Australian Securities and Investment Commission’s (ASIC), Senior Executive Leader, Markets & Participant Supervision, Greg Yanco, discusses dark pools and HFT, on a recent GlobalTrading conference call, with market participants Matt Saul, Head of Trading Asia ex. Japan at Fidelity Investment Managers, Rob Liable, Division Director at Macquarie, and Nathan Lewis, Sales Trader at CLSA.
Greg Yanco, ASIC: The one part of dark liquidity where I think we are still concerned regards the impact of too much business going into the dark, to the point where it might impact the quality of the lit market. However, we have recently made the rule to require meaningful price improvement in the dark, which we think will arrest the drift of a lot of business into the dark or reverse the trend. We have seen some promising data from Canada where they already have this rule in place. So the dark liquidity task force we have established is looking at the impact of both of those developments on the quality and integrity of the market. We have undertaken a thematic review of dark pools and high frequency trading. A thematic review is a term that for a regulator means we are looking for misconduct as well as looking at the market quality issues.
So, with the dark pools, one of our concerns was about the impact on market quality. We have found research suggesting that we are already seeing some impact, but I believe that the proposal regarding meaningful price improvement will address that. We are still looking at the concept of a minimum order size in dark pools. I think that will come out again in our consultation. Tick size is an interesting area, as there are a number of stocks always used as examples where it’s said that the tick size is too big. Really the key is if the spread is too big people don’t want to jump over, so they trade in the dark within the spread. So we are looking at other markets, looking at different tick sizes. We are also finding a lack of transparency in dark pools; there is a lot of high frequency trading in there, but it isn’t described as high frequency trading. We have been looking at whether there should be obligations requiring transparency about what is in a dark pool. I did a presentation recently in Singapore with some of our findings. We are seeing some predatory trading but the dynamic here is that the buy-side clients are pretty big, and they have taken an active interest in their brokers’ other clients, as in what high frequency traders they have got in the dark pools.
On high frequency trading generally I think the brokers here are alert to the fact that the high frequency clients aren’t always their best clients, so they have been very responsive to our enquiries about some of the unwelcome behaviour that we have seen. There are not that many high frequency traders that are large enough to cause problems, so we are really dealing with that using our existing powers. We might look at some of the guidance around manipulation but we think that the tools we have got are sufficient. We are sending a few matters through to enforcement, so most of these have been about disorderly conduct. We are also looking at what we can do about noisy small orders. I don’t think we will eliminate them, but we may do something to actively discourage very small orders.
Rob and Nathan, are you finding the same as well with your buyside clients coming in and asking about your other clients and asking about that HFT data? Nathan Lewis, CLSA: Our traditional clientele is the big long-only fund, as we are an agency-only broker without the hedge fund focus in the past. So yes, the guys who are looking down into our crossing engine want to know who is in it, and we don’t have any HFT or aggregators inside, because that’s what suits our clientele best [laughter].
Rob Laible, Macquarie Bank: We do not have HFT clients in general, or aggregators inside our dark pool either. In general, clients want the flexibility to control who they trade against – principal risk or agency. I am just wondering, when you talk about dark pools and them potentially affecting the quality of the lit market, what’s your observation around the overall volume that is done off exchange? Has that been pretty much flat and are dark pools taking some of that liquidity from the upstairs market or is something else happening?
Greg: Well there are two things, one is that last point you made is correct. But the upstairs trades are getting smaller and being executed using broker algorithms in dark pools and on the lit market as well, which is another issue. Another thing we found is that a lot of the disruption that we hear the buy-side is concerned about is actually caused by other similar buy-side algorithms. But the second part of the thing about the market share of dark liquidity is the lit market, even though overall I think there has been a reduction, conditions have been bad, there has been increase in electronic trading on lit markets. So if high frequency trading wasn’t in the lit market, I think if it didn’t exist there would be a much bigger appearance of growth in the dark pools. But what we have seen is growth in dark pools taking business from the lit market, but also from the upstairs market.
Greg Yanco, Senior Executive Leader of Market and Participant Supervision, ASIC looks at the electronic trading environment in Australia and where regulation can play a role.
ASIC is Australia’s corporate, markets and financial services regulator. In relation to its responsibilities supervising markets, ASIC believes that well-regulated, transparent and well-functioning capital markets are the engine room for economic growth: matching companies that wish to raise capital to grow their businesses, with investors that wish to place their funds for a return in a liquid market.
ASIC constantly monitors changes in global equity markets and draws on the surveillance experience of other regulators. It is clear that technology has increased the speed, capacity and sophistication of trading. Along with the new opportunities that this presents for participants, it also poses new regulatory challenges for ASIC.
Flexible Advanced Surveillance Technologies (FAST) In the May federal budget, the Australian Government announced a commitment to invest in new technologies to enhance ASIC’s capabilities in market surveillance and enforcement. The $43.7 million over four years will allow ASIC to plan for a future that includes greatly increased message traffic, new trading technologies and techniques, increased competition between trading venues, and the increasing globalisation of capital markets.
The funding allows ASIC to provide four key deliverables. Firstly, it allows for the replacement of ASIC’s market surveillance system – a system which was originally designed for a single market and for which the contract expires in 2013. ASIC’s new system will continue to use the existing FIX specification. The upgrade will add capacity and capability, and enable the system to cope with both a multi-market environment and the increase in high frequency trading (HFT) and algorithmic trading. It will also allow for real-time surveillance of futures markets, which is currently post-trade. The new system will provide the capacity to handle the dramatic increase in messaging, with the ability to handle up to one billion messages per day.
Secondly, the system will allow for advanced analytics; for analysts to search data records and identify suspicious trading by connecting patterns and relationships. This will be crucial for greater levels of detection of insider relationships, and will also allow for the development of post-trade surveillance capabilities to identify market trends, patterns of trading behavior and repeated or systemic behavior. These capabilities are common in other comparable markets.
Thirdly, the new system will also include a portal for market participants to connect with ASIC. This will allow for the enhancement of efficiencies in dealing with ASIC, and enable participants to electronically lodge certain material in accordance with their obligations. Fourth, the development of a workflow system will help ASIC improve the management of cases from the moment ASIC receives an alert, complaint or enquiry, to the end of an enforcement action.
With Australia having some of the highest levels of share ownership globally, this funding is crucial in allowing ASIC to strive towards one of its strategic priorities of confident and informed investors and financial consumers. This is achieved through markets operating with integrity and efficiency which, in turn, helps to achieve another strategic priority: fair and efficient financial markets.
The funding costs will be smoothed and recovered over 10 years to minimise impact. In our view, the cost will be outweighed by the medium to long-term benefits of competition and of well regulated, fair and efficient markets. These costs also reflect the additional costs of supervision due to the increased speed and complexity of trading and dispersed trading venues, including dark pools. As a percentage of market turnover, the cost of market supervision remains favourable to comparable jurisdictions.
The Capital Markets Cooperative Research Centre (CMCRC)’s Alex Frino talks about his research over the past 18 months and the conclusions as to the truth about high-frequency trading.
What inspired you to focus your research on High Frequency Trading (HFT)?
There is a very poor understanding of the impact of HFTs on the market place. There is a lot of ill-informed opinion in circulation about the impact of HFT on price volatility, and their contribution to liquidity. I wanted to provide some hard data to help markets move forward and inform sensible evidence-based policy decisions.
There was also considerable interest in the idea of conducting HFT research from our regulator partners, including the FSA and ASIC.
What were your views on HFT at the outset of your research program?
When we first set about doing the research 18 months ago, I began by speaking to the investment management community to gather their views and insights into HFT and its impact on their trading. The feedback I got was overwhelmingly negative. One comment sums it up best – an investment manager said to me that “liquidity provided by the HFT community is like fog – you can see it, but when you reach out to grab it, it is not there.” So I began the program expecting to confirm these dominant views. To my surprise we discovered that the realities about HFT are almost exactly the opposite of that the investment managers were telling me.
HFT liquidity has been described as ephemeral by many on the buy-side. What does your research suggest about the ability of the buy-side to interact with HFT liquidity?
We have done research with data from the LSE, ASX, SGX, NASDAQ and NYSE Euronext on exactly this subject. The exchanges furnished us with data that identifies when HFTs are present in the market place. We then looked at the make-take decision. HFTs make liquidity when they put up a quote that gets hit by someone on the other side of the trade. They take liquidity when they hit someone else’s quote. The data clearly showed that HFTs are net makers of liquidity.
Interestingly some of our data also included information about when firms are trading through co-located servers within the exchanges. This data too showed that co-lo HFT activity was also a net provider of liquidity in those markets.
Co-location is described by some as an ‘unfair advantage’. What is your take on that given your research into the area?
My view is that if the advantage is being put to good use in providing liquidity, then it is not being misused. That pool of co-located flow is providing liquidity that would not be there otherwise, so I cannot see how that is a negative for markets.
Many market participants – including recent widely-quoted comments by Andrew Haldane of the Bank of England – are critical of the speed and sophistication of markets generally, using HFT as their example. They argue the playing field is not level and that markets should be slowed to take away perceived unfair advantages. What is your view?
I was frankly amazed by Haldane’s suggestion that markets should be slowed [by introducing speed limits and resting periods]. What he is in effect suggesting is that we should take markets backwards by a decade. That is astonishing to me because I just do not see the arguments. Market participants who do not have the technology to compete with other players can easily access brokers with algorithmic trading engines to help them execute their trades. If you cannot or do not want to build the technology yourself, you can outsource it fairly cheaply and very efficiently.
From an HFT perspective, our research demonstrates emphatically that the liquidity they provide is real and other participants interact with it constantly, so I cannot see a problem there either.
Australian Securities and Investments Commission’s (ASIC) Greg Yanco tells FIXGlobal how Australian markets are preparing for the future, including the launch of Chi-X Australia.
What are ASIC’s goals for an Australian consolidated tape?
ASIC has consulted with industry in relation to options to consolidate data from all venues. In Consultation Paper 145: Australian equity market structures: proposals (CP145), two options were put forward – a single provider established by tender process or multiple providers provided by ASIC. To this end, respondents overwhelmingly preferred a multiple consolidator model. As we have previously stated in the Response to Submissions on CP145 Australian equity market structure: proposals (REP237), this was based on industry expectation that existing data services can produce the most efficient outcome for users.
Submissions also overwhelmingly supported the proposal that market operators should be obligated to provide information to consolidators on a non-discriminatory basis in order to maintain a level playing field. While ASIC expects that more than one consolidator will emerge in Australia, if it becomes apparent that no industry solution is likely to eventuate to consolidate data from all markets, ASIC may revisit the issue and consider introducing a single consolidator via a public tender process.
Are additional clearing agents needed in Australia?
ASIC is aware that the topic of additional clearing agents in Australia is indeed a timely one. It is currently in discussion between industry representative bodies, ASXClear and RBA (as the regulator in the clearing & settlement space) with ASIC as an observer. Issues have arisen as to both quality and quantity of third party clearers, as ASXClear seeks to significantly increase minimum capital adequacy requirements for clearing participants, in particular third party clearers.
It is an area that ASIC will continue to monitor and a discussion that will be followed with great interest, both inside and outside of ASIC. We look forward to continued frank and candid discussions with the financial industry in this space.
How can smart order routing be most effective?
Smart Order Routers (SORs) will assist market participants in meetingtheir best execution obligations in a multi-market environment. Some participants will use SORs developed by independent service providers and some will build their own systems in-house.
Trading participants will be able to route orders automatically to different venues depending on specified criteria. In a multimarket environment the routing of orders could be split across venues depending on liquidity. In this way, ASIC expects that clients will received a better outcome overall, particularly so for retail clients, who will receive the best price across the markets unless they wish to instruct otherwise (e.g. for an order to be executed with an emphasis on speed, rather than price).
Does ASIC seek to encourage high frequency trading in Australia? If so, under what terms?
ASIC neither encourages nor discourages the practice. High frequency trading is, however, an area that is continuously monitored by ASIC, and we will respond if necessary to ensure that any such activity does not interfere with market integrity and fair, orderly and transparent obligations. In addition, market operator platforms must have adequate and scalable throughput capacity.
In the coming months, ASIC will release a consultation paper (CP) pertaining to the broader enhanced market structure. This CP will discuss, among other things, the issue of market makers in the cash equity products. We look forward to industry feedback to this CP when released in the next few months.
Fragmentation has evolved in the U.S. and Europe, but the diverse Asian markets are likely to forge their own course, as technological advances and regulatory developments make their impact felt around the region, argues Steve Grob, Strategy Director at Fidessa.
Fragmentation of liquidity has completely reshaped the equities trading landscape in the US and in Europe. It changed the roles of market participants forever by breaking the national monopolies of major exchanges and replacing them with a dazzling array of lit and dark venues. At the same time, it has also blurred the previously clear cut distinction between venues, brokers and buy-sides as each jostles for position in the new liquidity workflow. The next generation of winners and losers is now emerging – the trading equivalent of the“haves” and “have nots” – as different market players seek to embrace the challenge of fragmentation and turn it to their advantage.
This article looks at what may happen across Asian markets in terms of fragmentation. There are, of course, many differences between the trading environment across Asia and the more homogonous environments we see in Europe and, particularly, in the US. Top of the list is the fact there is nothing like the regulatory mandate for change in Asia as we have witnessed in the US and in Europe. Nevertheless, a number of isolated “bush fires”have already broken out in the region, and these raise the issue of whether fragmentation will really take hold and how it might spread. And, if it does, how will it be similar (or different) to our experiences in other parts of the globe?
RegNMS and its European cous
RegNMS and its European cousin MiFID were two pieces of legislation that introduced a concept of “best execution” for both retail and institutional investors aimed at providing greater transparency throughout the whole trading life-cycle. This was achieved by dismantling the national monopolies of the existing stock exchanges and fostering the creation of low cost alternative venues that focussed solely on providing markets for secondary trading in equities. Because these new venues were unencumbered by the other operations of stock exchanges (primary listings, trade reporting, supervision, etc.) they were able to operate on a much smaller cost base. These venues also invested in the latest matching technology which operated faster and at lower cost. The net result of this was that ECNs in the US and MTFs in Europe were able to aggressively compete for trading volumes and, in many cases, caught the incumbent exchanges napping. On top of this, they also introduced maker-taker pricing models which rewarded participants for posting passive liquidity and charged traders for removing or aggregating liquidity.
Many of these new venues were backed by the new Electronic Liquidity Providers (ELPs) such as Getco, Citadel, Optiver and Knight. These firms are able to use their technological prowess to benefit from tiny differences in prices and trading fees between the different venues. Such is their dominance that, according to the TABB Group, High Frequency Trading (HFT) of this sort now accounts for nearly 50% of US equities volume and over a third of the trading in Europe.
The large banks and brokers sought to leverage their own crossing networks against this backdrop too, whilst the alternative and primary market centres also jumped at the opportunity to introduce their own “dark pools” into the mix.
Tania Caldow, FIX Product Manager for IRESS, explains how Australian traders use FIXbased platforms to achieve onshore best execution and provide new infrastructure for offshore investors.
For some time now talk of the imminent introduction of alternative trading venues, such as new exchanges and liquidity pools, has been changing the profile of Australian electronic trading at a rapid rate.
The Australian Securities Exchange’s (ASX’s) current role as Australia’s single, centralised market is changing. The beginnings of a new regulatory regime are already in place, with the responsibility of market regulation moving from the ASX to the government run Australian Securities and Investments Commission (ASIC) in August 2010.
Market participants are helping drive this change to see a more open marketplace, in-line with other key global markets, which will bring increased competition along with other benefits such greater liquidity, market innovation and ideally lower overall execution costs. However, fragmenting liquidity across multiple trading venues also brings about complexities that market participants are beginning to address in preparation for these changes.
Whilst the actual details of ASIC’s best execution policy remain unclear, we expect Chi-X Australia to be the first alternative exchange to compete with the ASX. Being part of Chi-X Global, an international firm who has successfully launched the Chi-X platform in Europe, Canada and Asia, Chi-X Australia is readying its trading platform for the Australian market.
This imminent change presents a number of challenges to local brokers. Ideally, exchange connectivity when trading across multiple venues is most efficient if consolidated into a single encapsulated layer. Whilst primarily streamlining best execution, this layer handles the particulars of each exchange and provides consistent, uniform access to all execution venues. Internalisation also becomes important, whereby a broker attempts to maximise opportunities to cross with other in-house flow before routing to a preferred exchange. The current situation, where a broker may have multiple trading applications all accessing the ASX independently, becomes inefficient.
Historically, the adoption of routing orders electronically to the market for many firms has been approached in an ad-hoc fashion. Flows such as algorithmic and systematic trading, direct market access, live market data tools and FIX have been taken up only when required and often implemented independently of each other. The emergence of global exchange connectivity, whether via an Order Management System (OMS) or by a dedicated network, was also thrown into the mix, adding a new layer of complexity. It would be fair to say that the uptake in Australia has been slow and cautious. Firms, especially those at the larger end of the scale, often invested heavily in their own proprietary OMS’s. At the time, it seemed a straightforward decision to make and gave firms a competitive advantage by owning their own proprietary system. But as things started to change, connectivity between systems and exchanges became a difficult issue to address.
This is one area where we have seen strong adoption of the FIX Protocol. Australia’s usage of FIX messaging by firms has not been as widespread as it has been in other Asia Pacific markets. With the recent strong appetite for Australian investments from offshore emerging, however, connectivity between systems using applications like FIX has become a necessity. Whilst within Australia there are only a few types of trading platforms used across the majority of brokers, it becomes a theme of adaptation when enticing flow from offshore. Trying to make offshore clients take Australian only trading platforms is unrealistic. At the same time, global brokers and investment houses also need to provide connectivity to their centralised systems. Therefore, the focus has shifted to providing seamless connectivity and FIX is the ideal solution.
The result is that, more often than not, an Australian broker’s site will contain a complex web of order routing systems and solutions with the use of the FIX Protocol at its heart, ensuring that it is all held together.