Fears misplaced over high-speed trading
The corporate regulator this week released its highly anticipated report on the impact high-frequency traders and "dark pools" have had on local financial markets.
The report was expected, among other things, to provide a new definition of "market abuse" that could be used to stamp out those questionable trading strategies that high-speed traders have been suspected of using.
But the Australian Securities and Investments Commission said, surprisingly, that it discovered it did not need to do so.
"There appears to be widespread international recognition that the existing definition for market abuse is sufficiently broad to encompass abuse occasioned by high-frequency trading," the report said.
This was not the first surprise.
ASIC commissioner Belinda Gibson said there was little wrong with the way high-frequency traders (HFT) operate in Australia.
"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," Ms Gibson said.
So it appears that fears of manipulative or out of control algorithms - the cause of so many whispers and rumours - have largely been a figment of brokers and fund managers.
ASIC's investigation of high-speed trading and "dark pools" took place over nine months last year, between January 1 and September 30.
Some of the things it discovered about these traders include:
There are 550 separate traders whose trading can be described as high-frequency trading (as defined by ASIC)
High-frequency traders account for 27 per cent of total turnover in the ASX200
This trading is dominated by a small group of firms with the 10 largest responsible for roughly 60 per cent of all high-speed trading turnover.
In general, high-frequency trades do not trade within sub-second intervals. It found only 0.1 per cent of high-speed traders have an average holding time - the period of time a trader holds a position - of one second or less. Instead, the average holding time of shares traded by high frequency traders was actually 42 minutes.
These findings appear, on first glance, to skewer the heart of the critics. And the more one reads of the report, the more skewers come.
One of the main complaints about high-speed traders has been that they send out millions of tiny trades called "fleeting orders", which fail to rest in a market for any meaningful period of time, which overwhelm the market.
But, according to the report: "The widespread belief that high-frequency traders were responsible for the vast majority of fleeting orders is not supported by our analysis."
One critic of these trades, the Industry Super Network, has long questioned the way that they have been able to put their processing systems next to the stock exchange's matching engine in a bid to transmit and receive information quicker than others.
Its argument has been that, since high-frequency trades can react to information faster than other market participants - so that, in effect, they can buy or sell shares based on new information before others can physically see that information - then the game is tilted in their favour. But ASIC disagreed with that argument as well.
"We do not regard the fact that market participants can co-locate to obtain a speed advantage as inherently unfair. Speed of access to the market has always been contestable, from the days of physical proximity on the floor, when an open outcry system operated," the report said.
"In Australia, no specific investor or participant category has access to data before the broader market. While the technological advances discussed allow for faster reaction times, for the removal, replacement and introduction of orders across markets, this is done based only on public and non-privileged information."
And ASIC found no direct relationship between high-frequency trading and a manipulative trading strategy called "layering".
However, the report was not completely one-sided. "Over the past year, ASIC has identified instances of abusive and dysfunctional trading by some high-frequency traders. This has primarily involved foreign high-frequency traders and large-scale wash trading, with this conduct presently the subject of enforcement action."
ASIC also said it discovered some "problematic behaviours" and "continued instances of market disorder" during its investigations.
"[But] these are more strongly associated with algorithmic trading generally, than exclusively with high-frequency trading."
In response to ASIC's report, the Industry Super Network's Zachary May said policy makers still needed to question whether Australian markets were becoming more like US markets and whether this was in the interest of long-term investors.
"The question is whether the direction in which our market is headed is a direction that is good for growth, jobs and economic efficiency," Mr May said.
"In a high-speed market, high-speed traders have an advantage over other participants, including long-term investors. That's why we called for the institution of electronic 'call auctions' as a way to mitigate the unfair advantages of fast traders, while improving price formation, system resilience and reducing volatility."
Frequently Asked Questions about this Article…
ASIC's report found the existing definition of market abuse is already broad enough to cover abusive conduct that could be caused by HFT, so the regulator concluded it did not need to create a new definition. ASIC also said public concerns about HFT have been overstated and that, overall, there was little wrong with how many HFTs operate in Australia.
According to ASIC's review, high-frequency traders account for about 27% of total turnover in the ASX200. The report identified roughly 550 separate traders classed as HFT, with the 10 largest firms responsible for about 60% of all HFT turnover.
ASIC found that sub-second trading is rare among HFTs: only 0.1% of high-speed traders had an average holding time of one second or less. The average holding time for shares traded by HFTs was actually about 42 minutes. The report also said the common belief that HFTs cause the vast majority of fleeting orders is not supported by its analysis.
ASIC said co-location and speed advantages are not inherently unfair. The report noted no investor category in Australia gets market data before the broader market. While technology allows faster reaction times, orders are placed based on public and non-privileged information, so ASIC does not regard co-location as automatically disadvantaging other participants.
Yes — the report identified some instances of abusive and dysfunctional trading, mainly involving foreign high-frequency traders and large-scale wash trading. ASIC said these instances are subject to enforcement action. It also noted some problematic behaviours are more closely associated with algorithmic trading generally rather than HFT exclusively.
ASIC concluded many public concerns about HFT have been overstated, but some industry groups remain concerned. The Industry Super Network warned policy makers to consider whether the market is becoming more like US markets and whether that direction serves long-term investors, so it's reasonable for long-term investors to watch regulatory responses and market-structure changes.
The Industry Super Network has proposed electronic 'call auctions' as a way to reduce the speed advantage of fast traders. The idea, as described in response to the ASIC report, is that call auctions could improve price formation, boost system resilience and reduce volatility — potentially making markets fairer for long-term investors.
ASIC's report covered the impact of high-frequency trading and dark pools, but the main conclusions highlighted in the article focus on HFT. The regulator did not find a need to change the market-abuse definition because it already considered it broad enough to cover problems that could arise from HFT or dark pools, and it did not single out dark pools as requiring a new legal definition in the findings described.
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