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.
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.