Applying the brakes to High-Frequency Trading
Moves by ASIC to maintain a levy on trading will curb the growth of High-Frequency Trading in Australia and hinder Chi-X from gaining market share against the ASX.
Last year Treasury issued a discussion paper looking at options for amending the Australian Securities and Investments Commission’s market supervision cost recovery arrangements when the current arrangements expire on 30 June. The deadline for submissions was 1 February.
ASIC itself established two task forces late last year to review the impact of high-frequency trading (HFT) and dark liquidity on Australian markets, with both taskforces scheduled to publish reports on their findings by the end of this month. Those taskforces were established in response to market concerns about the impact on the market and the market’s efficiency of HFT and dark liquidity.
There is some degree of over-lap between Treasury’s consideration of how ASIC’s market supervision costs should be recovered and ASIC’s own concerns about the impact of HFT — execution costs have the potential to impact the level of HFT activity quite significantly.
The costs of market supervision are set to increase substantially because ASIC, which took over responsibility for supervision in 2010 ahead of the launch of the Chi-X market and the end of the ASX monopoly, is about to upgrade its surveillance capabilities and its systems.
A key issue that was canvassed in the submissions to Treasury was whether or not some market participants should be exempted from activity-based fees or receive a discount relative to other market participants or whether they should face higher activity or message-based fees.
Chi-X in particular argued that there should be relief for ‘’market makers,’’ or traders that offer both a bid and an offer on a security, on the grounds that they provide liquidity and aid pricing efficiency. It is also concerned that the current arrangements (which also entail levies on the two market operators) unfairly discriminate it as a new market operator because they cause it to pay a much larger proportion of its trading revenue than ASX. (And has a disproportionate level of HFT activity on its platform).
It is difficult to distinguish market-making activity that adds liquidity and aids efficiency from HFT activity that simply adds activity and which leverages off the lit markets by effectively, albeit legally, using technology to ‘’front run’’ more traditional transactions. That kind of HFT activity has driven a lot of institutional trading into dark pools.
HFT activity now accounts for 25 per cent to 30 per cent of all lit market transactions and a much higher proportion of orders and messages because high-frequency traders test the market and gain their intelligence by continuously sending messages and orders and withdrawing them, within milliseconds.
HFT activity in Australia is only a fraction of the levels being experienced in the US and Europe, where it dominates activity. Its growth and the increasing surveillance burden and costs it places on ASIC is an argument for ensuring it carries its fair share of the supervision costs and isn’t subsidised by other market participants.
Another argument for making no distinction between HFT activity and other market activity in recovering ASIC’s costs is that the Australian market does ‘’tax’’ high-frequency transactions, something that has helped prevent HFT activity from replicating its dominance of trading elsewhere and kept the order-to-trades ratio at fractions of the levels experienced in the US and Europe.
It is also worth noting that only the top 200 stocks are traded on the Chi-X platform. It is not clear why any company in the ASX 200 would need a market maker, given that any stock in that index could be expected to attract significant liquidity.
At this point it appears Treasury isn’t going to offer market makers any relief from the cost recovery arrangements. The unanswered question, at this stage, is whether it plans to re-weight the arrangements to impose higher costs on messages relative to completed orders.
Given the level of concern about the growth of HFT and dark pools in this market among legislators, regulators and some heavyweight market participants (as well as retail investors who see their market being transformed from a market for investors into one for traders with a technology advantage) it is improbable that either Treasury or the ASIC reviews are going to do anything to actively encourage more HFT activity.
The bigger question is whether they will or should do more to actively discourage it.