Australian Equity Markets: Structural Reform Continues
The Australian Securities and Investments Commission (ASIC) recently closed its consultation on the Australian equity market structure. The Commission is now considering how best to tackle a range of market structure issues that have become increasingly prominent in recent years — issues such as algorithmic and high-frequency trading (HFT), dark pools, price transparency, and liquidity fragmentation.
The consultation follows a series of earlier papers exploring the Australian equity market structure and the introduction of new market integrity rules following ASIC’s decision to open up exchange markets to competition over a year ago.
High-Frequency Trading, Dark Pools Are Major Focus
Regarding the automated trading environment, ASIC proposes that algorithms and order management systems are tested before use and that appropriate pre-trade risk controls are in place to limit the potential for erroneous orders hitting exchange books and propagating instability. The proposals also contain a number of specific measures related to direct electronic access to markets. The CFA Institute view on these issues is that firms engaging in algorithmic trading, including HFT, should register with regulators and have effective risk management systems and controls. Further, firms providing direct electronic access to exchanges should implement robust pre-trade risk management procedures and retain adequate oversight of the activities of their clients.
The ASIC consultation also addresses the issue of extreme price movements — in part recognition of the “flash crash” in the United States and the potential systemic disruption triggered by such events. The proposals are based on the introduction of volatility-induced trading halts along similar lines as the U.S. SEC’s “limit up-limit down” proposals. Both the Australian and U.S. approaches would prevent trades from occurring outside a specified price band for a certain period of time if percentage price movements exceed pre-set limits.
On the controversial subject of “dark” or non-displayed liquidity, the Australian proposals are built around three main elements. First, the proposals would replace the existing $1 million threshold for block trades — which are exempt from pre-trade transparency to protect against market impact costs — with a tiered model, to more closely link “large” trades to liquidity factors. Second, the proposals would require dark orders to provide “meaningful” price improvement of at least one tick size or the mid-point of the quoted best bid and offer prices. And third, it is proposed that the minimum trade size for passive orders qualifying for an exemption from pre-trade transparency would increase from the current $0 to $50,000 if there is a significant shift of liquidity into dark venues. That is, a minimum order size for dark orders of $50,000 would be introduced if the value of dark liquidity below block size increases by 50 percent over three years or less. This latter point is sensible thinking on the part of the regulator. Dark liquidity has grown by 67 percent in the U.S.; this proposal allows ASIC to swiftly curb dark trading if it grows excessively. The consultation paper notes that pre-trade transparency information accounts for approximately 77 percent of price discovery, so it is clearly desirable to protect the predominance of pre-trade transparent orders. These proposals should help avoid any risk of impairment to the price formation process from future growth in dark trading.
Global Context
These moves come within the context of increasing regulatory attention to market structure issues globally. For example, a similar equity market structure review has been undertaken in the United States, Canada recently approved new market integrity rules to limit dark trading, Europe is in the process of finalising new legislation to affect market structure, and the International Organization of Securities Commissions has published international standards on dark liquidity and on various technological aspects of today’s equity markets. Elsewhere in Asia, trading activity in dark pools is on the rise, most notably in Japan and Hong Kong, although such activity has not yet reached a level to draw the attention of regulators.
The ASIC is due to publish its new market integrity rules in a few months’ time. In recognising the issues that have arisen in other fragmented markets, it is hoped that Australian authorities will be able to develop a framework that engenders fair competition and efficient-functioning markets.
