Taking Aim At Misconduct

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.