Dark Pools Hamper Market Efficiency, Should Be Avoided, ASX Says

Dark pools reduce efficiency by dividing markets and should be avoided unless there’s a good reason, such as block trades, to use them, said ASX Ltd. Chief Executive Officer Elmer Funke Kupper.

“Fragmentation is ultimately the enemy of efficient markets, so you need a good reason to not transact in a single market,” Funke Kupper, head of Australia’s biggest exchange operator, said in a speech in Sydney today. “Block trades, where institutions try to find each other with large orders in an efficient way with minimum market impact costs, is such a good reason.”

New rules to be enforced in May will require trades done in dark pools, broker-operated private venues that don’t display orders publicly, to achieve a better price than public venues. A study by the Australian Securities and Investments Commission released this month proposed that where price formation deteriorates due to dark-pool trading, there should be a trigger to implement a minimum-size threshold for orders.

“We do support a threshold of between A$20,000 ($20,904) and A$50,000 or possibly higher, what we’d like to do is make sure that the trigger for that is as simple as possible,” Funke Kupper said.

ASX’s main Australian exchange handled 67 percent of trades of shares listed on the S&P/ASX 200 Index in February while its dark pool, Centre Point, handled 3.7 percent, according to Fidessa Group Plc.

In the U.S., a Rosenblatt Securities Inc. report tracking 19 venues showed dark pools accounted for a record 14.3 percent of U.S. equity volume in January.

High-Frequency Trading

On high-frequency trading, while some behavior by market participants does “undermine confidence,” that is more a result of the number of trades taking place, rather than the speed, Funke Kupper said.

“Today, trades below A$500 represent some 40 percent of the trades on the exchange; that used to be 10 percent a number of years ago,” he said. “We should have controls for small orders. When we analyzed the market, there tend to be between five and nine investment banks and brokers that generate all this order proliferation.”

In a separate study also released this month, ASIC said concern about high-frequency trading is “overstated,” and that it found no systematic manipulation of markets by traders using these strategies. ASIC proposed a new rule for minimum resting periods for “small and fleeting” orders and another for the guidance on trading practices that may illustrate manipulative activity.

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