A consultation released by the Australian Securities and Investments Commission (ASIC) on 4 November is a welcome move towards the creation of a regulatory framework for best execution that could pave the way for similar efforts in other Asia-Pacific markets, market participants say.
However, competition between trading venues including Chi-X Australia, which had hoped to launch by Q1 2011, is expected to be pushed back until final guidelines are released. The consultation period for the proposals is open until 21 January 2011, after which the regulatory guidance will be released “as soon as reasonably practicable in 2011”, according to ASIC.
“Chi-X is delighted that ASIC has released its market consultation paper,” said Jason Keady, director of markets & operations at Chi-X Australia. “This is a key milestone in finalising the regulatory framework that will pave the way for the early introduction of competition in accordance with the government's stated objectives. Based on our preliminary review, the paper demonstrates that ASIC has separated out the issues required to facilitate competition from debates about broader market structure reform and provides a comprehensive assessment of international trends and specific details concerning market competition.”
Keady said Chi-X looks forward to being actively involved in the consultation process and working with ASIC and the broader industry to achieve a world-class regulatory framework for competition in the Australian market. “We are particularly pleased that ASIC has recognised the desirability of transitional arrangements and phased-implementation to minimise industry disruption and enable the earliest possible introduction of competition in 2011,” he said.
ASIC made the latest proposals in Consultation Paper 145 (CP-145), titled ”Australian equity market structure'. The paper also addresses options for modernising the market in light of developments and events that have affected capital markets globally, such as the 6 May ”flash crash'.
“If you look at 2010, with the impact of the US flash crash and its trickle-down regulatory impact, and couple that with the election in Australia, these events created some uncertainty which conspired against competition coming into the market earlier,” said Steve Zilioli, co-head of Liquidnet Australia, a buy-side only crossing network. “ASIC is firmly committed in trying to bring competition into this market place. Liquidnet has been working with ASIC for four years to ensure they understand the relevance and importance of differentiation of institutional and retail order flows. Reading the consultation paper, I'm really pleased that they have taken that to heart and they will not impede the ability of the institutional investor trade in their attempts to regulate flow across markets. ASIC is trying to defend price formation and ensure that the introduction of competition will not erode price formation and that's really important for capital markets.”
Among the proposals covered by CP-145 are those relating to formal obligations on market participants to deliver best execution to clients. CP-145 proposes that “a market participant must take reasonable steps to obtain the best total consideration (may be interpreted as ”price') for clients” and that “market participants must have policies and procedures for complying with the best execution obligation”, amongst others.
“It appears ASIC has looked at both the US and European models and have tried to take the best of both,” said Michael Corcoran, ITG's managing director and head of sales & trading, Asia Pacific. “They are proposing two sets of best execution rules, one for retail and one for institutional. That makes sense because institutional and retail investors trade in a very different manner. The policy around the retail space is a bit more prescriptive, with best price as the focus. The policy around the institutional market allows consideration of a number of factors – it's more the concept of what is the overall objective of the fund therefore price may be one determinant of best execution but factors such as size, market impact and overall costs of execution also need to be taken into account from the institutional perspective. This paper attempts to do that.”
Corcoran also notes the CP-145 proposals relating to dark pools, which state that “competition between market operators and the recent international trend towards trading in ”dark pools' (i.e. non-pre-trade transparent electronically accessible pools of liquidity) will change the price formation process in Australia. Fragmented data across venues will need to be consolidated. We need to balance the benefits to individual investors of trading in the ”dark' against the public good of contribution to price formation. This is particularly important because the market prices of products are used by investors to value their assets and by companies to raise funds.”
“In the draft document, ASIC made a statement that they are concerned about increased activity in dark pools and the propensity to move trading away from the lit environment,” said Corcoran. “And they are proposing a A$20,000 limit, i.e. orders in dark pools must be minimum size of A$20,000. That could have an effect on the dark pool space because a lot of dark pools include algo flow and may be crossing individual orders of less than A$20,000. Research has shown that there is typically price improvement in the dark pools regardless of whether the order is less or greater than A$20,000. Given one of the key reasons for utilising a dark pool is the price improvement, this point should be explored in more detail.”
Efforts to standardise best execution practices in Australia could have a knock-on effect in other jurisdictions in the region. Clare Rowsell, head of client relationship management & marketing, Asia Pacific, ITG added, “Very few companies now operate within a single market, so from their own internal policy perspective they may well take best execution policy of one market and try to apply that to a wider internal policy for consistency. So we're likely to find some Asian or Australian-based firms who start to use their ASIC-compliant best execution policy as the basis of their regional policy.”
CP 145 also states that “market participants should disclose to clients the venues on which clients orders may be executed. We are considering whether, for a transitional period, we should explicitly enable participants to meet best execution solely on ASX.”
A spokesperson of the Australian Securities Exchange (ASX) says the exchange welcomed ASIC's equity market structure proposals to prevent regulatory arbitrage by ensuring a level playing field for all market operators. “It is encouraging that ASIC appears to be addressing many of the issues ASX has raised as topics for attention in a multi-market environment, such as best execution obligations, market controls to curb extreme price movements and coordination among operators of trading halts and suspensions,” the spokesperson said.
“It is particularly pleasing that ASIC has underlined the vitality of transparent, centralised public markets that promote efficient price formation and reduce incentives for trading to shift to dark pools. ASX agrees with ASIC that equity markets are undergoing considerable change. It is essential that Australia's regulatory framework and the varied capital market participants that operate within it, develop to keep pace with competitive and technological change. While ASIC does not deal with the ASX-SGX (Singapore Exchange) merger proposal in its report, it does note – accurately, in ASX’s view – that cross-border exchange consolidations are a growing, global trend. ASX encourages all interested stakeholders to contribute to ASIC's consultation process and to assist in shaping a new market structure that will underpin an efficient, stable and robust capital market for the coming years,” the source added.