David Chaplin 's Opinion

A personal finance columnist for the NZ Herald

Inside Money: The speed of dark: report lets machines off with caution

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Photo / Thinkstock
Photo / Thinkstock

Caution: this report contains high frequency reference to dark liquids.

But by bundling two of the most-vexed technologically-driven market problems into a single document, the Australian Securities and Investment Commission (ASIC) Report 331, 'Dark liquidity and high-frequency trading', has gone about the job efficiently.

Both dark liquidity (also known as 'dark pools') - where institutional investors use off-market systems to trade large share tranches - and algorithmically-controlled high-frequency trading have been bothering investors around the world over the last few years.

The twin evils, which incorporate a variety of underlying practices, have been blamed for, amongst other ills, increasing market volatility while decreasing transparency and fairness.

Well, yes and no, ASIC says.

Its report, based on the investigation of two taskforces, concludes that generally the machines don't run things too badly.

Nonetheless, the market regulator has noted a few areas of concern, more so with the dark pools than the high-frequency flash mobs.

For example, ASIC found "anecdotal evidence that there is less trading by fundamental investors" on regular open exchanges.

Furthermore, the report says as smaller tranches of shares change hands on the dark exchanges there is "evidence that the quality of price formation has been adversely affected".

ASIC has proposed "a trigger for implementing a tiered minimum size threshold" to combat the problem when it is identified in "a security or group of securities".

However, the report says fears about high-frequency traders disrupting the markets with super-smart algorithms are mostly over-cooked.

ASIC says there is little evidence that high-speed traders are flooding the Australian share market (which New Zealand investors are heavily exposed to) with insincere orders in an attempt to skew prices. In fact, the report says the Australian "order-to-trade ratio" is moderate compared to offshore markets.

Another tell-tale metric of high-frequency trading, the holding time of security ownership, also indicates the algorithms aren't operating at full-speed.

"Our analysis shows that only 1.2% of high-frequency traders held positions for an average of two minutes or less, 18% for less than 10 minutes and 51% for less than 30 minutes," the report says.

But to throw a little more grit in the mechanism, ASIC has recommended a "minimum resting time of 500 milliseconds for small orders of $500 or less".

Despite high-speed traders mostly getting off lightly, ASIC says "there is some basis in fact for other perceptions (eg about high-frequency trading creating excessive noise and exhibiting predatory or 'gaming' behaviours)".

The machines, however, aren't the only ones playing games, as ASIC points "other traders are also contributing to the problem".

David Chaplin

A personal finance columnist for the NZ Herald

David is a freelance journalist who has covered the financial services business on both sides of the Tasman for over 15 years. David has edited magazines and websites for the financial advice, investment and superannuation industries. Today, he contributes to various publications in Australia as well as his bi-weekly blog for the NZ Herald under the 'Inside Money' banner.

Read more by David Chaplin

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