Taking Aim At Misconduct


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.ASIC is committed to the project representing value for money, which means the process needs to be thorough. We will put in place strict evaluation procedures and will ask vendors to demonstrate competency in a range of functionalities important to ASIC and the market.
ASIC is acutely aware of the size of the IT project and build, and has hired experienced technical staff that have the requisite skills.
Electronic and Automated Trading
Technology has increased the speed, capacity and sophistication of trading. This has opened the door for new types of market participants that bring innovative trading strategies and an increase in platforms where orders can be matched.
Two regulatory challenges that ASIC is particularly interested in relate to the increased use of dark liquidity and HFT. ASIC has recently established internal taskforces to specifically consider these areas.

Dark liquidity
As many of you will know, a ‘lit’ market, like the ASX and Chi-X, allows orders to be seen before the market matches them. Dark liquidity however, has no or little pre-trade transparency. On current estimates, dark liquidity may account for as much as 30% of market turnover. There are independent dark markets and also ‘crossings’ markets, which while originally operated by the major investment banks for their institutional clients’ large order flows, are now open to a broader range of market users.
Dark pools, which are a subset of dark liquidity, are now required to register with ASIC and provide monthly statistics of their activity.
The number of dark pools has increased almost fourfold since 2009. Given this growth, the changing nature of dark liquidity, as well as new forms of activity that challenge the boundaries of what we have traditionally considered to be manipulation, ASIC’s dark liquidity taskforce will consider how these dark pools are impacting the market in Australia, and whether our historically light-touch approach needs to be reconsidered.
As ASIC only sees the final trades when they are posted to the lit market, the taskforce will also look at how dark pools are supervised. We will consider whether a pool is truly dark to everyone, or whether an information asymmetry exists. We will also look at whether the dark market operator’s proprietary desk, or even a favoured client, is able to see orders coming through and pick the best ones.
The taskforce will review conduct in dark pools and other trading done off-market. This review will look at compliance with market integrity rules, and review conduct in dark pools and other trading done offmarket for compliance with the Corporations Act and market integrity rule obligations. This will focus on market manipulation, insider trading, handling of client money, conflicts, records and disclosure. ASIC will take enforcement action for non-compliance where appropriate. The taskforce will also consider the nature of trading by high frequency traders in dark pools and whether certain behaviour should be discouraged. We will propose new rules where necessary.
The taskforce will also consider more “market operator-like” obligations for dark pools (e.g. conflict management; monitoring; information dissemination; transparency of access, pricing, operations) and review the extent of payment for order flow and facilitation in our market and the impact on outcomes for client.
It will also consider whether incentives beyond our meaningful price improvement proposal are required to foster price discovery, for example, amending tick sizes.
All up, we are confident that the taskforce will provide the means for further promotion of market quality for delivering efficient price formation, informing investors about how their orders are executed, and overall confidence in the integrity of the market.High frequency trading
HFT is generally considered to be trading characterized by the automatic generation of large numbers of trades based on price movements and market information, with traders holding positions for a very short time. While not as prevalent in Australia as it is overseas, HFT is growing. Industry feedback suggests it may now account for 15-25% of equity market turnover. This is up from 3-4% which was estimated by the industry in February 2010.
ASIC acknowledges the increased role of technology and the efficiency benefits it brings, particularly from greater liquidity. However, we are also aware that it brings with it new regulatory risks. ASIC has no tolerance for any form of market misconduct, whether it originates from high frequency traders or other participants. We expect the taskforce to provide us with a better understanding of how HFT operates in this market, and whether there are any abusive practices or inadequate filtering trends emerging.
ASIC already monitors HFT and algorithmic trading as part of its ongoing supervisory function. We use the current rules that are in place to mitigate some of the regulatory concerns about electronic trading, including HFT. Participants are already required to have controls in place, and unfiltered DMA is prohibited under existing market integrity rules.
The taskforce will go further and consider whether the current framework is equipped to deal with the continued expansion of HFT. The taskforce will analyse the prevalence, nature and impact of HFT in our market (and abroad) as well as consider the drivers for growth. It will conduct surveillances examining the conduct of HFTs for non-compliance with the market integrity rules and the Corporations Act, and will take enforcement action for non-compliance where appropriate. It will assess algorithms employed by high frequency traders and whether certain types of trading or strategies that are disruptive should be prohibited.
The taskforce will also consider the nature of trading by high frequency traders and on which markets they are most prevalent, and whether there is a positive correlation between speed to market and profitability.
As always, ASIC is looking forward to engaging with the industry and the markets in considering the issues discussed above. If we believe there should be changes to the current rules, we will consult and work closely with the industry on implementation. The responsibility in working to ensure our markets are fair and efficient, and investors retain their confidence in the markets is a collective one, and one that we should all contribute towards.