Contributions to this article by Jasmine Sprange
Key Points:
The new rules for Chi-X are only the start of changes in securities exchange regulation.
Australia's securities exchange industry is currently undergoing a period of fundamental structural change characterised by innovations in trading technology, global trends towards the development of alternative execution venues (such as "dark pools"), and competition between financial markets for trade execution services.
Competition in the Australian exchange industry has been a long time coming, and started in earnest with the Australian Government announcing its in-principle support for competition between securities exchanges and the granting of an Australian market licence to Chi-X Australia Pty Ltd (Chi-X) in March 2010, which was followed by the transfer of ASX's regulatory and supervisory functions to ASIC. Chi-X was granted a licence to operate an equity trading market on 4 May 2011, and will commence operations on 31 October 2011, when the necessary ASIC rules to accommodate competition come into effect.
How does Chi-X affect you?
- For brokers, traders, and data consolidators there are complex operational, systems and back office changes required to accommodate two markets, which have been underway for months;
- For listed companies the impact will be relatively minimal. They will continue to liaise with ASX (and not Chi-X) in relation to listing and continuous disclosure issues, and the methodology for determining S&P/ ASX index inclusion won't change to take into account trading on Chi-X. On the positive side, Chi-X could result in improved liquidity in the shares of those entities that trade on both ASX and Chi-X.
How has securities exchange regulation changed to accommodate Chi-X? What are the practical implications?
There are new market integrity rules that provide a multilayered regulatory framework for exchange competition. The ASX MIRs are essentially the old ASX market rules, and address how the ASX and ASX24 markets will be conducted from an operational perspective. The Chi-X MIRs are specific to the Chi-X market, but are effectively the same as the ASX MIRs, except without the provisions that address derivatives products (as Chi-X will not trade derivatives).
The substantive changes to the way markets will operate are contained in the Competition MIRs. These rules are designed to deal with issues brought about by exchange competition.
From an exchange operational perspective the Competition MIRs ensure that ASX and Chi-X will have consistent trading hours (including synchronised watches), trading halts, and trading tick sizes, and that data providers will consolidate the data feeds from both exchanges to prevent the fragmentation of trading data. Chi-X will not be competing with ASX in relation to listings, and this means that issuers will continue to deal solely with ASX in relation to listing and continuous disclosure. Practically, this means that there will be no requirement for entities that are traded on both exchanges to lodge the same information twice. If a company is traded on both exchanges, and seeks to issue further securities, for example as part of a rights issue, it does not need to apply to both exchanges for quotation of those securities – only to ASX.
Market participants, such as brokers, are now obliged to take reasonable steps to obtain the best outcome for their clients (known as the best execution rule). The best outcome means different things for different clients. For retail clients it means best total consideration, for wholesale clients a range of factors (such as timing) may be relevant. The purpose of this rule is to create a regulatory incentive for brokers to direct orders to the venue that offers the best outcome for clients – which is important given the different pricing structure that will be adopted by the two exchanges, including the provision of rebates by Chi-X to brokers in certain circumstances. The best execution rule does not mandate that all participants connect to Chi-X – there are transitional rules that allow the rule to be complied with for the first 12 months through utilising ASX's TradeMatch. Overall, despite the compliance burden, the best execution rule should promote market integrity and investor confidence.
As noted above, the impact on most investors and companies traded on both exchanges will be, at least theoretically, greater liquidity for their shares. The compliance burden to accommodate exchange competition will fall primarily on brokers and the exchanges themselves. The introduction of Chi-X should have a neutral effect on market integrity, as both exchanges are required to provide information to ASIC to allow them to track issues such as market manipulation and insider trading, and are subject to the same pre and post trade transparency requirements and the same reporting requirements.
What's next in securities exchange regulation?
Exchange competition is only part of the story in relation to the development of the Australian exchange industry, and there are several key regulatory issues which are (or should be) next on the regulatory agenda:
- the impact of high frequency trading (HFT): Specifically, whether ASIC has sufficient regulatory control to address the potential for "flash crashes" brought on by algorithmic trading strategies employed in HFT.
- competition in clearing and settlement of trades: Although ASX currently retains its monopoly in clearing and settlement of trades, ASIC has signalled that it will accommodate competition in the clearing and settlement space. Practically, any new entrants to clearing and settlement will need to wait for the outcome of a review by the Council of Financial Regulators into the regulatory control that the government has over clearing and settlement, which was announced in the aftermath of the rejection of the ASX-SGX merger in May 2011.
- dark pools: ASIC is also considering the regulation of "dark pools" – which are non pre-trade transparent execution venues[i]. A number of dark pools already operate in Australia, and they are common in overseas markets. The key issue with dark pools is that if a significant volume of trading shifts into dark pools, this can impact on the quality of price formation on public "lit" markets, such as those operated by ASX and Chi-X.
Australian securities market regulation will need to continue to evolve to accommodate broader market developments to ensure continuing confidence in Australian markets as a trading and listing venues. Listed entities and other market participants will need to keep abreast of the implications of these changes on their businesses and the market as a whole – a case of "watch this space".
[i]. More specifically, a dark pool is a private electronic transaction network, typically maintained by major banks, where stocks are bought and sold by clients of those banks. Because the matching of buyer and seller is done entirely within the control of the bank, the bid, offer and sale prices are not published to exchanges such as ASX or Chi-X. Typically dark pools charge lower transaction fees than established exchanges, and allow clients to protect disclosure of their trading strategies or to prevent large volume trades from creating major price moves in the public markets.
Clayton Utz communications are intended to provide commentary and general information. They should not be relied upon as legal advice. Formal legal advice should be sought in particular transactions or on matters of interest arising from this bulletin. Persons listed may not be admitted in all states and territories.
