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Dark liquidity

ASIC reports on dark liquidity and high-frequency trading

ASIC has released a report and a consultation paper examining the impact of dark liquidity and high-frequency trading on Australia's financial markets.

The documents are the result of analysis by two internal ASIC taskforces. The dark liquidity taskforce was set up in response to concerns about its impact on market efficiency and quality; the high-frequency trading taskforce addressed concerns about disorderliness and unfairness.

Report 331 Dark liquidity and high-frequency trading (REP 331) and Consultation Paper 202 Dark liquidity and high-frequency trading: Proposals (CP 202) focus on the quality of the market for capital raising and long term investment, and thus Australia's competitiveness as a regional financial centre.

ASIC deputy chairman Belinda Gibson, says: “In developing the proposals ASIC has been conscious of the need to balance the cost of regulation against the benefits, in addition to the impact on market efficiency.

“Companies should have confidence that share prices reflect their true value, and that they are able to efficiently raise capital. Similarly, investors should have confidence that they will be able to buy and sell shares at a fair and efficient price on an orderly market.”

ASIC found that public concerns over HFT appear to have been overstated and can be attributed to the increasing use of trading technology by investors generally.

While the taskforce did not find systematic manipulation or abuse of markets by high frequency traders, it found that their trading strategies are commonly adopted by many other algorithmic traders, including the institutions.

Gibson says: “Many issues can be dealt with by existing regulations and there has been a marked change in the professional traders' behaviour during the course of the ASIC study.”

It was found that high-frequency trading in Australia is dominated by a small group of trading entities with the 20 largest entities accounting for about 80 per cent of all HFT turnover (or 22 per cent of total equity market turnover).

The taskforce found that order-to-trade ratios in Australia are moderate compared to overseas markets and that the average holding time is 42 minutes, not seconds. Most traders, whether high-frequency traders or not, had order-to-trade ratios below 4:1. The market average is approximately 10:1.

High-frequency trading strategies – like other algorithmic strategies - can create “noise” in financial markets through small orders and trades. ASIC is making some suggestions to moderate this activity.

The taskforce found that while the volume of dark trading has remained around 25-30 per cent, the composition of dark liquidity and market participant-operated dark venues (crossing systems) has changed significantly. There are now 20 crossing systems operated by 16 market participants and they have started to connect to one another.

“One of ASIC's priorities is ensuring markets are fair and efficient,” says Gibson. “But dark trading is now occurring in smaller sizes that are similar to ‘lit’ exchange markets and for some securities this has influenced their price. ASIC uncovered some practices that require further controls and there are regulatory gaps that need to be filled.”

Both taskforces found potential breaches of Market Integrity Rules and the Corporations Act, and some matters are being investigated.

Gibson says that markets with a high degree of integrity give investors and listed companies confidence.

“We strive to make the Australian market as free from misconduct - including market manipulation and insider trading - as is possible. Financial markets are always evolving. Electronic trading has been with us since the 1970s. It is now exponentially faster and regulation must move with it.

“The work of the two taskforces has shown that while there are some regulatory gaps to be filled, the overall framework is robust, and that markets and participants are adapting to the faster pace of change.”

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