By Ben Jefferys, Head of Trading Solutions, IRESS
Constant change is the new normal these days for sell side brokers not only in Australia but also across the rest of the world. Regulation is the main driver of this constant change, followed by competitiveness and an overall quest to reduce costs and introduce efficiencies where possible. In 2013 trading volumes still remain subdued even though there have been noticeably good volume for days even weeks seen earlier in the year. The positive in this is that the sell-side is focussing on the order flow that they have, making sure it gets the best possible result for their clients and are keen to do so in the most efficient manner. Thankfully the barrage of change due to the competitiveness between the exchanges has become less intense. The regulator, ASIC, has helped to control some of this by trying to have exchanges release innovation based changes on a biannual basis. This almost routine release of innovation by exchanges has had to be balanced carefully so that sell-side brokers have the ability to test, release and ultimately incorporate it into their day-to-day operations. Brokers can become saturated with change and the cost to deploy new software into production can be high. This teamed with scarce or limited test resources means that decent innovation can unfortunately go by the wayside. The priority for brokers is always meeting regulatory requirements, anything else comes second.
Some of the recent regulatory changes have had a significant impact on trading in Australia. Perhaps not strictly in terms of the amounts traded, but certainly when it comes to how and where. One of the objectives that saw changes to the Market Integrity Rules (MIRs) was to limit small orders at either the bid or offer price being crossed off the market by dark pools and crossing systems. Crossings within the spread or rather the National Best Bid Offer (NBBO) are still permitted as long as they offer a meaningful price improvement. This has in effect removed the far majority of these types of NBBO crossings and instead the orders must route through to the exchange to trade with the existing lit liquidity on either the ASX TradeMatch or Chi-X order books. It would seem that the ASX, where the bulk of passive orders sit, would be the main beneficiary for now as prior to the rule change operators of dark pools and crossing systems could execute both orders via an NBBO crossing at a cheaper combined rate. Orders are now trading separately on the market where brokers must pay the full buy and sell transaction fees instead of a slightly cheaper combined fee for a crossing.
Another of the changes that has been more positively accepted by sell-side brokers is where ASIC have relaxed the requirements for reporting large block sized special crossings by introducing a tiered structure where smaller stocks have a smaller minimum block size requirement. As these crossings don’t share the restrictions of their NBBO siblings we are seeing dark pools being adapted to cater for the change. Overall the changes bring Australia more in line with its overseas peers which is especially positive when attracting order flow from offshore. Regulation aside there has been little time left for brokers to innovate by way of introducing new technology. The exchanges have new products available for faster trading that use ITCH and OUCH protocols, but for the most part brokers still rely on the older and slower products because the new versions are not quite rich enough in terms of the available data to be fully replaced.
For those that do or rather can take such products, their focus is likely being as fast as possible to react to market movements and subsequently trade whilst for others it will be about minimising the disruption to their existing order flow from latency arbitrage or rather the dreaded High Frequency Trading (HFT) strategies. Whatever you want to call it, HFT, gaming or information leakage, there has been a noticeable rise in this type of activity over recent months. Some brokers are able to combat the issue by taking the newer products as mentioned above from the exchanges. Others look to fine tune their smart order routers by normalising the arrival times when spraying an order across exchanges. This reduces the window of opportunity to be beaten by an HFT strategy and for the most part is rather effective.
The last area of change that we see is where brokers are reviewing their infrastructure for a number of reasons. First of all is cost, all brokers are under pressure to cut costs in this environment. Add to this the geographical issues associated with using a smart order router and gaming, and brokers have compelling reasons to look at how and where they host their trading systems. Centralising infrastructure to save money, deliver better trading performance whilst at the same time offering a more complete disaster recovery setup seems to be a good result all round.
Looking towards the future we expect to see more of the same. Globally, regulators are still working out how best to deal with dark liquidity and HFT. Thankfully the approach in Australia has been well balanced and measured ensuring that brokers have enough time to react and adapt. The pressure to drive down costs and increase efficiency will continue. At least by ensuring that brokers are compliant with regulatory changes also means that from a technology point they are up-to-date and aren’t left behind giving everyone the best possible chance at survival in a tough and changing market.