Feb 01, 2012
ASIC algo plans may require rethink
Respondents to an Australian Securities &
Investment Commission (ASIC) second-phase consultation paper on equity market
structure have urged the regulator not to take an overly restrictive approach
in its planned new market integrity rules.
Liam Madden, agency broker Instinet’s head of compliance
for Asia, warned ASIC against using overly prescriptive market
integrity rules to exert control over certain types of trading technology, such
as algorithms.
“The principles-based
approach that ASIC has had to regulation in the past has given them an enormous
amount of flexibility in dealing with different technological and other
challenges as they arise. Rather than issuing granular details in
market integrity rules on, for example, how to test and develop an algorithm
before release, we’d rather see more specific guidance in ASIC’s Regulatory
Guide publications. This would allow ASIC to be more
responsive to changes in technology more quickly.”
Madden also stressed the need to harmonise
Australia’s securities market rules with international standards. “It's
important that whilst there are appropriate and robust regulations to deal with
trading, it has to be done in such a way that will allow global firms to have a
consistent approach across the globe, rather than having to take a piecemeal
approach to regulation,” he added.
ASIC released
‘Consultation Paper (CP) 168: Australian equity market structure: Further
proposals’ on 20 October 2011 and the deadline for comment has been extended to
20 February. The consultation seeks industry feedback on ASIC’s proposed market
integrity rules on high-frequency trading, volatility controls for extreme
price movements, pre-trade transparency and price formation, best execution and
market data supervision.
CP 168 tackles a number of issues initially raised in
CP 145, the November 2010 blueprint for reforming Australia’s market structure,
which paved the way for the introduction of trading venue competition on 31
October 2011, the launch date for alternative platform Chi-X Australia. ASIC
has been monitoring market developments and CP 168 proposes enhancements to
supplement the regime that is already in place. “We believe that these changes
maximise opportunities for innovation while maintaining market integrity and
mitigating the risks to price formation,” CP 168 stated.
In CP 168, ASIC has set out a table of comparison of International
Organisation of Securities Commissions (IOSCO) principles for direct electronic
access (DEA) with its own market integrity rules. While IOSCO requires
intermediaries and markets to have adequate operational and technical
capabilities to manage risks posed by DEA, ASIC has proposed in CP 168 a
requirement for market participants to, amongst others, test all order
algorithms before use, or before implementing material changes, and ensure that
automated order processing client complies with the same requirement.
Pre-trade controls
To counteract the scope for high-frequency trading
(HFT) activity in the Australian securities markets to amplify price
volatility, CP 168 proposes that market operators implement automated
volatility controls, including in relation to domestic index ETFs and index
futures. The regulation also proposes that market participants install
pre-trade controls that can stop an order or series of orders that may cause a
disorderly market.
Lee Porter, head
of Liquidnet Asia Pacific, the block trading platform operator which is in the
process of responding to CP 168, said, “HFT is now a very tangible part of the Australian
marketplace. While Liquidnet is not active in this area, our customers
certainly have to navigate the ever-increasing role of HFT. Customers find it
increasingly difficult to execute institutional-sized trades in the market
without leaving a footprint that HFT firms can use as a signal to trade. That
being said, it is important that ASIC consider all market participant’s
perspectives and opinions, and not just with the largest vested interest.”
Porter also called on ASIC to take into consideration independent empirical
data and research prior to making any recommendations or policy changes.
Instinet’s Madden said the concept of best execution should be
extended beyond the cash equity market. In CP 168, ASIC has proposed to expand
the scope of best execution to cover products quoted on the Australian
Securities Exchange, including equity market products, options, warrants and
interest rate securities. “With CP 145 and CP 168, ASIC has been
quite measured, but there are some areas we would like to see a bit more pace.
Just making best execution a requirement for the market participants only gets
you part of the way there. Australia has an enormous amount of money invested
in pensions and superannuation. It will be good to see some consultation on the
concept of best execution at the fund level. We definitely support the concept
of best execution as it currently stands, but we think it would be in the best
interests of the Australian investor if it were extended,” Madden added.
A number of the rules in CP
168 address issues on which there was previously no market consensus. Opinions
are still divided on the issue of dark pool liquidity and transparency. ASIC
proposes replacement of the current definition of a block order at A$1 million
with a more flexible regime governed by liquidity levels. The regulator has
also suggests that a A$50,000 threshold be imposed on dark trades arising from
limit orders if dark liquidity below block size grows by 50% in the next three
years.
Madden added, “There seems to be a question in ASIC’s
mind about the best way to deal with dark pools. Big block trades – the kind
that dark pools are designed for – are unlikely to be put on the lit market
anyway, so the distinction regulators should be looking at is between dark
pools and brokers’ internalisation engines. If liquidity is being taken off the
lit market with no benefits in terms of either price improvement or market
impact, then that is something that regulators should be looking at, but that’s
a much finer distinction than the simple difference between dark or lit
liquidity.”
Jill Wong