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Monday 18 March 2013

13-052MR ASIC reports on dark liquidity and high-frequency trading

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

They 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 said: ‘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,’ she said.

High-frequency trading

We found 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.

Ms Gibson said: ‘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% of all HFT turnover (or 22% 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 our financial markets through small orders and trades. We are making some suggestions to moderate this activity.

Dark liquidity

The taskforce found that while the volume of dark trading has remained around 25-30%, 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. 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.

Ms Gibson said 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.’

Details on the taskforces’ recommendations can be found in CP 202. Broadly, they relate to:

  • safeguarding against dark liquidity negatively impacting prices

  • improved disclosure and supervision of dark trading

  • restrictions on small fleeting orders.

‘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.’



Dark liquidity refers to orders on a market that are not pre-trade transparent (i.e. not known to the rest of the market before the orders are matched as executed trades). Such trades, known as ‘dark trades’ can occur on public exchanges and in venues other than public exchange markets. Rather than routing an order to market, a market participant may choose to fill the order from its own inventory (known as internalisation) or it may choose to ‘cross’ it with other client orders.

High-frequency trading is not a technical term and has been defined in various ways. The International Organization of Securities Commissions (IOSCO) describes it as:

High-frequency trading is frequently equated to algorithmic trading. However, while high-frequency trading is a type of algorithmic trading, not all forms of algorithmic trading can be described as high frequency. Common features of high-frequency trading include:

  • The use of sophisticated technological tools for pursuing a number of different strategies, ranging from market making to arbitrage

  • Use of a highly quantitative tool that employs algorithms along the whole investment chain

  • A high daily portfolio turnover and order-to-trade ratio

  • Flat or near flat positions at the end of the trading day

  • Mostly employed by proprietary trading firms or desks

  • Latency sensitive

Last updated: 18/03/2013 12:00