Speaking at a Centre for International Finance and Regulation conference in Sydney yesterday, University of Sydney lecturer in finance Dr Sean Foley said dark trading regulation has been a "tale of intended and unintended consequences".
While many regulators around the world have expressed concerns about dark trading, said Dr Foley, Australia and Canada have been the only two markets to implement new rules around the practice.
The rules set down by ASIC in May 2013 (and by the Canadian regulator in October 2012) require dark trades below block size to offer "economically meaningful price improvement" to the lit market.
According to Dr Foley, the most notable effect of the regulations in Australia and Canada has been to force a substitution from two-sided 'dark' markets to one-sided 'dark' markets.
There was also a "very immediate and marked reduction" in the level of dark trading – which achieved the stated purpose of the new trading rules.
"You saw many market makers just leave Canada. They said, 'I can’t market-make in the dark anymore, I’m not going to market make'," Dr Foley said.
The volume of 'dark' trades in the Canadian market went down from 9.7 per cent to 7.9 per cent, while Australia saw a reduction from 17.6 per cent to 10.9 per cent.
"That's exactly what the regulation was intended to do – to minimise the extent to which we see dark trading in the market," Dr Foley said.
But one of the failures of the new dark trading rules is that they have not resulted in an increase in the size of individual trades by institutional investors, he said.
Nor was there any increase in lit market liquidity provisions – another stated purpose of the regulators.
Finally, the cost of trading has increased as a result of the dark trading rules, with wider spreads now in place, he said.
"There were increases in both Canada and Australia in transactions costs. This is likely due to these differences we see – [with participants moving to one-sided from two-sided dark trades]. You can no longer make markets," Dr Foley said.
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