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.