island and Uclick will provide investors with direct access to securities listed on the Korean Stock Exchange and Kosdaq, as well as Island's current market for US equities.
Counter attack
Stock Exchanges in Asia have been watching the situation in the US with interest, and are developing strategies to head off the incursion of ECNs into their territory. Most exchanges in Asia already have electronic order matching and are now moving to allow straight-through processing of online orders, if they haven't already done so. Another strategy considered by several exchanges is to build their own in-house ECN or develop other alternate facilities to attract order flow. Consolidation of futures and equities markets, as seen in Hong Kong and Singapore, is also a big boost to efficiency.
Exchanges are increasingly looking at global partnerships with other exchanges as a way ofá maintaining influence and trading volume. A good example of this is the co-listing arrangements between Australia's stock exchange and the Nasdaq, which will go ahead later this year. Concannon, however, says he is not worried by the prospect of more mergers and partnerships. "The exchanges are slow," he says. "And they're bound by so many regulations."
But increasingly so are the ECNs. New US Securities Exchange Commission regulations require that ECNs with significant market share are subject to more comprehensive regulations, or be regulated as exchanges.
Critical mass
In a speech late last year, Alec Tsui, chief executive of the Stock Exchange of Hong Kong (SEHK), warned that ECNsáwere a threat to exchanges in the region. "So far, ECNs have not made serious incursions into Asian markets outside Japan, but there is little to stop them when trading volumes make the effort worthwhile," he said.
It seems trading volumes have now reached that worthwhile level, and Concannon says this was one of the major factors behind Island's decision to move into Korea. "Korea has a strong equity market, high volume and high acceptance of online trading," he says. In fact Korea has the highest percentage of online turnover in the world. At the end of last year, 29% of the Korean Stock Exchange's turnover was generated online.
Looking at the internet penetration and retail investor base in the rest of Asia, Concannon says Hong Kong will likely be the next step for Island. "But we'll have to wait and have a look at the [SEHK] AMS/3 system and study the inefficiencies there to see if it's worthwhile."
