ASIC takes dark liquidity and high-frequency trading in hand

The Australian Securities and Investments Commission (ASIC) says public concerns over high-frequency trading (HFT) appear to have been overstated and can be attributed to the increasing use of trading technology by investors generally.

This week, it released Report 331 Dark liquidity and high-frequency trading (REP 331) and Consultation Paper 202 Dark liquidity and high-frequency trading: Proposals (CP 202), which examine the effects of dark liquidity and HFT on Australia’s financial markets and result from analysis by two internal ASIC taskforces.

ASIC found that HFT in Australia is dominated by a small group of trading entities with the 20 largest entities accounting for about 80 per cent of all HFT turnover (or 22 per cent of total equity market turnover).

While it did not find systematic manipulation or abuse of markets by traders, it found that their trading strategies were commonly adopted by many other algorithmic traders, including the institutions.

It also found that order-to-trade ratios in Australia are moderate compared to overseas markets and that the average holding time is 42 minutes, not seconds. Most traders, whether high-frequency traders or not, had order-to-trade ratios below 4:1. The market average is approximately 10:1.

ASIC also discovered that while the volume of dark trading (orders on a market that are not pre-trade transparent) has remained around 25-30 per cent, the composition of dark liquidity and market participant-operated dark venues (crossing systems) has changed significantly. There are now 20 crossing systems operated by 16 market participants and they have started to connect to one another.

“One of ASIC’s priorities is ensuring markets are fair and efficient. But dark trading is now occurring in smaller sizes that are similar to ‘lit’ exchange markets and for some securities, this has influenced their price. ASIC uncovered some practices that require further controls and there are regulatory gaps that need to be filled,” says ASIC’s Deputy Chairman, Belinda Gibson.

She adds that both of ASIC’s taskforces found potential breaches of market integrity rules and the Corporations Act 2001 and some matters are being investigated.

Broadly, the taskforces’ recommendations relate to:

Safeguarding against dark liquidity negatively affecting prices;

Improved disclosure and supervision of dark trading; and

Restrictions on small fleeting orders.

But Gibson notes: “The work of the two taskforces has shown that, while there are some regulatory gaps to be filled, the overall framework is robust, and that markets and participants are adapting to the faster pace of change.”

She adds that in developing its proposed market integrity rules and guidance to address ASIC’s concerns about the impact of developments in dark liquidity and HFT, ASIC has been conscious of the need to balance the cost of regulation against the benefits.

The Stockbrokers Association of Australia expressed concerns about the effect that dark pool trading was having on the lit market, a trend confirmed in ASIC’s report.

“It is vital that market quality on the lit markets be maintained and it is good to see that ASIC is proposing ways to ensure the appropriate regulation of dark trading venues,” notes the Stockbrokers Association’s managing director and CEO, David Horsfield.