U.S. Should Watch Australia Dark Pool Laws, Schapiro Says

U.S. regulators seeking to increase the efficiency of anonymous trading platforms should monitor the progress of counterparts in Australia and Canada, the former chairman of the Securities and Exchange Commission said.

“The Australians are moving ahead on issues around dark pools, as well as the Canadians,” Mary Schapiro, who is now a managing director at consulting firm Promontory Financial Group LLC, said in an interview in Hong Kong today. “It’s really important for the U.S. to look at what’s happening in those markets.”

Almost 40 percent of U.S. stock trading takes place privately on alternative venues such as dark pools, venues that don’t display prices until after trades take place. The rise of alternative platforms has spurred requests from public exchanges to curb the trading and new disclosure requirements from the Financial Industry Regulatory Authority.

Dark equity trading has slumped in Australia after the nation implemented a rule in May requiring all trading done in dark pools to beat the best price offered by the main exchange. Anonymous venues accounted for 23 percent of total trading last week, down from 34 percent in the last week of April, according to data from ASX Ltd., the country’s main exchange operator.

U.S. exchanges want the SEC to pass a similar rule, which would require brokers to route an order to an exchange unless they can improve on the best public quote by a defined amount. Since Canada imposed such a rule last year, quoted spreads and volatility have fallen, the chief executive officers of NYSE Euronext and Nasdaq OMX Group Inc. told current SEC Chairman Mary Jo White on May 1.

Less Complex

Asia’s less complex market structures mean regulators have been better able to regulate the growth of electronic trading and alternative venues during their nascent stages. While U.S. stock trading is spread across more than 50 venues, Japan and Australia are the only Asia-Pacific developed markets that allow public platforms to compete with the main exchanges.

Ashley Alder, chief executive officer of the Hong Kong Securities and Futures Commission, said in August that the city had a “last-mover advantage” when it came to writing regulations around dark pools and high-frequency trading, which both account for less than 2 percent of equities trading in the jurisdiction.

“There’s an opportunity to learn from the U.S. experience and some of the issues we’ve had,” Schapiro said. “It’s resulted in a fair amount of fragmentation, a significant amount of volume being executed in dark pools without as much transparency as one would hope and as much contribution to price discovery as one would hope.”

Corporate Governance

Schapiro helmed the SEC from 2009 to 2012, taking over after Lehman Brothers Holdings Inc. and Bear Stearns Cos. collapsed. She was given the task of implementing much of the sweeping financial reform mandated by the U.S. Dodd-Frank Act.

Having previously also served as chairman of the Commodity Futures Trading Commission and chief executive officer of the Financial Industry Regulatory Authority, Schapiro joined Washington-based Promontory in April as a managing director advising clients on risk management and corporate governance.

Electronic trading and exchange technology have drawn regulators’ focus after market disruptions including a May 2010 incident that saw the Dow Jones Industrial Average fall almost 1,000 points in minutes before rebounding. China had its own version when faulty trading software used by Everbright Securities Co.’s proprietary-trading desk sent unintended buy orders that caused the Shanghai Composite Index to swing more than 6 percent on Aug. 16.

Market Disruptions

“Having data about what the impact is of dark pool trading, or algorithmic trading or high frequency trading on the quality of our markets is really critical,” Schapiro said. “Armed with that kind of data, it would become much more clear what, if any, steps regulators need to take to take with respect to the market structure.”

The SEC’s White told U.S. exchanges on Sept. 12 to collaborate on making markets more resilient to prevent further disruptions such as the one caused by Nasdaq and gave the bourses 60 days to respond. The operators said Nov. 13 that they’ve identified potential improvements in five areas, including the stock market’s main public data feeds.

System Malfunctions

Nasdaq’s data system failed on Aug. 22, forcing it to halt transactions in all of its shares for about three hours. That came two days after a glitch at a Goldman Sachs Group Inc. computer flooded options markets with orders.

Knight Capital Group Inc., based in Jersey City, New Jersey, bombarded exchanges with mistaken orders on Aug. 1, 2012. The firm, renamed KCG after being purchased by Getco LLC, almost went bankrupt following the software malfunction that caused more than $450 million in trading losses.

Regulators can “require more rigorous testing of algorithms, better understanding of what can go wrong and what’s the impact of things that go wrong,” Schapiro said. “Whether it’s the actual trading mechanisms at the exchanges or important infrastructure like the consolidated tape, all of these things have to be tested and backed up and have seamless fail-over to alternative systems, so there is a lot of work to do.”

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