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Transparency is supposed to be good for the world of finance. Perhaps some of the subprime crisis might have been averted if banks had been more transparent in their off-balance sheet financing. One of the world's most notable warriors against corruption is called Transparency International.
So it is perhaps a surprise to discover that share markets might be more liquid, dealing costs lower and trading more efficient and fairer if there was less transparency when trades were made, not more. At least, that is what supporters of "broker anonymity" say.
In many of the world's largest markets, such as in the US or the UK, the identity of the broker offering to buy or sell shares electronically is hidden from other market participants. It is particularly important in markets where big investors, like funds, are wired into the trading system, which is becoming more common as fund managers trade automatically, based on the decisions of proprietary computer algorithms.
Broker anonymity means they can acquire or dispose of a large stake without attracting the attention of other traders. When brokers are identified, investors can trade on this information if they notice a string of trades in the same security or sector coming from one source. That is tantamount to "front-running", says one managing director of equities at a big investment banker.
Strictly speaking, front-running is the practice of brokers executing trades on their own account before processing a customer's order. It is a way of unfairly taking advantage of the customer's insight, or, if the order is particularly large and likely to move the market significantly, benefiting from the effect on prices.
When brokers are identified "the statistical effect is the same", says the investment banker. In his experience, liquidity is reduced as investors will spread out their transactions over several days to avoid alerting rivals. It makes algorithmic trading less attractive.
Academic studies also support the idea that bid-ask spreads are narrower when brokers are not identified. For example, Nasdaq dealers quote narrower spreads on anonymous electronic communication networks than on the Nasdaq's transparent dealer quotation system. The theory is traders can collude to quote wider than necessary spreads as they can quickly identify participants who are offering more competitive price ranges and reprimand them.
Then again, brokers who know something about future price movements may not want to post competitive spreads to bluff the market. This should not happen when the identity of brokers is restricted.
Several markets have changed the level of transparency. The Korean stock exchange required brokers to be identified in 1999, and started displaying the identity of the five most active brokers for stocks. Researchers at the University of Sydney concluded liquidity fell as a result.
Conversely, liquidity increased and bid-offer spreads narrowed in Australia, Canada and France when anon-ymity increased in those markets in the first half of this decade. Interest in anonymity seems to be gaining momentum. Investment banks lobbied hard at the World Federation of Exchanges annual meeting in Shanghai last year for the organisation to favour anonymity.
The OMX Nordic Exchange will remove member identity from its market data feed and trade ticker for all companies traded in Helsinki and Iceland from June, and for the five most traded shares in Stockholm. And last November, the head of the Philippine Stock Exchange said he was considering removing broker identifiers.
Other markets are ambivalent. For example, the Hong Kong exchange (HKEx) has no plans to change. "However, please note HKEx would generally consult the regulators and market participants if it were considering any significant changes in market operations," the HKEx says. "The stock exchange's electronic trading system, now in its third generation, inherited the display of exchange participant ID numbers from the semi-computerised trading system first introduced in 1986 [when four markets merged to form the exchange].
"Some investors and some other market participants consider current arrangements to be a contributor to market transparency."
A big challenge for supporters of broker anonymity is to find a better name. After all, transparency is like apple pie and motherhood - everybody has to be in favour of it. Anonymity smacks of something to hide.
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