“There is evidence to suggest that too much dark liquidity may result in wider spreads in pre-trade transparent markets and in the dark.” The regulator is keen to come to grips with the operation and impact of dark pools on the market before the alternative venues proliferate. In the US, electronic trading venues and dark pools broke the monopoly of the NYSE and NASDAQ before regulators could ascertain the effects of the fragmentation that was taking place, and they were forced to play catch-up. ASIC aims to prevent such a “haphazard” evolution of the market in Australia, says Steve Hammerton, head of direct trading in Australia at UBS and head of the broker’s local dark pool, the UBS Price Improvement Network (UBS PIN).  Dark pools also contribute to the fragmentation of liquidity that has taken place in the US, Canada and Europe, as electronic trading venues such as Chi-X challenge traditional bourses.

According to ASIC, the Securities and Exchange Commission in the US is considering lowering the volume threshold at which dark pools remain hidden from 5 per cent to 0.25 per cent to encourage more pools to become pre-trade transparent. The Committee of European Securities Regulators is recommending a cap on the amount of business that can pass through broker-crossing networks. But ASIC does not want to wait until the debate overseas is over before it sets dark pool rules in Australia. Arguing that a single standard for trade transparency will be important in a market destined to host multiple execution venues, it proposes that investors provide pre-trade transparency for orders below $20,000.  It wants block trades to remain in dark pools and for price formation to continue unaffected on the central order book.  “It is our view that this threshold should provide sufficient incentive for orders to remain on pre-trade transparent markets and contribute to price formation, while being low enough to avoid market impact.”

Hammerton says the ASIC proposal, if enforced, would not have any “material” impact on UBS PIN or any serious block traders. “The heavy lifting in dark pools is above $20,000. It’s many times larger than that. That’s when you’re  really doing the work. Taking a three-day order and turning it into one day’s work.” For some the smaller, illiquid securities, central order books don’t play a very significant role in price formation. In these names, “real price action is done on brokers’ desks already”.  He understands why ASIC wants to maintain pre-trade transparency, encourage volume into the central order book and “protect the retail investor”. But these measures could come at a price: “I would argue that we could provide price improvement for retail investors,” he says. The regulator admits that some retail investors can get better prices if they trade off the order book.