ASIC Publishes MIR FAQ
Australia Competition Market Integrity Rules and Implementation Issues
1. How does this exception differ from ASX’s priority crossing rule?
Our approach to the pre-trade transparency market integrity rules for the start of competition has been, as far as possible, to harmonise across all markets ASX’s existing pre-trade transparency exceptions. This approach includes pre-trade transparency exceptions for large block and portfolio trades and trades outside continuous trading hours.
One key difference is MIR4.2.3, which is intended to:
(a) achieve substantially the same outcome as ASX’s priority crossing and CentrePoint order types (i.e. the same test – trades must be priced at or within the spread at a tick or mid-point); and
(b) accommodate other crossings on the basis of the best available bid and offer across all markets.
As announced in April 2011, we intend to review these initial pre-trade transparency policy settings with public consultation intended by end Q3 2011.
In FAQ 6 we outline the role of market operators in their capacity as reporting and publication venues for trades done otherwise than on an order book. To assist market operators to plan and build their systems, we have provided them with guidance about the nature of validation they should undertake on trades reported to them. There will be occasions when market operators do not accept a trade report. Like today, market participants will need to manage this process.
In FAQ 7, we set out our expectations about how market participants should comply with this exception and their obligation under MIR5.1.1(4) to ensure that post-trade information they report is and remains complete, accurate and up-to-date.
2. What order information must participants consider in determining whether a trade is able to rely on this exception?
Crossings other than on an order book:
Where a transaction is entered into other than by matching of an order on an order book (in accordance with MIR4.2.3), it must be at or within the spread of the best available bid and best available offer at the time (unless it comes within one of the other exceptions described in Regulatory Guide 223). The best available bid and offer are the highest pre-trade transparent bid and lowest pre-trade transparent offer available across all pre-trade transparent order books (also known as the national best bid and offer or NBBO). This includes ASX’s TradeMatch and will include Chi-X’s order book and ASX’s PureMatch when they commence operating. In the example below, the best available bid is 5.03 and the best available offer is 5.06.
Table 1: Example of bids and offers on multiple order books
Best bid Best offer
TradeMatch 5.03 5.07
Chi-X 5.02 5.06
PureMatch 5.02 5.07
Market participants have suggested that there are timing and system implications of including PureMatch data into their compilation of the consolidated best available bid and offer. To address these concerns, we will not expect market participants or market operators to include PureMatch data in their compilation of the best available bid and offer for the purpose of this exception until the later of 1 March 2012 or when PureMatch commences operation.
Where a transaction is entered into in accordance with MIR4.2.3 by matching of an order on an order book, it must be at or within the spread of the reference bid or reference offer. The reference bid and offer are the highest pre-trade transparent bid and lowest pre-trade transparent offer available, based on a reference to a widely available source specified by the market operator in its operating rules and agreed to by ASIC. For on-market crossings on the ASX, the reference is TradeMatch.
3. How does this exception apply when the best bid and offer are the same (i.e. a locked market)?
We consider that where there is no spread because the best bid and offer are the same (e.g. if the bid is 5.05 and the offer is 5.05), transactions relying on this exception can only be done at the locked price (i.e. 5.05).
4. How does this exception apply when the best bid exceeds the best offer (i.e. a crossed market)?
A crossed market occurs when the best bid (e.g. 5.05) exceeds the best offer (e.g. 5.04). We do not expect this scenario to occur often. It is likely to occur more in volatile products, when orders are being entered pre-open and as a result of increasing messaging traffic/ latency. We expect that where it does occur, the arbitrage opportunity it creates will mean it will be very short-lived.
The ‘at or within the spread’ exception was intended to apply when there is a positive spread (i.e. the bid is lower than the offer). It was not intended to apply when there is a negative spread. We consider that if it is imperative to trade during a crossed market, it should be priced at the mid-point (i.e. 5.045 where the bid is 5.05 and offer is 5.04)
5. How does this exception apply when there is only one of either a published bid or offer (i.e. there is no spread)?
We consider that where there is no spread because there is only one of a best bid or offer (e.g. the offer is 5.05 and there is no bid), any trades relying on this exception must be done at the published price (e.g. 5.05 in this example).
6. Will market operators in their role as publication venues validate that trades reported to them and that rely on this exception are actually at or within the spread?
Yes. Market operators, as publication venues, are required under MIR5.1.4(2) to take reasonable steps to ensure that post-trade information they publish is and remains complete, accurate and up-to-date. In RG 223 Guidance on ASIC market integrity rules for competition in exchange markets, we have confirmed that we expect market operators to have systems in place and to take steps to check that the information reported is consistent with the pre-trade transparency exception relied upon by the market participant.
We have subsequently provided guidance to market operators about our expectations, which as far as possible mirror the existing regime. The market operator receiving a trade report must validate, against its own calculation of the consolidated best available bid and offer data across all pre-trade transparent markets, that at the time the trade is received, the trade is:
(a) at the best available bid or at the best available offer (e.g. 5.03 or 5.06 in the example in Table 1 of FAQ 2), subject to a very small tolerance as agreed with ASIC. The purpose of the small tolerance is to take account of latency and complexities in compiling consolidated bid and offer data, particularly initially when there will be different approaches to the inclusion of PureMatch data. All market operators will apply the same tolerance and we will keep the tolerance under review; or
(b) within the best available bid and offer range in so long as it is at a valid price step, or at the mid-point of the best available bid and offer (e.g. 5.04, 5.05 or the mid-point of 5.045 in the example in Table 1 of FAQ 2).
Where the trade is outside (a) and (b) above, the market operator will not publish the trade and will inform the market participant in real-time that the trade report has not been accepted for reporting purposes.
As is required today, market participants need to be prepared to manage transactions that are not accepted, as noted in FAQ 7.
7. What controls does ASIC expect participants to have to comply with this exception?
We expect market participants to have robust procedures and processes in place to ensure that trade reporting systems and associated filters enable only trades that are actually ‘at or within the spread’ to be reported to a relevant market operator under the appropriate exception code. This will assist participants in complying with MIR5.1.1(4), requiring market participants to take reasonable steps to ensure that post-trade information they report is and remains complete, accurate and up-to-date. We consider that there should be regular review of the arrangements and verification by a sufficiently senior executive.
The market integrity rules for the ASX Market and Chi-X Market (rule 4.2.1 in both) also require a market participant to maintain accurate records in sufficient detail, including about transactions. To ensure participants maintain accurate records in sufficient detail when trading under the ‘at or within the spread’ exception, we expect participants to record the best available bid and best available offer at the time the trade is matched (or executed as the case may be) and reported to a market operator. We expect market participants to make this information available to ASIC for inspection on request.
In our consideration of market participant compliance with MIR4.2.3 (the ‘at or within the spread exception) and MIR5.1.1
(4), we will have zero tolerance for error. We will not accept any variation away from the best available bid and offer used by the market participant. Market participants cannot rely on a market operator’s acceptance of a trade as evidence that a trade complies with the MIR4.2.3 exception. The small tolerance afforded to market operators is for their validation purposes only to take account of the additional latency and complexity in the compilation of best available bid and offer data and to help to manage the volume of trade reports that are not accepted.
As is required today, market operators are expected to validate transactions reported to them for accuracy. Market participants need to be prepared to manage transactions that are not accepted (and therefore not published) by market operators as they do today. Where a trade report is not accepted by a market operator (and therefore not published), we will not consider market participants to have met their obligation under MIR5.1.1 until the trade is resubmitted and published.
Refer to FAQ 6 for further information about market operator validation.
Market participants must understand and adapt to any contingency arrangements the relevant market operator may have in place if the reporting service were to have an outage. This may include a manual process.
8. What minimum expectations does ASIC have about the compilation of a consolidated tape of best available bids and offers for the purposes of this exception?
In compiling best available bid and best available offer data we expect market participants and market operators, or their service provider for this purpose, to:
(a) consider all orders from pre-trade transparent order books (i.e. TradeMatch, Chi-X and PureMatch), irrespective of the size and nature of the order. This includes small volume orders and orders that may result in a locked or crossed market;
(b) compile the data in real-time; and
(c) have appropriate systems and controls in place to ensure data is collected and processed in a timely, accurate and reliable way.
Other pre-trade transparency exceptions
9. Will market operators in their role as publication venues validate that trades reported to them and that rely on other pre-trade transparency exceptions comply with the exception?
Yes. Consistent with existing Australian market practice and required under MIR5.1.4(2), market operators will have controls in place to ensure that the trades reported to them meet the criteria of the pre-trade transparency exceptions relied upon. For example, that block trades (MIR4.2.1) meet the $1 million size requirement and that order types subject to time criteria (e.g. post-trading hours, pre-trading hours and out of hours (MIR4.2.4, 4.2.5, 4.2.6)) meet the time requirements. Market operators will also be ensuring there is appropriate use of the large portfolio trade exception (MIR4.2.2).
Automated order processing (AOP)
10. Should AOP filters and checks be based on a market by market assessment or on a whole-of–market assessment?
The market integrity rules for the ASX Market and Chi-X Market (rule 5.6.1 for both) require market participants to ensure that there are appropriate filters in place and that the AOP orders do not interfere with the efficiency and integrity of the relevant market (ASX or Chi-X) or on the proper function of a trading platform on one of those markets. ASX Market and Chi-X Market rule 5.7.2 – Circumstances of the Order (and the associated guidance on AOP operational requirements), require market participants to have regard to the impact that a disruption caused by an AOP order on one market may have on another market (i.e. that they do not interfere with the conduct of an orderly market and do not assist or facilitate manipulative trading). As noted in the “introduction of ASX’s PureMatch” section, we do not expect market participants to include PureMatch market data in their consolidated best bid and offer data until 1 March 2012 or until PureMatch commences operation, whichever is later.
Market participants will also need to certify (or re-certify) their systems when connecting to Chi-X (see FAQ 11). We intend to consult further on a range of broader market structure issues in Q3 this year. The consultation will consider whether existing AOP arrangements need to change to reflect the new multi-market environment, including whether current guidance on filters should offer a more descriptive approach towards multi-markets.
11. Do ASX market participants need to re-certify their AOP systems in order to connect to Chi-X and/or PureMatch?
Yes. We consider connectivity to Chi-X and PureMatch to be material changes within the context of the market integrity rules for the ASX Market and Chi-X Market (rule 5.6.6 for both and 5.6.6A for the Chi-X Market) and ASX Guidance Note 19. We are working with market participants on this re-certification process.
12. Do I need to connect and route client orders to Chi-X and/or PureMatch?
As outlined in RG223, we expect market participants to have the capability to transmit client orders to the markets offering the best outcome for clients and to consider the respective merits of all order books of licensed markets. However, it is not our expectation that every market participant must connect to every order book trading equity market products. In limited circumstances, it may be appropriate to remain solely with ASX’s TradeMatch (for example, where a market participant predominantly deals in products only offered on TradeMatch).
Once a market participant is able to transmit client orders to an order book other than TradeMatch, the participant needs to:
(a) take account of that market in its best execution policies and procedures; and
(b) transmit client orders in accordance with those policies and procedures (see MIR3.2.1 for more detail).
This is subject to the transitional arrangements outlined in FAQ 13.
13. What transitional arrangements are in place for best execution?
MIR3.1.1(6) provides a 12 month transitional period whereby ASX participants may nominate to transmit orders only to ASX’s TradeMatch until 31 October 2012. This transitional arrangement was designed for those existing ASX participants that would prefer more time to prepare to connect (or to consider whether to connect) to an order book other than ASX’s TradeMatch. Before the end of the 12 months, participants relying on this transitional arrangement need to review whether they could obtain a better outcome on other order books. Where this review indicates other order books consistently deliver better outcomes, we expect participants to amend their best execution policies and procedures to access those other order books either directly or indirectly.
Under MIR3.1.1(6), once an ASX participant connects to an order book other than TradeMatch (whether it be Chi-X or PureMatch), the 12 month transitional arrangement would no longer apply. The participant would need to consider that order book in its best execution policy, and route client orders there if it represents the best outcome for the client.
However, we appreciate that for those participants connecting to Chi-X or PureMatch at or near their commencement date, that connecting to a new order book is a significant system and process change requiring a bedding-in period.
Some participants may wish to phase in their use of a new order book to ensure that their systems and processes are working as intended before transmitting significant order volumes. Others may connect to an order book in stages based on business area (e.g. due to different connections and/or systems and processes for proprietary desks and by client type – wholesale or retail). To accommodate this bedding-in period we will allow participants of Chi-X and PureMatch some additional time (until 1 March 2012) to fully comply and incorporate these order books into their best execution arrangements.
14. How does best execution apply in a chain of execution?
We have said in RG 223 that where a market participant seeks to execute a client order by placing it with an intermediary, the duty of best execution for the client under MIR3.1.1 remains the obligation of the original market participant. The intermediary does not need to look through to the underlying client.
We wish to clarify that where a client deals with an agent (whether or not that agent is a market participant) who executes a client order by placing it with another intermediary and that other intermediary:
(a) is a market participant;
(b) also has a relationship with the client (and the terms of business have been agreed); and
(c) is aware that the first participant is acting as an agent (e.g. in an advisory capacity only) for the client,we consider that the intermediary owes a duty of best execution to the client. The Intermediary has the relationship with the client.
15. Can I opt my wholesale clients out of best execution?
No. We will have zero tolerance for participants that are actively inducing their clients into providing a standing instruction that opts them out of their best execution protection.
We note that wholesale clients may provide a standing instruction to a market participant relating to the way they want their orders managed (MIR3.1.1(4)). This includes a request that best execution not apply to the client. This is something that must be at the request of the client and unsolicited by the participant. We note that retail clients are not able to provide standing instructions.
The participant must review at least annually standing instructions by wholesale clients for the best execution protection to not apply. This will ensure the instructions remain relevant.
We expect that this type of instruction will not be used often. The types of clients that may elect to make this type of standing instruction might include clients that use a participant’s infrastructure to directly access a market or a client that happens to also be a participant.
16. What are ASIC’s expectations about disclosing the detail of best execution policies to clients?
The disclosure of a market participant’s execution arrangements will enable the client to make an informed decision as to whether they are likely to receive best execution. The disclosure needs only to provide information about clients the policy covers (i.e. if the participant only deals with wholesale clients then the disclosure does not need to address retail clients).
The best execution policy must disclose certain matters to clients, which are set out in more detail in Table 8 of RG 223.
In brief, it must inform the client that the market participant has an obligation to obtain the best outcome for clients and provide an appropriate level of detail of how the best execution obligation affects the market participant’s handling and execution of client orders, including handling of client instructions. The participant’s arrangements may vary by client type. The disclosure must also include the order books that will be used to achieve best execution and the circumstances under which the orders will be transmitted to those order books (i.e. when one may be considered more appropriate than another).
The policies and procedures, as well as the disclosure statement, will need to be reviewed regularly. We expect this will likely be annually for most participants, but may be more or less frequent for others depending on their circumstances.
Clients must be properly informed when there is a material change to the participant’s best execution arrangements (for example, if they stopped using certain order books that may provide best outcomes).
A market participant must make its best execution disclosure to clients in written form. This includes printed or electronic form such as via email or hyperlinks or references to a website, unless the client specifically asks for it in print form.
All existing clients must receive the disclosure by 31 October 2011, and for new clients the disclosure should be made before accepting a client order for the first time. This is a one-way communication to clients (i.e. the client is not required to acknowledge or consent to the disclosure). We understand that there may be some practical issues in meeting this obligation in full for all existing clients in the first few months after commencement of the best execution obligation. We expect market participants to make all reasonable efforts to comply with this obligation.