Regulators scrutinising dark pools should take note of recent recommendations from Australia's securities watchdog, argues Lee Porter, Asia-Pacific head at alternative trading venue Liquidnet.
The Australian Securities and Investments Commission put forward new rules in March with flexibility and proper surveillance techniques rather than imposing a rigid, one-size-fits-all framework, he notes. Asic's proposals for dark pools could, if implemented, prove a role model for others to follow, says Porter.
Meanwhile, Hong Kong's Securities and Futures Commission (SFC) is set to start a consultation on dark pools later this year. It is understood some dark pool operators in the city have been discussing their views with the regulator before it drafts its proposals.
“One thing for sure is that the SFC will learn from Asic, which [in turn] will learn from IIROC [Investment Industry Regulatory Organisation of Canada],” says Porter. “Regulators are all looking at each other to see if they [impose certain rules on dark pools], what would be the unintended consequence.”
If Asic's proposals get incorporated as part of its market integrity rules, “other regulators would follow, as best practices would find their way”.
Buy-side traders are certainly supportive of Asic's approach in general. The regulator is "the most approachable" in the region in terms of discussing trading regulations, says Derek McCole, Singapore-based Asia-Pacific head of equity dealing at Aberdeen Asset Management.
Core to Asic’s dark pool proposals is its use of a targeted approach that would impose a minimum trading size either for a group of securities or security by security. Importantly, it proposes to monitor dark trading liquidity on a quarterly basis, to assess whether the traditional price-formation function of the lit market – in this case, ASX – is negatively affected.
Asic seeks to establish whether bid/ask spreads on the lit exchange have widened due to trades not classified as block trades in Australia also trading in the dark. To achieve this, it proposes that several triggers be met before minimum trading sizes are implemented – proposed at A$20,000 or A$50,000. If the conditions are met, transactions below the size threshold could no longer trade on dark venues.
“If dark volume ramps up to significant levels across every different stock, these thresholds would kick in,” says Porter.
Around 25-30% of total trading happens in the dark, notes Asic, but the nature of such trading has deviated from its supposed function of facilitating the trading of large blocks for institutional investors to minimise market impact.
In recent years, says the regulator, a growing number of small trades have been done in the dark, as more retail investors use dark venues and more fundamentals-focused investors avoid lit pools in an attempt to avoid high-frequency traders (HFTs) on the primary exchange.
The value of executing in dark pools is no longer under debate. Academics, regulators and economists now agree, says Porter, that there needs to be a well-functioning, orderly lit market to complement a well-functioning, orderly dark market.
“Lit and dark venues impact on each other. All dark trades are done referencing current [lit-] market prices," he says, adding that investors lacking confidence in the lit market price won't trade in the dark either. "If you can combine them and get the right mix of dark and lit liquidity, you would have a far more efficient market."