Regulation

ASIC reforms to change 'complexion' of Australian markets

New market integrity rules issued by the Australian Securities and Investments Commission (ASIC) in response to growing use of automated trading and dark liquidity will improve overall safety, but at a cost to some market participants. The rules will be phased in over the next 18 months and include kill switches and extreme trading rules for high-frequency trades, as well as new requirements for dark pools relating to meaningful price improvement and reporting. Other additional measures have also been tabled, including re-introducing a minimum order size on dark trades.

‘The rules, the result of industry consultation dating back to 2010, address issues ASIC considers necessary to maintain fair, orderly and transparent equity markets,” said ASIC chairman Greg Medcraft last week.

Alex Frino, chief executive officer of the Capital Markets Cooperative Research Centre (CMCRC) in Sydney comments that the introduction of kill switches is a “good move… it will prevent a ‘robots gone mad’ scenario and will protect market integrity”. Frino adds that “it foists the responsibility for switching off the server of a client that is causing a disorderly market on the broker.”  

Previously in the instance of disorder in the market, the regulator would have to get in touch with the client itself. Frino notes, though, that the actual instances of market disruption caused by algos are extremely rare. How the regulators will define a market disturbance has yet to be fixed, and the regulator will eventually need to provide brokers with guidance.  

A second component of the new rules on high-frequency trading (HFT) requires brokers to filter each order submitted by client.

“This will have unintended consequences. I believe it will increase latency, and that may change the composition of the HFT community – some sections of the community are very latency sensitive and their business might no longer be viable.” 

Frino believes that one of the unintended consequences could be that it makes 'parasitic' traders more potent, with the greater latency. “It could completely change the complexion of the market.”

David Jenkins, head of business development at Fidessa, commented that the updated regulations on HFT were "not a surprise” noting that changes follow international guidelines, though he did also highlight the cost of compliance the new rules. He said that with the kill switches and credit checks “there’s a very real risk of regulatory cost becoming a drag on the business model of a lot of brokers. Markets are down and brokers are earning less commission, but regulatory costs are increasing." He added that this could further encourage the shift to non-member exchanges.

On dark pools, Frino notes that with ASIC proposing a licensing regime it has “recognised that dark pools are de facto exchanges. Whilst in lit markets there is incredible scrutiny of whether orders are manipulative, there has been no scrutiny of dark pools; so this proposal is in recognition of this.” However, he notes that licencing will inevitably lead to greater surveillance and compliance requirements, and that this will cost ASIC money. ASIC's policy of recovering costs from the industry could drive up costs for players, which might be a challenge for smaller dark pools. There are currently 16 dark pools in Australia needing oversight.

Frino was also positive on the proposed re-introduction of a threshold minimum order size for dark pool trades. Previously the regulators specified a A$1 million minimum, whilst current proposals are for in the region of A$25k or A$50k. Frino notes that whilst one million may have been too high, the higher benchmark would generally be better than lower.

Jenkins, however, believes that the re-introduction of minimum order sizes could force brokers to “standardise” their business models. “It’s not a very attractive environment, and that’s why we’re seeing brokers shift into clearing and non-participant broking. We’re already seeing some close-up shop.” He added that if clients are squeezed towards a smaller number of brokers this could ultimately end up as concentration risk. However, Jenkins also notes that the requirement to prove that there is meaningful price improvement in a dark pool is much less problematic.

Harry Thompson