Australia: ASIC toughens up rules on dark pools and high frequency trading

Key Points:

Investment banks will be required to publicly disclose information about their trading activities in dark pools and report suspicious activity under strict new obligations.

New amendments to the ASIC Market Integrity Rules (Competition in Exchange Markets) ("MIR") announced by ASIC last month impose greater disclosure, transparency and reporting obligations on market participants who run dark trading venues known as "dark pools" or "crossing systems", where buy and sell orders are not visible to the rest of the market.

The development of the new rules was prompted by ASIC concerns about the transparency and integrity of crossing systems and a perceived lack of fairness in the way dark pool operators deal with client orders.

At the same time ASIC has added new rules to address perceived risks to market integrity posed by high frequency trading.

The new rules will be introduced at various stages over the next nine months and will require investment banks to quickly implement systems to ensure compliance.

Dark pools

The new rules concerning dark pools contain the following new requirements:

Public website disclosure: crossing system operators must publish details of their crossing systems on a public website including operator details, start date, products traded, eligibility criteria and the aggregation of orders across other crossing systems (new MIR 4A.3.1).

Disclosure to clients: clients of crossing system operators must be given further details of the operation of the crossing system including user obligations, order types available, a description of the operation of the crossing system, fees, whether and how the crossing system operator trades as principal and how any conflicts that may arise are managed (new MIR 4A.3.2). In addition crossing system operators must notify users and ASIC of any significant system outages (new MIR 4A.3.3).

Fair treatment of users: a common set of operating procedures must be employed by crossing system operators which balance the interests of all users, do not unfairly discriminate between users and allow users to opt out of having their orders sent to a crossing system (new MIR 4A.4.1 and 4A.4.4).

Priority in dealing: fairness and priority rules similar to those imposed on market participants on lit trading platforms now apply to client orders in a crossing system. The new rules prevent crossing system operators from systematically matching client orders with principal orders without considering matching client orders (new MIR 4A.4.2 and 4A.4.3).

Monitoring use of crossing system: crossing system operators must monitor the use of their crossing system for compliance with their own user obligations and operating procedures, maintain records of monitoring activities for seven years and notify ASIC of significant breaches (new MIR 4A.5.1).

Reporting suspicious activity: market participants must notify ASIC if they have reasonable grounds to suspect that a person trading on the crossing system has engaged in insider trading or market manipulation (new MIR 4A.5.2).

Tick sizes: the same minimum tick sizes that apply to licensed exchange markets will apply to equity market products traded on crossing systems (new MIR 4A.6.1).

Efficiency and integrity controls: crossing system operators must have the same automated filters and controls as are required for automated order processing on licensed exchange markets to enable immediate suspension, limitation and prohibition of orders which have interfered or are likely to interfere with the efficiency or integrity of the crossing system and the subsequent cancellation of those orders (new MIR 4A.6.2).

Course of sales information: market operators must make available information concerning product identification, transaction time, price, volume, value, participant identifier for the buyer and the seller, condition code and execution venue (including which crossing system the transaction was executed on), for each transaction in a financial product executed on or reported to its market on the third business day after the transaction was executed (new MIR 5.1.6A).

Managing confidential order information: crossing system operators must take reasonable steps to ensure that their officers and employees do not use or disclose information about orders or transactions unless disclosure is permitted or required under the market integrity rules or the law (new MIR 7.4.1).

Ban on negative commissions: crossing system operators are prevented from making a cash payment to another person for the opportunity to handle or execute an order as a result of an arrangement with that person to direct orders to the crossing system operator, if the cash payment means that the net cost ( the value of the commission received by the crossing system operator for handling or executing the order less the value of the cash payment to the other person plus the reported price) is less than the value of the reported price of the transaction or transactions the subject of the order (new MIR 7.5.1).

High frequency trading

ASIC has also introduced new market integrity rules designed to reduce the risk of transactions which give the false or misleading appearance of active trading that may occur as part of high frequency trading.

Market integrity rules already require a market participant not to facilitate trading where it ought reasonably suspect that the trade has been placed with the intention of creating a false or misleading appearance of active trading.

The new rules now require market participants across all lit markets to consider additional circumstances including: the frequency with which orders are placed; the volume of contracts the subject of each order; and the extent to which a person amends or cancels an order relative to the orders executed for that person, when determining whether an order has been placed with the intention of creating a false or misleading appearance of active trading.

The rules regarding monitoring of trades that give the false or misleading appearance of active trading have also been harmonised across all markets, by extending rules that currently only applying to ASX and Chi-X to market participants on the ASX24 market.

In separate amendments, ASIC has also tightened automatic order processing ("AOP") rules and changed reporting requirements for market participants who use AOP:

Annual AOP certification: Market participants will now need to undertake an annual review and certification of AOP systems and provide annual compliance notification to ASIC (new MIR 5.6.8A – 5.6.8B).

Kill switch and other controls: In addition to existing AOP requirements, systems must include automated controls that enable a market participant to immediately suspend AOP or classes of AOP. Market participants must also ensure controls are in place that enable immediate suspension of trading messages in a series, and cancellation of trading messages in a series that have entered the market, where messages are likely to interfere with the efficiency or integrity of the market. (new MIR 5.6.3).

Further details and guidance on the new market integrity rules are available on the ASIC website.

Thanks to James Potter and Elina Spilia for their help in writing this article.

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.