Measuring Change To Find A New Path

By Ben Jefferys, Head of Trading Solutions, IRESS
Whether you look at it from a global, regional or local perspective, markets have changed a lot in recent times. A lot of this is to do with newer regulatory requirements but in markets where more than one exchange competes there has been a lot of competitive innovation too. With no sign of the rate of change slowing anytime soon could there be a better way for the industry to move forward? To explore this we first take a look at the effects of recent regulatory change on trading volumes and patterns.
Despite slight increases in overall market volume, the value of share trading today is averaging lower than where it was a year ago. Some brief periods of increased volatility supported higher volumes but relatively speaking markets remain quiet. Still the number of transactions across the board continues to rise as the markets further fragment. We now have well over a year of trading since the Australian regulator ASIC made changes to off-market transactions relating to price improvement and block sized trades.

Message rates on the Australian exchanges have remained stable for 2014. By looking at the number of create, amend and cancel messages on each exchange we see both ASX and Chi-X exchanges are following a similar level of activity this year. Even though the ASX is effectively a busier exchange in terms of the headline number of messages it looks a little different when we compare it to the actual amount of volume transacted on each exchange.

Here we can look back a bit further to the start of 2013 and see that the total Chi-X volume has been slowly increasing whilst the total ASX volume even though being more volatile is slowly decreasing. Overall Chi-X still trails ASX in terms of market share but the message rate on Chi-X relative to its traded volume is higher than the ASX giving it a higher order to trade ratio. What we see here in Australia is really no different to what we see in other markets around the world where newer alternative exchanges are competing with the incumbent exchange. The newer alternative exchanges need market makers passively resting in their order books at the same or better prices than the incumbent so that broker smart order routers will target these exchanges. As prices move around on the incumbent exchange the market makers tend to move in sync on the alternative exchange adding to its ‘busyness’ whilst not transacting as much volume.
Because the messaging rate has remained reasonably stable whilst the volume on Chi-X is slowly growing it is a positive result for those supporting competition. The market is becoming more confident in trading away from the incumbent exchange. Market makers are supplying more liquidity by sitting passively with more volume. At the same time sell side brokers are also happy to post liquidity into these exchanges driven primarily by cheaper execution costs and a reduced queue time for stocks where this counts.
But these last 12 months have also been interesting from a post regulatory change point of view. In May 2013 ASIC changes regarding off market crossings for dark liquidity took effect. ASIC have recently made public comment on these changes in “Report 394 – Review of recent rule changes affecting dark liquidity”. A lot of focus has been put into trading around the new block special tiers but it is equally interesting to look at the effect on trades below block size that are now referred to as trades “with meaningful price improvement”.
ASIC were concerned with the amount of off market trading taking place away from the lit exchanges of ASX and Chi-X and for amongst other reasons its effect on price formation. Previously below block size crossings could take place at the best bid/offer and within the spread. The rule changes sought to address the situation and protect market quality by limiting what can be done off market and encouraging brokers to post liquidity back onto the lit exchanges. Nowadays these off market crossings below block size can only trade within the spread and offer a meaningful price improvement.
Looking at some sample data helps illustrate just what the effect has been. Telstra is a great example to use because it is well fragmented not only due to its size but also because of the way it trades. Telstra is a “queue stock” where establishing priority for passive orders is important.

Prior to the rule changes vast amounts of Telstra traded via NX crossings that could be done at the bid or offer. Brokers would always try and establish queue priority but then jump the queue and cross with an opposing order when the opportunity arose. The immediate effect of the rule change was a sharp drop in the number of below block size crossings. In fact these ‘NX’ crossings were down +60% the following month. Since then the number of NX crossings has remained fairly stable. It’s worth noting that in this example we don’t include what were known as ASX Priority Crossings that would extend the effect of the change as some broker crossing engines still used this order type at the time.