This is the first of a two-part discussion of recent developments on the island-continent as they may affect the alt-invest world. In the second paper, we will discuss a new study of stock return predictability in Australia. Today, though, we will look at the ruminations of a critical regulator, the Australia Securities and Investments Commission.
ASIC recently issued two reports (or, to be technical, one report and one consultation paper) each discussing two of the cutting-edge questions facing exchanges, and their regulators, around the world today: dark liquidity and high frequency trading. The two documents together end up committing ASIC to the odd stance that (1) there is no very serious problem, but (2) we hereby propose a lot of solutions.
Report 331 diagnosis the problems created by these two developments. Consultation Paper 202, a document analogous to a proposing release form the Securities and Exchange Commission in the U.S., offers a prescription.
In a statement referencing both documents, Belinda Gibson, deputy chairman of the ASIC, said that ASIC “has been conscious of the need to balance the cost of regulation against the benefits, in addition to the impact on market efficiency.” Also, it would appear, ASIC recognizes the need to balance re-assurance about the status quo with reform thereof.
Comments on these proposals are due by May 10.
REPORT 331
The volume of dark trading in Australian equities has remained at between 25 and 30 percent of total market share over recent years, but there has been a change in the composition of this market segment, so that now 16 market participants operate 20 crossing systems and they increasingly connect to one another.
Market participation is becoming more multilateral and ‘market-like’ over time.
That doesn’t sound especially alarming, but ASIC believes the situation may encourage breaches of the Market Integrity Rules and the Corporations Act. The paper cautions that the task forces have found some situations that need investigation. Such situations have been “referred to our Enforcement teams.” Also, dark pools fragment the markets, allowing for inefficiencies.
ASIC alludes to a CP issued by the Treasury in November 2012 that focused on whether to regulate new types of market categories and/or create a more targeted licensing system. Yet it also observes that it has “looked at conduct in off-market trading” and has found that for the most part participants in these pools “have sound operations.”
On the issue of HFT, too, the report is remarkably re-assuring, saying that some of the “commonly held negative perceptions … are not supported by our analysis of Australian markets.”
Many institutions exhibit a number of the attributes commonly attributed to HFT, without identifying themselves (or being identified as) HFT. For example, the use of algorithms to trade, or to make execution decisions “according to predetermined parameters,” is not at all extraordinary in the early 21st century, and doesn’t make one an HFT trader.
Further, although there are institutions in Australia that are HFT by any definition, and identify themselves as such, they don’t do the sorts of harm often attributed to them. In particular, order-to-trade ratios “have been moderate [in Australia] compared with overseas markets….” Also, the average holding time in Australia is 42 minutes, and “only 1.2% of high-frequency traders held positions for an average of two minutes or less.”
CP 202
Despite the rather relaxed view of the two alleged problems one encounters in Report 331, there are a lot of solutions on offer in CP 202.
The Consultation Paper proposes, for example, the creation of a trigger that would indicate when the dark character of certain trades has impaired price formation for a security. A minimum size threshold would then take effect.
ASIC looks to minimum size threshold as a solution because it sees large orders between institutions as a way of lowering market costs, which is a good reason for a dark trade. It is the small orders that have to be discouraged: and, once a trigger is pulled, prohibited outright.
ASIC proposes that crossing system operators provide users with information about their (the users’) obligations and execution risks.
It proposes that crossing system operators be required to monitor their orders and trades and report instances of suspicious activity to ASIC.
Those are examples of items within the extensive list of reforms addressing dark pools. There is another list (a shorter one) addressing HFT.
ASIC proposes minimum resting periods for orders, a proposal to be implemented within six months of the time the rule is made. It also proposes amendments to the existing rules against manipulative trading that would allow consideration of “the frequency with which orders are placed, the volume of products [and] the extent to which orders made are cancelled or amended relative to the orders executed” in that connection.
Tick Size
To an ignorant Yank, all this raises the issue of tick size. After all, a common refrain in the debates in the U.S. over market structure issues has been that the 1990s move from fractional pricing to penny pricing may have encouraged and empowered the playing of electronic games that in turn have had harmful consequences for small investors and many issuers.
There has been no analogous change in Australia. Historically, the exchange itself established its tick size. I say the exchange because a single exchange, the Australian Stock Exchange (ASX) has been dominant since April 1987, when it was created through the amalgamation of six smaller exchanges.
But in 2011 ASX lost its utility/monopoly status when the government approved the launch of Chi-X Australia. Since then, ASIC has taken over functions it once left to ASX’s in-house deliberations. It has not (yet) tampered with the tick sizes.
The tick sizes remain at the levels that ASIC took over from ASX though. All stocks with prices of AUD $2 or more have a tick size of one penny. Fractional penny pricing is allowed for stocks worth less than a dollar. [The US and the Australian dollar are close to parity. The USD/AUD exchange rate has been zigzagging in recent months around 1.04/1.00.]
So Australian already has the small-tick regime that many in the United States are coming to rue. One aspect of the proposed reforms that strikes me as odd and (o far as its actual discussion in either of these papers goes) unmotivated is the idea that Australia needs still smaller tick sizes, allowing trades of stocks with a value in the $2 to $5 range with half-penny ticks.