Australian Regulator Goes Light on Dark Pools – Recognizes HFT and Dark Liquidity as Part of Financial Landscape

ASIC joins the international debate on high-frequency trading, today releasing a refined set of rules for HFT and dark pool

The worldwide regulatory debate on high-frequency trading and the transparency associated with liquidity supply continues, this time in Australia as the Antipodean regulator ASIC has refined its proposed rules on dark liquidity and high-frequency trading (HFT), the details of which were released today.

ASIC has demonstrated a pattern of tightening rules during recent months, the majority of which relate to the protection of client assets, ensuring industry participants adhere to correct practice and the introduction of the Deal Stream surveillance system to monitor the behavior of FX companies in detail.

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In this new report, ASIC has published the results of considerations concerning methods of regulating HFT and, as much as can be possible, those who seek anonymity through the use of dark liquidity pools. On the face of it, ASIC’s rulings appear to be relatively favorable toward such traders at this stage.

While Germany’s BaFin succeeded in passing a law called the High-Frequency Trading Act on May 15 this year aimed at the prevention of risks and what the regulator terms as abuse in High-frequency Trading and requiring all participants engaging in high-frequency trading to be registered and monitored as such.

The Great Speed Debate

In other jurisdictions such as the United States where a large proportion of HFT takes place, the Securities and Exchange Commission (SEC) has engaged in a collaboration with the FBI, forming a new unit within the SEC that examines hedge funds and other firms that are using algorithm trading strategies.

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Designated the Quantitative Analysis Unit, the lawmakers and US regulators are focusing on the emergence of high-frequency trading firms and the rise of dark pools, along with some technology companies discussing the possibility of imposing a latency floor as in the case of EBS which is considering building in a delay of up to 3 milliseconds to avoid disruptive trading practices.

With these worldwide factors borne in mind, the Australian regulator has thus far refrained from any draconian steps toward HFT and the use of dark pools and indeed has demonstrated a degree of support for such methods.

ASIC Welcomes HFT

ASIC Commissioner Cathie Armour detailed this on the publishing of the proposed rulings: “The rules allow for flexibility to maintain a competitive market regulatory model, one that can move with the increasingly dynamic nature of our markets”

“Dark liquidity and high-frequency trading are now an integral part of our financial market landscape, and ASIC has confidence that the regulatory settings will ensure an appropriate and measured outcome” explained Ms Armour.

The rules follow extensive consultation with industry participants, and it has been confirmed that ASIC will not go ahead with proposals to rest small orders on the market for a set time or for dark orders to meet a minimum size.

“ASIC’s taskforces on high-frequency trading and dark liquidity, and earlier work over the past two years, has seen an improvement in the awareness of these areas of trading, hence the move not to proceed with some rules at this time. Today we are announcing our direction for the full suite of proposals and we are confident they will maintain the quality, integrity and fairness of the Australian market” concluded Ms Armour.

Certainly the viewpoint of the Australian regulator is likely to be received amicably by high-frequency traders, as well as those using dark pools for which there has been an increasing demand in the past few months, most recently demonstrated by TMX Atrium adding connectivity to UBS multi-lateral trading facility, the world’s largest dark pool, just last week provided by point-of-presence connectivity to the London 4 hub.

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With the onset of regulatory barriers seeking to hamper the methods by which algorithmic traders and HFT participants operate, and ASIC demonstrating that as a very reputable regulator it can still accommodate such practices, it will be of great interest to note which direction HFT and algorithmic traders will go when looking for a region in which to set up business.

Summary of Rule Changes

Dark Liquidity

• On minimum size thresholds and tick size reform, ASIC will not proceed with these proposals at this stage. Instead, the regulator will monitor the impact of the new meaningful price improvement rule that was approved by Minister Shorten in November 2012 and commenced on 26 May 2013. There has already been a decline in the volume of dark liquidity as a result of this rule.

• On crossing system transparency and disclosure, ASIC will proceed with the rules but allow disclosure of fees and order types to clients only and not require publication of aggregate statistics. Rely on existing rules to disclose crossings on trade confirmations for retail clients, rather than introducing a new rule. Flexibility will be provided for flagging the ‘crossing system’ and ‘as principal’ on trade information for wholesale clients.

• On crossing system fair treatment, ASIC will proceed with these rules, but without a fee constraint on client opt-out.

• On crossing system monitoring and record keeping, ASIC will not proceed with the enhanced record keeping rule, however the regulator will proceed with the monitoring rules but clarify that it relates to a crossing system operator’s procedures, and should be proportionate to the nature and size of the business, and not necessarily be real-time.

• On crossing system controls, the regulator will proceed with rules requiring that all crossing systems comply with core existing requirements for automated order processing, and proceed with requiring notification to ASIC and impacted clients of system outages.

• On T+3 course of sale reports, ASIC will proceed as proposed.

• On enhanced conflict of interest obligations, ASIC will proceed with the rules to protect client information (with carve outs for client consent) and to prevent intentional interposing between client orders, however a decision was taken not proceed with requiring client orders to receive time priority over principal orders and instead amend the existing rule on fairness and priority in dealing so it applies to crossing systems.

• On payment for order flow, ASIC will modify its approach to be limited to negative commissions.

• On indications of interest, the regulator will introduce guidance about managing client information.

High-Frequency Trading

• On small order resting time, given the considerable drop evidenced in small and fleeting orders, ASIC has decided to not proceed with this proposal at this time, but will continue to monitor it, and will reconsider should such orders return to problematic levels.

• On manipulative trading, ASIC’s proposal to remove ‘materiality’, instead to rely on the impact of any order, will not be implemented.

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