Australia’s Multi-Market Landscape

Ben Jefferys, Head of Trading Solutions, IRESS, looks back at a year of the multi-market environment, and the future growth potential.
With almost a year of a multi-market environment in Australia, it’s time to stop and reflect on the year that has just passed. The question often talked about town is whether expectations have been met; but depending on who you are or who you talk to those expectations were very different things, if anything at all.
As Australia anticipated the launch of Chi-X and its rival ASX PureMatch we looked abroad to get a sense of what to expect. It didn’t take long to realise that the legislative framework and market structure within Australia was different to other countries and regions in the world. Many felt that the Canadian experience would be the closest, but still there were enough significant differences to ensure that Australia’s journey was a unique one.
The most relevant point of difference between Australia and other parts of the world was just what happens when there is a better price on one market compared to another. In Australia there are no hard and fast rules about having to solely execute at the better price. It comes down to the market participant (i.e. the broker) and their respective best execution policies. The latest guidance from the regulator, ASIC, says that a broker needs to make a decision on whether to trade on markets other than the ASX if outcomes, including all costs involved, are consistently delivering better results for clients.
In Europe where the European Union’s Markets in Financial Instruments Directive (MiFID) applies, best execution is “principles based” where the premise lies in achieving the best outcome for the client. It is important to note that it states best outcome and not just best price.
The US and Canada have what are known as trade-through protection rules but then the definition in each country differs. For the US, if there is a better quoted price on another exchange, then the order must be forwarded by the receiving exchange to the exchange with a better price. In Canada it is similar but not quite the same. If there is a better price elsewhere, then the exchange must reject the order and the broker must then try again and send it to the exchange where the better price exists.
Delving into the detail of how each market is structured and how their respective legislative frameworks operate one would have found it increasingly difficult to predict just what might happen in Australia in a multi-market environment.
Depending on what side of the fence you sat those expectations ranged from cheaper transaction costs through to tighter spreads and everything in between. If you went and asked the industry as to whether these last 12 months constituted success for multi-markets in Australia, sadly the response is most likely to be one of indifference.
The Arrival of Fragmentation
But a lot has been achieved in the last two years by exchanges, market participants, regulators and vendors. The change has been immense. If we focus just on innovation around the fragmentation of the Australian marketplace most people would be surprised at just how long this change has been in motion. It was back in June 2010 when the ASX fragmented its own market with the CentrePoint and VolumeMatch products. The latter traded once and has not since, whilst CentrePoint has developed into a successful alternative market where price improvements can be realised by trading at the mid-point of the spread.
Then on 31 October 2011 Chi-X Australia commenced trading on a small number of stocks and was in full swing by 9 November 2011 trading all ASX 200 stocks plus ETFs. Similarly, the ASX soft-launched its competing PureMatch product a month later on 28 November 2011.
Fragmentation had officially arrived and a survival of the fittest began. Market participants were now spoilt for choice. There were the lit markets ASX TradeMatch, ASX PureMatch and Chi-X along with the dark ASX CentrePoint market and ASX VolumeMatch sitting somewhere in between. Hidden orders could also be pegged within the spread on Chi-X.
When it came to the lit markets it didn’t take long for there to be only one alternate exchange left competing with ASX TradeMatch. ASX PureMatch traded upon its launch but has been dormant ever since. The regulator, ASIC, finally confirmed the fate of PureMatch when on 23 February 2012 it indefinitely extended its waiver that PureMatch bid/offer quotes are not required to be included in National Best Bid Offer (NBO) calculations until it reached a liquidity level on average over 10 consecutive trading days of 0.2%.
Gaining Ground
Chi-X however has been slowly gaining ground since its launch – but is it the success that everyone expected? How did it compare to what was seen in other markets around the world? Looking at what happened in Canada in terms of market share we can directly compare just how the Australian foray into multi-markets stacks up. Markets first fragmented in Canada back in 2007 when a market called Pure launched, which in all respects never gained significant market share. But a more realistic comparison can be made by benchmarking against Chi-X Canada and another called Alpha which is owned by Canada’s biggest banks. After six months of trading, Chi-X Australia’s overall market share sat at approximately 1.9% and at the time of writing and after 11 months market share had risen to 4.6%. Comparing this to the two successful alternative exchanges in Canada we can see that Chi-X Australia is tracking well. Out of interest, the most recent market share statistics for these markets see Chi-X Canada and Alpha with approximately 9% and 19% respectively.

The following chart helps visualise this comparison over a longer period. It shows the first 24 months of multi markets in Canada and overlays what we have seen to date in Australia. Within that 24 month period in Canada four separate exchanges launched; Pure in September 2007, Omega in December 2007, Chi-X in February 2008 and Alpha in November 2008. Momentum gathered pace once volumes got past 2-3% and within 18 months close to 10% of volume in Canada was traded on alternative markets. Within two years it was pushing 20%. Whether Australia follows is anyone’s guess but looking at the numbers so far it appears that things are heading in the same direction.

Trading volumes and market share are simple measures but buy- and sell-sides must find more comprehensive ways of determining how multi-markets can possibly benefit their business. As discussed earlier, best execution in Australia doesn’t just have to mean the best price, and as ASIC states, we should be looking for a consistently better outcome for the client. For a private client it is likely to be driven on best price, whilst an institutional buy-side client needs the best price considering depth and availability of liquidity to the stocks they are trading, whilst accounting for latency and minimising market impact.
Analysing the Change
New suites of tools are evolving to help with the necessary analysis to seek liquidity at the best price possible. The emphasis for the buy-side on transactional costs analysis (TCA) is heightened since liquidity is split across more exchanges and dark pools making it more complex to minimise market impact. As the marketplace fragmented, the buy-side would often express that it becomes harder to trade stock in size, whilst at the same time proponents of HFT and market makers on alternative exchanges claim that they are adding liquidity to these markets and offering tighter spreads. Whatever the outcome this reiterates the need for tools to monitor the quality and cost of execution, whether it is on one or multiple exchanges.
Similarly, whether you are trading on one or multiple exchanges there is now a need to monitor what are known as “trade-throughs”. A trade-through occurs when there was a better price available on a different exchange compared with the price on the exchange that you traded at. To date in Australia the monitoring of trade-throughs has been a function of a select number of brokers using smart order routers. Trade-through analysis (TTA) is a good way to measure the effectiveness of a smart order router but as awareness grows along with the market share of alternative exchanges we are now seeing greater interest in TTA. In Australia the brokers to a trade become publicly disclosed on T+3 and this is incorporated within TTA tools. One broker can compare their trade throughs with the next and the same applies for the buy-side who can look across all brokers and rank them according to the number and value of trade throughs. As volume on alternative exchanges increases then so does the likelihood of a trade through.
So it is no wonder that the expectation of multi markets in Australia is varied if not distorted. We have a marketplace that has dramatically changed with the introduction of alternative exchanges, suites of new tools and data to monitor execution quality and two exchanges competing in an arms race for liquidity with an almost constant stream of innovation. All in all it is a difficult path to navigate but spending the time to understand the change is advantageous. Whether the outcome is one of realising a better price or not it is certainly worth understanding the new structure to help uncover ways of extracting the best and most efficient means of getting the desired result. Only then can a true expectation be set and then later evaluated.