The Australian Securities and Investments Commission (ASIC) has proposed that market participants on the Australian Securities Exchange and Chi-X implement a kill switch if their automated trading systems threaten the normal behaviour of trading.
Its second-phase consultation paper (PDF) raises the issue of automated trading, including high frequency trading (HFT), and how it can be used to manipulate the market or possibly contribute to "flash crashes", such as the US 2010 Flash Crash in which US$1 trillion in market value temporarily disappeared and the price of certain securities became extremely under or overvalued. Apple and Hewlett-Packard, for example, increased to over US$100,000 per share during the flash crash.
According to the paper, HFT accounts for about 15 to 25 per cent of the Australian equity market turnover. However, with the commencement of an alternate market operator, Chi-X, which focuses on low latency, electronic trading and is scheduled to come online at the end of the month, ASIC expects the use of HFT to increase.
The recent popularity of HFT is due to the ability for market participants to use automated algorithms to conduct trading over fractions of a second and take advantage of tiny variations in share price over an extremely short period of time.
While ASIC has recognised the contribution of automated trading in developing a more efficient market, it also said that they introduce new risks to market integrity.
Such risks include gaming other automated systems by creating a large number of orders to sell a particular stock, artificially driving its share price down. Other automated systems may be set up to limit losses by selling stock once a certain price drop has been reached will then perpetuate the trend, driving the share price lower and allowing the original trendsetter to repurchase stock at the lower price.
While ASIC monitors these sorts of behaviours, it has proposed new rules stating that market participants must be able to exercise complete control over their trading messages to prevent automated trades from affecting the market. This would include the ability to stop an order, a series of orders or its disrupt connectivity to an exchange, and essentially save itself from a potential loss due to a misconfigured algorithm. While there has been nothing to stop market participants from implementing these sort of "kill switches", the new rules would make this measure mandatory.
In addition, it has proposed that market participants be able to monitor trading in real time, an issue it has stated is particularly important due to the speed and volume of trading messages that can be transmitted.
ASIC's paper seeks comments particularly on whether the market participants will need to change their systems and procedures, the cost of doing so and whether they have the necessary time to effect the changes.
Submissions close 20 January 2012.