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Liquidnet: ASIC’s Market Integrity Rules on Blocks and Price Improvement

James Chatfield, Head of Liquidnet Australia

James Chatfield, Head of Liquidnet Australia

ASIC’s Market Integrity Rules covering block trades (Rule 4.2.1) and trades with price improvement (Rule 4.2.3) become effective 26 May 2013, marking a significant change to Australia’s larger and more electronic equity market.

The rules tier thresholds for blocks and define trade price improvement - both exceptions to the obligation on market participants to submit orders to a pre-trade transparent order book. We believe these rules constructively align market structure and the needs of investors, defining parameters that protect investors trading size while restoring certainty and confidence in the price formation process.

There are few stronger proponents of this dual objective than Liquidnet. For us, our business is built on the premise of sourcing and facilitating block liquidity with price improvement – both explicit and implicit. We allow institutions to efficiently trade large blocks of stock while significantly reducing the risk of information leakage and market impact associated with that trade. Liquidnet has saved members trading Australian listed securities over $47 million in price improvement since February 2008, calculated as spread savings from matching trades at the midpoint. In Q1 2013, 75% of executions were at the mid. While ASIC’s concept of price improvement centres around ‘tick size or at midpoint’, ostensibly the far greater component to price improvement is the saved implicit market impact costs, which for a $1.3 million block trade [Liquidnet’s average trade size over five years] can be far greater than the spread savings.

In short, we believe the fair and highly considered measures implemented this week compliment Liquidnet’s wholesale model of sourcing and matching liquidity for institutions around the globe looking to optimise trading outcomes. Our average trade size being well above the block tiers means we do not expect material change to our pool activity, rather it reinforces the need for buy-side traders to consider ways that preserve full block size without inadvertently signalling trades via direct market access and algorithms.

A brief synopsis of the block and price improvement rules below.

MIR 4.2.1: Block Trade Tiers
This rule replaces the historic $1 million block trade threshold with three revised thresholds, tiered according to type of stock traded.

The tiers allow a transaction to be executed without pre-trade transparency where the consideration for the transaction is not less than:
• $1 million or more for Tier 1 equity market products [most liquid shares]
• $500,000 or more for Tier 2 equity market products [less liquid shares]
• $200,000 or more for Tier 3 equity market products [least liquid shares]

The initial allocation of tiers take effect on 26 May 2013. Thereafter, ASIC will publish revised tier allocations on a quarterly basis, starting from June 2013.

MIR 4.2.3 Price Improvement
This rule replaces the ‘at or within the spread’ exception under Rule 4.2.3 (Competition) and applies only where the transaction is entered into at a price (at the time of execution) that is:
• at a valid price step (i.e. tick size) that is both above the best available bid and below the best available offer or
• at the midpoint of the best available bid and best available offer (where midpoint = (best available bid + best available offer) ÷ 2).

[For trades below the applicable tier threshold, Liquidnet will only allow negotiations at the mid-price.]

For more information on the rules please view ASIC’s information sheet: ASIC market integrity rules: Exceptions to the pre-trade transparency requirements

Meanwhile, we anticipate a response in the coming months from ASIC following its Consultation Paper 202: Dark liquidity and high frequency trading: Proposals, including the decision to implement a minimum size threshold for dark orders. We believe mid-point execution overcomes many of the issues pertaining to dark order sizes, reasons for which we have outlined in our response to ASIC. That aside, and as indicated at the time, we believe the measures ASIC has proposed will reduce predatory trading, lower fragmentation and preserve dark trading measures as they were originally intended.

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