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Justin Grant
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As Dark Pools Grow, ASX Fights To Keep Public Exchanges Relevant

ASX CEO Elmer Funke Kupper says the growth of dark pools is hurting Australia's largest public exchange, and without stronger regulations, remains a threat to lit markets around the world.

It appears the Australian Securities Exchange will not become a fan of dark pools anytime soon. Earlier this week, the ASX submitted a number of proposals to Australian securities officials that it contends would better regulate dark pools and keep traditional exchanges Down Under relevant, according to theTRADEnews.com.

The proposals include a $25,000 minimum order size for trades done in the dark and increased regulation of transactions that are smaller than a typical block execution, theTRADEnews.com said. ASX Chief Exective Elmer Funke Kupper has previously warned that although dark pools play a crucial role in helping institutional investors buy or sell large blocks of stock, they're also threatening to drain liquidity from the lit markets if better rules aren't put in place.

In remarks published in the May 2012 edition of the ASX newsletter, Kupper said there was also evidence from overseas markets that the rise of dark pool trading has been causing wider spreads and higher trading costs on public exchanges.

"I have deep concerns about the way dark pools and broker 'internalisation' is evolving around the world, which is removing liquidity from exchange traded markets," Kupper said.

"Don't get me wrong. There is a role for dark execution in well-regulated markets … But we are starting to see dark pools executing orders well below large sized blocks and there are no limits on how small these orders can get – in theory most of the market could execute through them. This creates risk to our market and there should be clear boundaries to ensure the lit markets (ASX and Chi-X) remain relevant."

Kupper's comments echo research published in June by Alex Frino, head of the Sydney-based Capital Markets Co-operative Research Centre. Frino devised a mathematical model, which found that if 20 percent of Australian equities trading moved into the dark, spreads in that marketplace would widen and result in higher transaction costs on public exchanges. Transaction costs would surge by nearly a full basis point, or about triple the ASX's round-trip exchange fee of 0.3 basis points, the model found.

[For more on the danger of too much dark liquidity.]

This idea isn't limited to Australia either. Rutgers University professor published a similar report on the U.S. market last year, which argued that the more a stock is traded off-exchange, the wider its spread will be. Most estimates say 30 percent of all trades in the U.S. are done in the dark, although Advanced Trading reported in July that among the nation's smaller stocks, that figure is actually 50 percent.

As for Australia, the first six months of 2012 put Frino's idea to the test. ASX said last month that around 25 percent of all Australian equities trades were done in the dark during the first half of 2012, which it claims is already damaging price formation in the lit markets. Kupper also believe this figure will grow over time.

From theTradenews:

"We think there should be very strong controls to make sure the lit market remains relevant because that is the only market... in this country where every investor can get the same deal and trade every equity and every fund and every instrument," said Kupper, adding: "It is the only place and so it has to be relevant and we are very concerned that liquidity is being removed, because finance theory tells us that the best way – the most efficient market – is one where liquidity gets funnelled to one place by all investors." Kupper later dubbed dark pools "unregulated private exchanges."

Lee Porter, head of APAC at Liquidnet, commented that "the debate rages on right now," noting Liquidnet has also contributed to discussion with ASIC. "We feel that people must understand that not all dark pools are the same. We work in a very different way."

As the Senior Editor of Advanced Trading, Justin Grant plays a key role in steering the magazine's coverage of the latest issues affecting the buy-side trading community. Since joining Advanced Trading in 2010, Grant's news analysis has touched on everything from the latest ... View Full Bio
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