ASX:A Leopard Can Change His Spots
Since 1987, the Australian Stock Exchange (ASX) had enjoyed a monopoly as a self-regulating utility for equities trading. As with all monopolies, fees were high, service was low with fat profit margins paid out to shareholders in the form of dividends rather than being reinvested in the business. Having been demutualised in 1998, the ASX sought to put the Sydney Futures Exchange in its grasp to consolidate derivatives trading as well but failed in that attempt. They were not deterred and in 2006 successfully merged the ASX and SFE to create the Australian Securities Exchange. By this time, REG NMS and exchange competition was in full swing in the US and the European Union under MIFID opened its markets in 2007. The shackles of exchange monopolies were being broken around the world and Australia would be no exception. On March 31, 2010 the Australian Government endorsed competition between exchange operators for trading in listed securities. Nineteen months to the day on October 31, 2011 Chi-X Australia executed its first trade bringing an end to a 24 year monopoly.
The ASX could see the writing on the wall and had the experience of its global peers to counter this challenge to its dominance. Particularly, in the UK at the venerable London Stock Exchange who baulked at competition and was slow to put in place its battle plans saw it lose a substantial amount of market share which it is still fighting to overcome. Not to fall victim to the same complacency, the ASX set out to overhaul its entire business with new investments, initiatives and incentives.
Technology is what modern electronic trading and exchanges are made of. And at its heart is the NASDAQ OMX’s Genium INET which went live in the derivatives segment, called ASX Trade 24, October 11, 2010 and the equity segment, ASX Trade, November 29, 2010 pushing latency down to 300 microseconds and orders per second up to 100,000. Supersonic matching engines capable of outsized throughput are the global standard and the ASX can count itself among them.
Like floor trading of the not too distant past, traders wanted to be as close as possible to the market and the advent of colocation mirrored this behavior in the electronic era. The ASX introduced this service back in December 2008 with the likes of UBS, JP Morgan, Instinet, Optiver and Tibra Trading being among the first to populate the facility. A new home, dubbed the Australian Liquidity Centre (ALC), is slated to go live February 6 after a 3 month delay from an outage experienced in October. The ASX ALC is located at the Gore Hill Business Park in Artarmon only 5km north-west of Sydney’s Central Business District. The A$32 million facility is designed to be carrier neutral housing both ASX and ASX 24 market participants and vendors, including application service providers (ASPs), network providers, data vendors and independent software vendors (ISVs). All facility tenants can use their own domestic and international network service providers for communications outside of the building.
Australian Liquidity Centre Services:
• Tier 1 and Tier 2 technical support.
• 24/7 security and surveillance.
• Locking cages.
• Two connection choices: Liquidity Cross Connect (LCC); and a Gateway in Cabinet (GiC) solution for standard latency connection.
• Delivery receipt and storage for up to 24 hours.
• Equipment installation.
The ALC is designated as a Tier 3 data center holding 47 Rack Units (RU). Each cabinet is supplied with 2 kW of power from two independent feeds along two independent power rails. VESDA fire control, DRUPS back up and redundant Meet-Me Rooms are just some of the facility features. ASX provides managed connectivity via fiber Local Area Network (LAN), point-to-point physical direct cable, an ASX Switch in Cabinet (SiC) or a Gateway in Cabinet element. The Liquidity Cross Connect is a 10 Gbit/s pipe whose length to the matching engine is the same for everyone providing location neutrality within the ALC. The GiC option offers 1 Gbit/s and allows for FIX Protocol connectivity to ASX.
• A fiber connection as well as UTP Cat 6 standard cabling.
• Cabinets are 1.10 m deep and 0.80 m wide, with a 6-port fiber patch panel and a 6-port UTP patch panel. Front and rear doors to the cabinets are standard 80 percent free air mesh doors and all are equipped with electronic locking.
• Standard 2kW of power per cabinet with additional power up to 6kW. Cabinets come with 32A/230V unmetered power rails.
• Connection speeds up to 10 gigabytes per second.
• Roof space available for antennae and satellite connections.
New Order Types
With new technology comes the latest order types and order books. The new matching engine made it possible for the ASX to roll out a series of innovative transaction types. In 2010 Centre Point, Centre Point Crossing, Icebergs, and VolumeMatch were introduced then PureMatch in late 2011. Each feature is catered for a specific segment of the market.
Centre Point orders allow for market participants to trade anonymously by executing in a separate dark pool in which buyers and sellers are matched and trades executed automatically at the midpoint of the bid and ask prices current in the Central Limit Order Book (CLOB). Centre Point orders can only trade with other Centre Point orders completely separate from the CLOB. The venue has been a huge success for the exchange and the industry with price improvement as high as 42bps. (See Graph)
Centre Point Crossing
Similar to Centre Point, this order type allows for orders to cross at the midpoint of the best bid and offer on the CLOB. However, the system “locks in” a price for up to 30 seconds, giving the market participant the option to execute within that period of time regardless of the price the name is showing in the CLOB after initiating the cross. Once executed the trade appears in the order book history. This order has been very successful as well (See Graph)
Icebergs are limit orders that allow market participants looking to buy or sell large quantities of securities but want to mask the true size of their order. Once the child order is filled a new slice is sent to the back of the queue at the limit or better price.
ASX also makes it possible for participants to place orders without divulging the intended volume. These orders are available on order sizes of A$500,000 and up. Traders can elect to place day-only orders, fill-and-kill, or good-til-cancel orders. Undisclosed orders can be used to indicate a size dealing commitment, in order to attract possible counterparties.
VolumeMatch is the ASX’s non-display venue for block trading. Trade sizes are no less than A$1 million with the reference price derived from the last price of the CLOB on TradeMatch.
Built for high frequency trading, this display venue will offer the lowest latency trading and will operate in parallel to the CLOB. Using strict price/time priority with no auctions, crossings, hidden or contingent orders this venue will attract clients seeking pricing differences between itself and the main market.
Impact of New Order Types
The additional flexibility of the new order types was a major success. Two University of Sydney professors, Andrew Lepone and Anthony Flint, studied hundreds of thousands of transactions over a six-month period and concluded that the use of Centre Point orders resulted in market impact effects that were 10.5 to 12.5 basis points lower than conventional transactions executed in the ASX central order book. The reduced market impact costs were partly offset by the higher fees for the newer order types: the exchange imposes a fee of 0.5 basis points for Centre Point orders, and 0.15 basis points for Centre Point Crossing orders. However, with the average price impact on the CLOB reaching over 12 basis points during December of 2010, Centre Point and Centre Point Crossing orders have been more than earning their keep.
Best Execution and Smart Order Routing
With the ASXs multi venue platform, the introduction of Chi-X and the established brokerage community operating their own internalizers, smart order routing and best execution governance protecting client interests are serious issues. The quality of execution must be verifiable and ASIC must be able to govern and impose these policies effectively. In order to achieve best execution smart order routers must be applied and the ASX’s answer is ASX Best. Powered by Fidessa, ASX Best is a multi-market front-end with a smart order routing capability that provides a consolidated view of Australian listed equities across all display venues including Chi-X. Participants can manage venue routing priority and send orders directly to a specific venue, even non-display. This type of service will likely be used by the smaller broker who can’t afford to fabricate their own smart order router as the mainstream sell-sides will have built their own. However, the ASX levies an A$1500 per month tax for routing orders to Chi-X. Unfortunately, this will discourage connectivity, damage the exchanges role as a center for price discovery and undermine best execution. Old habits die hard.
In anticipation of competition and expectations of how Chi-X prices executions in the other markets they operate in, ASX dropped its transaction fees by more than 40 percent. Headline fees went from 0.28 bps to 0.15 bps, on-market crosses were reduced from 0.15 bps down to 0.10 bps and off-market crosses cut to 0.05 bps from 0.075bps. As it stands, Chi-X earns 0.18 bps per trade and ASX 0.30 bps.
Large War Chest
ASX has been an enormously profitable enterprise because of its monopoly. In 2011, the exchange posted net after-tax profits of A$356.6 million up 7.2 percent YoY. The exchange was able to maintain a dividend payment of $1.83 per share equating to a 90 percent payout ratio. ASX, therefore, has substantial headroom available for further investment in technology, improvement of services, and fee cuts.
The Australian Securities Exchange has undergone a remarkable transformation in a very short time. It has reinvented itself and rose to the challenge of competition. There is still more work to do in the clearing space, however, but the ASX has shown itself to be agile, aggressive and to aggrandize its role as an exchange.