Australia is proving to be a test case for the impact of high-frequency trading and dark liquidity, as the nation experiences an upswing in both.

New research released by the Industry Super Network (ISN) shows the estimated cost of high frequency trading to Australian long term investors – including super funds and individual investors – to be over $1.5 billion per year.

It is the first time in Australia that an estimated cost has been placed on high frequency trading, which now represents 22% of total market turnover in Australia – a proportion that is only expected to grow.

In recent years, market operations have increased in speed significantly. Major Australian market systems can respond to orders in about 300 microseconds, or about a thousand times faster than the blink of an eye.

The market is now run in a way that gives these methods an advantage over others – resulting in an uneven playing field, according to ISN.

“A market system that caters to speed, rather than capital allocation, bestows an uneven playing field and gives traders whose strategies are based on relative speed advantages a leg up,” said ISN’s director of policy, Zachary May.

The Australian Securities and Investments Commission released a consultation paper earlier this year that examined the impact of dark liquidity and high-frequency trading on Australia’s financial markets.

They paper was the result of analysis by two internal ASIC taskforces. The dark liquidity taskforce was set up in response to concerns about its impact on market efficiency and quality; the high-frequency trading taskforce addressed concerns about disorderliness and unfairness.

While the HFT taskforce did not find systematic manipulation or abuse of markets by high frequency traders, it found that their trading strategies are commonly adopted by many other algorithmic traders, including institutions.

It was found that high-frequency trading in Australia is dominated by a small group of trading entities with the 20 largest entities accounting for about 80% of all HFT turnover (or 22% of total equity market turnover).

The dark liquidity taskforce found that while the volume of dark trading has remained around 25-30%, the composition of dark liquidity and market participant-operated dark venues (crossing systems) has changed significantly. There are now 20 crossing systems operated by 16 market participants and they have started to connect to one another.

Dark trading is now occurring in smaller sizes that are similar to ‘lit’ exchange markets and for some securities this has influenced their price. ASIC uncovered practices that require further controls and there are regulatory gaps that need to be filled.

High frequency trading involves complex mathematical algorithms to analyze and respond to market information and issue orders and cancellations at higher speeds than other traders.

High frequency trading is carried out in Australia by boutique speed trading houses, and large banking and financial institutions.