Elmer Funke Kupper is certainly enlivening, and informing, the debates around the role of the ASX and the functioning and regulation of its securities markets.
In recent months, the ASX CEO has been quite aggressive in criticising the flow-on effects of opening up the ASX’s former monopoly over equities trading with the licensing of Chi-X as a competitor.
In a speech in Western Australia yesterday, he reprised some of those comments, describing the creation of the new market structure as “an extraordinary story”.
“We are fragmenting our equity market, we hear concerns about high-frequency trading and dark pools (albeit some of those concerns are misplaced), we have delivered higher overall costs and we have not advanced our position in Asia,” he said.
Fair enough, too. Whatever cost reductions have been achieved by the arrival of Chi-X have been more than absorbed by the higher cost of regulation.
The growth in dark pools and, more significantly (although they are related) in high-frequency trading is causing retail and institutional shareholders concern and threatens to turn our market, like those in the US, into a traders’ market dominated by algorithms and unconcerned about issues of value and prospects rather than an investors’ market.
That wasn’t, however, the key message Funke Kupper wanted to leave. He has opened up a new front in the fight to preserve the ASX’s centrality within securities markets by arguing against the mooted introduction of competition within the clearing and settlement systems, where ASX retains a monopoly.
There has been a review, commissioned by Wayne Swan, by the Council of Financial Regulators into this issue and ASX fears that it will face competition in another key part of its business, albeit one where the earnings to be contested are only about $45 million.
It is worth noting that, in rejecting the proposed merger of ASX and Singapore’s SGX last year a key reason cited by Swan was the implications of the merger for clearing and settlement and the orderly and stable operations of Australian capital markets.
The advice he received from the Australian Securities and Investments Commission, the Reserve Bank and Treasury was that not having full regulatory sovereignty would create material risks and supervisory issues, particularly as it related to regulation of the clearing and settlement functions.
The Council of Financial Regulators was subsequently asked to establish a working group to look at how to protect the integrity of the financial infrastructure and supervision in the event of another commercial arrangement between ASX and another exchange emerging.
Clearing houses act as central counterparties to transactions in securities, or in Funke Kupper’s words, acting as the buyer for every seller and the seller for every buyer. It is a highly regulated role and one that requires significant capital support and collateral.
While the notion of competition in clearing, or securities platforms for that matter, appears appealing — competition is generally good for consumers or participants — the integrity and stability of the market is dependent on the integrity and stability of the central counter parties.
If the function is opened to competition the most likely competitors would be overseas clearing houses — the UK’s LCH Clearnet has expressed strong interest in entering the market — and it is probable that transactions cleared on a rival platform would actually be cleared offshore.
That’s not necessarily a problem but it does raise some issues, not the least of which is that the clearing house would be outside the jurisdiction of the Australian authorities and operating within a different economic and securities market environment to the ASX. The capital and collateral supporting the ASX competitor would presumably also be parked offshore.
Whether it is a good idea to have a slab of the credit risk within the Australian market — in effect, the financial stability of the Australian market — exposed to an offshore entity is a material question, as is the potential for the underlying securities market activity in the larger companies to eventually be flowed through offshore infrastructure and further undermine liquidity on the ASX. Only in Europe are their competing clearing houses.
A very similar and fairly inconclusive discussion has been occurring in relation to the global push to introduce more transparency — and central clearing — for over-the-counter derivatives and the potential they would have to fragment and distort markets, create regulatory complexities and inconsistencies and arbitraging and centralising and transforming risks within the (probably) global central counterparties that would emerge. The cross-border elements of the discussion have been particularly vexatious.
It would, of course, be open to the Australian government to insist that the capital and infrastructure be located and regulated here, although that would probably deter serious competition.
The idea of introducing competition to another ASX monopoly appears appealing and isn’t necessarily all bad news for ASX — it would remove a major obstacle to another attempt to merge with an offshore exchange.
Like the introduction of competition to its former equities trading monopoly, however, it is the unintended consequence and the net benefits, if any, in terms of both costs and risks that would ultimately determine whether that competition actually produced desirable outcomes.
*This article was first published at Business Spectator