Feature: ASX, Chi-X Prepare to Compete in Australia

Competition among trading venues is nothing new in Europe and North America. The splintering of the exchange landscape followed regulatory overhauls in both regions, and the markets have felt the impact.

The Australian equities markets, meanwhile, have so far been spared any serious competition—until now. And it certainly has been a long time coming, says Peter Fowler, COO of Chi-X Australia, an alternative trading venue that is set for an October launch in the country.

“We lodged our application with the Australian Securities and Investments Commission (ASIC) about three-and-a-half years ago. So it’s been a very long road, but it’s good to see that we’re close to the end of that road now, and hopefully the introduction of competition will be beneficial for Australia generally.”

This idea of introducing competition into the Australian equities landscape, an area that has been dominated by the Australian Securities Exchange (ASX) as the sole operator for many years, has received wide support across the board.

The Australian government granted approval for a license to Chi-X—based on ASIC’s recommendation—in April 2011. This, in turn, prompted ASIC to release a set of Market Integrity Rules (MIRs) after consultation, in order to allow for a stable market and to regulate the interaction between the two trading venues. These MIRs have been phased in their delivery, meaning that ASIC has chosen to regulate what it judges to be sufficient to allow for the operation of a competitive market with an expected go-live date of October 31 for Chi-X, while consulting further and developing specific regulation for more contentious areas at a later date.

Lessons Learned
This approach gives the Australian markets a chance to look at what happened in other regions when competition was introduced, specifically Europe and North America. ASIC, which declined to comment for this article, and the exchanges will thus be able to try and avoid being caught flat-footed. It also gives Australia the ability to build a model market without the enormous pressure of being a major financial center.

“One thing that ASIC has done has been to look at the European and US experiences, learn from them and set out to create a more level playing field,” says Steve Grob, director of group strategy at Fidessa and the author of Aussie Rules, the vendor’s recently published whitepaper on liquidity fragmentation in the Australian marketplace. “For example, they’ve maintained standard tick sizes, there’s one central clock that everyone syncs to, and all the stock codes are the same, which will definitely make it easier for Chi-X to compete.”

Harrell Smith, head of product strategy at Portware, says some of the measures introduced by ASIC have been modeled on other markets, but adds that future developments should be based on how the new market behaves. “With the lessons learned from the US and Europe, you really have to have a measured approach in some respects, particularly with things like proposals about minimum order sizes or order values in liquidity pools,” he says. “I think that is something that the US and Europe are still grappling with now, and it will be best left for future analysis, based on order flow and what the markets do. Only time will tell if there’s a measurable impact on price transparency in the lit market as more liquidity moves into dark pools.”

The key piece of regulation in the MIRs is the retention of ASX as the central clearinghouse for all trades. “You don’t see a lot written about how ASX is actually going to do the clearing for Chi-X,” says Rob Hegarty, managing director and global head of market structure at Thomson Reuters. “I think they have learned a lesson there—you almost have to open up your market to fragmentation on the trading side, and I think that is a healthy thing for the markets because technology has advanced so much that you have to let some new players come into the market with advanced technology and new models on the trading side, but I think they did a smart thing and said they’re still going to do clearing centrally.”

Fragmentation on the clearing side is not a healthy thing, Hegarty says. “If we compare and contrast the US and the European equities markets, you can see that. The European equities markets are 10 times more expensive to clear than they are in the US, and I think a lot of that has to do with the fragmentation in Europe.”

Jumping the Gun
ASX has been given quite a long period of time to prepare, according to Fidessa’s Grob. “I think they’ve been forward-thinking in their approach—for example, if you look at where ASX is now compared to where, say, the London Stock Exchange (LSE) was at the same time in relation to Chi-X, the contrast is quite startling,” he says. “If you think about it, ASX has already introduced a co-location center and a dark pool, it plans to introduce a high-frequency matching book in PureMatch, and Chi-X is still [a few weeks away] from its scheduled launch. Compare that to the LSE, where it was. Three years after Chi-X went live, it launched MillenniumIT as its low-latency platform to attract the high-frequency trading community. So you can see just how robust ASX’s approach is.”

Industry participants seem impressed with how the ASX has met the specter of competition head-on. The exchange’s CEO and managing director Robert Elstone points to the groundwork it has been laying in anticipation. “ASX has been preparing for the reality of domestic competition and a more complex environment for market services for several years,” says Elstone, who will be replaced by Elmer Funke Kupper in mid-October. “As our chairman, David Gonski, says in the annual report, we’ll be ready,” Elstone says.

Funke Kupper says he has confidence in the ASX and its ability to perform in the competitive market. “The ASX has better prepared itself than any other exchange—and you should assume that I have done my own due diligence before accepting the job,” he says. “It has prepared itself extremely well for the changes that are happening around it and it’s a change that needed to happen for the business.”

Preparing for Battle
Chi-X Australia has recognized this. Despite the ASX’s head start with initiatives such as its high-speed fiber-optic distribution network, ASX Net, its collaboration with Fidessa on the new trading platform ASX Best, and the aforementioned developments such as its datacenter and PureMatch, the new venue still points to other instances where competition has been introduced as a marker for its own future success. “I’m sure it’s made life more difficult for us. I think we would have loved to have taken the ASX on three years ago, but that wasn’t to be, and I’m sure that the ASX has taken advantage of that time,” says Fowler. “But I think it’s fair to say that wherever you look, the established exchanges all seem to have lost out to the new entrants. I’m not sure that there’s a good success story that ASX could point to; they can just see things that haven’t worked so far.”

ASX’s deployment of advanced technology, and the time it has had to prepare is unlikely to be enough to  mitigate the threat posed by Chi-X. The upstart operator has consistently performed nearly everywhere it has been deployed, including the Japanese market, where it has gained a foothold.

Often, that is all it takes for momentum to build behind a competitor, according to Fidessa’s Grob. “If you look at every single marketplace where Chi-X has put down roots, it has successfully changed the trading landscape,” he says. “You can see what Chi-X has done in Europe—it’s the largest venue for European trading at the moment. I think Canada is interesting, because Chi-X and others have been successful there, and I would also point to Chi-X Japan, which is probably the hardest market for them to break into. I think it now has just under 3 percent of the Nikkei, and is now vying to be the largest alternative venue in Japan—and that’s all in just a year,” Grob says.

Market participants stand up and take notice when a venue trades about 5 percent of a stock or index, Grob says. “The sell side starts tuning its routers to consider your venue more, and then you have a situation of liquidity begetting liquidity,” he says.

One of the more curious aspects of the new market structure in Australia is the prescribed cooperation between the venues. Ostensibly to preserve market integrity through uniform opening/closing times, tick sizes and clearing, this has necessitated a level of cooperation between the ASX and Chi-X to establish communicative and technological links between what will be rivals.

“ASX and Chi-X are working cooperatively to ensure that each market operator has access to the relevant regulatory data as required by ASIC’s new MIRs,” says ASX’s Elstone. “The technological aspect has been manageable rather than challenging, although it has involved extensive work. For example, ASX, where required, will provide Chi-X with access to its data feeds. Other MIR-related technological changes include the development of new order-entry controls and a crossing validation mechanism. Overall, the work undertaken by ASX has been to accommodate a new type of consumer of ASX products and services—namely, another market operator.”

Brave New World
A knock-on effect for Australian brokers, therefore, is developing tools that can work with both venues, and this brings in smart order-routing, something that was previously non-essential for an Australian participant. “If you’re an Australian broker, I think it means a couple of things,” says Grob. “First is that your world is going to change, and that’s an absolute fact. The second thing is that ASIC has given this a 12-month grace period where people can still be within the best execution framework by just trading on ASX. But I think for all practical purposes, people will pretty quickly have to have some smart-routing capability.”

All this is dependent on the timings involved. Chi-X’s Fowler says the venue is looking to an early-November launch, but that it wouldn’t dogmatically stick to that. “Under the MIRs released by ASIC, the earliest we can launch is October 31,” he explains. “We’re certainly targeting that date, but we’re also keen to stress that we’re not wed to that date but rather to a successful launch. So if that means we have to launch after, then we will do so in the interest of having a successful launch and of market integrity generally.”

The effect of technology on the markets is ongoing, and the process by which competition has been introduced in the Australian market provides insight into how it is shaping the way in which the financial industry operates and evolves.

More than that, it emphasizes the need for a flexible approach to technological implementation, one that allows for the most efficient day-to-day operations, and remains pliant enough to adjust and reform itself in the wake of heavy reform and change on the micro-structural level of a market itself.

Whether this reform and focus on technological competency will reduce the stumbling responses to competition that previously seen in Europe and North America is, at this point, the big question.