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.”