Who Should Pay ASICs Inflated Regulatory Costs?
When the Australian government agreed to introduce exchange competition, it was persuaded the market would benefit from a resulting increase in innovation, choice and improved market quality with a positive impact on market depth, liquidity and price formation. Additional market participants would be attracted to opportunities presented via new trading strategies and any additional costs resulting from the increased supervision would be more than offset by the expected cost savings.
The Australian equities markets has indeed taken strides in relation to choice with the Australian Securities Exchange (ASX) launching a range of new initiatives including the highly successful CentrePoint (a mid-point match that saves half the spread), VolumeMatch (a block execution facility) and most recently the low latency PureMatch platform. Chi-x Australia has been up and running since October 2011 and has captured around 2% market share. On the cost front, the ASX lowered their fees for trades executed on the central order book from 0.28bps to 0.15bps from June 2010, a saving of 0.13 bps for each side. Chi-x is operating a maker/taker model where those providing liquidity can benefit from lower transaction costs than those removing liquidity. ASX reported the average cash market trading clearing and settlement fee has come down steadily from AU$3.25 in 2006 to just AU$0.93 in 2011. On the surface it looks like the purported cost saving benefits have in fact come to fruition.
What is now sinking in is the reality of an estimated AU29.8 million bill for the period 1st January 2012 to 30th June 2013 to go on top of the AU12.2 million already spent from August 2010 to December 2011, as disclosed in the ‘Proposed financial market supervision cost recovery model’ consultation paper released by the Treasury in August 2011. The paper proposes that 84% of these costs should be allocated to market participants on the basis that the majority relates to surveillance of their activities. Market operators will make up the remaining 16% and although there has been a contribution of AU4.2 million from the National Guarantee Fund and the Australian Securities Exchange Fidelity Fund, the paper does not include a proposal for any further help being given to the industry supporting 100% of the costs going forward.
Historically, exchanges have covered their costs, including supervision, by charging on a per trade basis. In ASX Limited’s 2011 Annual Report, it was stated that the 11.2%, or AU16.9 million, decrease in the Cash Market revenue was primarily due to the above mentioned reduction of fees given there was not a significant difference in traded value from 2010 to 2011 with just under AU1,400 billion being traded each year. ASIC took on their additional responsibilities on 1st August 2010 and although real-time monitoring is unarguably new to ASIC, supervision of compliance with the regulatory framework including investigating market abuse and bringing enforcement actions have always been rightfully in the domain of the regulator albeit with the help of the venues. The cost recovery proposal includes recovery for these activities as well as the new supervisory costs.
Under the Government’s Cost Recovery Guidelines, entities should set charges to recover costs where it is ‘efficient and effective to do so [and] where the beneficiaries are a narrow and identifiable group’. The cost proposal breaks out the guiding principles and points to specific areas where the paper reflects this guidance. Interestingly, the ‘narrow and identifiable group’ is not included in the table of key principals which begs the question of whether the benefit can be attributed to such a group. Given Senator Bill Shorten’s introductory comments describing competition as necessary for an efficient Australian financial market, it could be said that the beneficiaries are far from a narrow group but are in fact a wide community. Later in the paper, the net impact of competition on investors and issuers is described as ‘very likely to be positive and large in net terms’ yet they do not seem to have to pay a share of the costs.
The proposal that has caused the most industry debate is the potential charge for all messages submitted to the trading venues. The Treasury state basing a charge on message count should ‘encourage market participants to more carefully consider how they are consuming ASIC’s [IT] capacity, and in turn the capacity-related costs that message traffic may impose on the entire industry’. This idea has been taken from IOSCO’s paper released in July 2011 titled ‘Regulatory issues raised by the Impact of Technological Changes on Market Integrity and Efficiency’ which said the ‘increased messaging that has come with the extensive use of algorithms raises costs for many participants, including marketplaces, vendors and competent authorities […] is especially true with respect to HFT.’
The ASX have not suggested that they are going to look to recover any of the decreased revenues through the introduction of a charge for entering, amending or deleting an order but this possibility should not be ruled out as other global venues are putting forward such proposals. Direct Edge, the fourth largest U.S. venue, may start to target order to execution ratios giving a less favourable rebate to those with rates in excess of 100 to 1. Brokers would earn one cent less for every 100 shares, with the exception of market makers who will not be subject to the new proposal. These sentiments are also present in Asia with the Shanghai Stock Exchange imposing trading limits on HFT firms which cancel a high proportion of orders.
So who really is bearing the cost of competition? Without getting into the debate around the value of HFT, it would seem that these are the strategies that will bear the brunt of the costs. It does not seem clear that the range of beneficiaries are paying, and the costs being recovered are wider than those relating to the new ASIC responsibilities. These costs will inevitably seep through to investors as they are passed from regulator to broker, to investment manger, to investor. In time it will be interesting to see whether the costs are truly offset by the savings as promised.
|How the industry voted|
Australia has arguably had one of the most sweeping regulatory reforms to accommodate exchange competition in any market in the world. Because of consultation with the industry and a national election that extended reforms across four years to come up with the Market Integrity Rules (MIR) Chi-X Australia was allowed to compete against the incumbent having sent its first trade 31 October 2011. As part of this reform the Australian Securities Exchange (ASX) handed over self regulation of its business to the Australian Securities and Investment Commission (ASIC) 1 August 2010. Despite the lengthy process of creating a competitive regulatory framework, on 1 January 2012 the regulator quietly told market operators and participants without warning that a transaction tax to claw back regulatory costs would be imposed. We ran this poll over the first six weeks of the year to find out from the industry who should pay these extra regulatory costs.
It is clear that the industry feels that either the government with 37.5% of the votes or the regulator with 29.2% of the votes should bear the cost and we agree. The purpose of a financial regulator is to create and enforce policies that maintain the integrity of the capital markets. The ASIC website even says “We contribute to Australia’s economic reputation and wellbeing by ensuring that Australia’s financial markets are fair and transparent” We don’t know that penalizing one market operator more than the other is fair and we don’t know that quietly imposing a tax without consulting the market is transparent either.
There were those that believed the exchange or market operators should foot the bill but they only represented 12.5% of the voters. ASX could certainly afford it but can Chi-X whose target market are high frequency traders? We were surprised to see that the buy-side came in as the third most voted selection in the opinion poll though with only 14.6% of respondents. Perhaps their thinking was that the high frequency trading firms should be paying the fee as the nature of the tax is transaction based. The fee structure is only limited to display equity transactions leaving dark pool and derivatives trades alone (See Article: Australia’s Invisible Transaction Tax?). The brokers will be encouraged to see that only 6.5% of respondents believed they should cover ASICs extra regulatory burden. It’s just as well as it’s been the brokers that have had to pay for the added infrastructure of connectivity, market data feeds and smart order routing already in the face of lower trading volumes and fierce competition.
In the end these costs are going to filter down to the little guy in either higher costs of commission or wider spreads in the market impacting liquidity and increasing volatility. The unexpected and unilateral decision by ASIC has actuality pushed Australia’s market structure back in some respects rather than pushing it forward damaging its “economic reputation and well being” to some degree.
We think the question begs have these regulatory costs actually negated the cost savings and efficiency in a competitive Australian market? Time will tell.