Warning over damage from dark trading in shares

Warning over damage from dark trading in shares

THE quality of Australia’s sharemarket may be severely damaged if the volume of trading in so-called ”dark pools” grows to a similar size to those in the US or Japan, a university research group warns.

The warning came as the corporate regulator released draft rules for market integrity, including plans to introduce protections for people who report suspicious trading activity on the Australian Stock Exchange and Chi-X markets.

Alex Frino, chief executive of the capital markets co-operative research centre, at the University of Sydney Business School, said sharemarket trading costs would increase and price discovery would be harmed if the value of shares traded in private exchange areas, called ”dark pools”, became too large in Australia.

Dark pools are areas away from the main exchange and are where traders go to buy and sell big blocks of shares anonymously. They do so to avoid exchange fees, and to prevent unfavourable price movements on large orders.

Professor Frino has released research that indicates Australia’s market would be too small to handle the volume of dark trading that occurs in larger markets such as in the US, and that if dark trading continues to grow, it may severely damage market quality, while raising the cost of trading.

”If 20 per cent of our trading activity went dark, the increase in the cost of trading [on the main exchange] would be about 1 basis point, which doesn’t sound like a lot, but it’s three times the ASX exchange fee,” he said.

”[But] the dark liquidity that’s occurring in our market place is already impairing the cost of trading in the lit market.”

At the moment, Australia’s lit market accounts for about 70 per cent of turnover while 30 per cent passes through off-market exchanges, according to the ASX. About of 5 per cent of off-market trading goes into dark pools.

Greg Yanco, senior executive leader of market and participant supervision for the Australian Securities and Investments Commission, said the corporate regulator would make no new rules on algorithm testing, nor any new rule on the minimum order size required for trades undertaken in dark pools.

But he said it would push ahead with plans to restrict the ability of traders to trade in dark areas unless they could prove that, by doing so, they would make meaningful price improvements.

”We can see signs that our market may go the way of other markets, where it would deteriorate if there’s too much business done in the dark,” Mr Yanco said.

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