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Finance VIP SeriesVision, Insight and Policy

2012-02

www.kif.re.kr

May 2012

Min-Kyu SongTaehoon Youn

The Establishment of Alternative Trading System in Korea: Issues & Considerations

Author Min-Kyu Song Research Fellow 02-3705-6371 [email protected]

Taehoon Youn Research Fellow 02-3705-6377 [email protected]

01

Summary

Summary 02

Ⅰ. Introduction 10

Ⅱ. ATS (Alternative Trading System) 12 1. Definition and Recent Trend

2. Classification

3. ATS & Stock Exchange

III. Cases: US and EU 21 1. Development

2. Key Factors of Growth

IV. ATS Industry in Korea 27 1. History

2. Effects of the ATS in the Domestic Market

V. Considerations 33

1. Advanced Structure of the Best Execution

2. Independent Clearing House and Market Surveillance

3. Transparency of Information & Fair Trade

4. Regulations on the Tick Size and Market Stability

5. Transaction Fees

6. Development of the Dark Pool

7. Mid-to-Long-term Plans for the ATS Industry

02


I. Introduction

■ On the recently proposed FSCMA (Financial Investment Services and

Capital Markets Act) revision, the introduction of ATSs (Alternative

Trading System) is positively being considered to be adopted so as to

boost the domestic securities markets‘ competition.

Ⅱ. ATS (Alternative Trading System)

■ An ATS is an trading system where brokers, dealers, and investment

banks participate to use as an electronic trading.

○ An ATS makes a trade on behalf of the stock exchange, so called

as “alternative” trading system.

○ Advance in information and communication technology has fos-

tered the ATS industry in the US and Europe.

○ Asian countries had the difficulty in adopting the system due to its

regulations, even though the system is widely accepted currently in

the region.

■ According to the regulations, the type of securities, and trading in-

formation, an ATS itself has many different forms.

○ In terms of the mechanism of execution and price discovery, ATSs

can be classified into ①bulletin board, ② crossing system, ③

quote-driven system, and ④order-driven system.

03

Summary

○ Not only the stocks, but also the bonds and FX position are actively

traded on the ATSs.

○ Based on the degree of investors’ public information, ATSs are di-

vided into lit pools and dark pools.

■ In terms of managing agents, type of securities, listing services, and

market surveillance service, an ATS is different from the stock ex-

change.

○ Investment banks, brokers, and dealers serve a role for the manag-

ing agents in ATSs.

○ While only the listed securities are traded in the stock exchanges,

ATSs include unlisted securities.

○ The stock exchange has the power to list companies but an ATS

has no authority.

○ The stock exchange is responsible for monitoring in order to pro-

tect investors from such as unfair trades in the market but such

role is rather limited for the ATS.

04


Summary

Ⅲ. Cases: US and EU

1. Development

■ In the US, the ATS industry has been growing after the legislation

of the Order Handling Rule, Regulation ATS, and Regulation NMS

(National Market System).

■ In Europe, MiFID (Markets in Financial Instruments Directive) was

adopted in 2007 so as to induce “best execution” and officialize the

business playground of ATSs.


■ Low transaction costs, shortened execution time, and less market im-

pact are the key factors to the success for foreign ATS.

○ In efforts to compete with the stock exchange, ATSs have reduced

their explicit costs.

○ ATSs have also reduced implicit costs which include “timing cost”

and “market impact.”

○ ATSs provide more advanced data processing facilities than those

of the stock exchanges so as to reduce the execution time.

○ Some crossing systems or dark pools take the orders of block

trades taking trading prices given from regular exchanges so as to

reduce the market impact.

05

Summary

■ ATSs involve various securities and flexible trading hours so as to se-

cure convenience to investors.

○ Not only the stocks, but also the bonds and FX position are traded

on ATSs to fulfill the trading demand that the stock exchange may

not cover.

○ Also, the stocks from different countries can be traded within an

unified system which may facilitate investors to proceed global

investment.

○ The trading hours in ATSs are more flexible than those of the stock

exchange.

■ Diversified execution system is also one of the main reasons for the

growth of ATS as a whole.

○ For those investors who are engaged in block trades may prefer

quote-driven system rather than the order-driven system; for those

who want to be anonymous may prefer dark pool; and those in-

vestors who only want to reduce the transaction costs and extend

the trading hours usually prefer order-driven system.

Ⅳ. ATS Industry in Korea

■ The adoption of ATS in Korea may contribute to advancing domestic

capital market, reducing transaction costs, along with the fulfillment

of the market participants’ various needs.

06


Summary

○ Customized transaction fees and faster executions play an

important role in competing with the existing stock exchange.

○ The improvement in the execution speed and reduced transaction

costs is likely to be crucial in meeting the customer needs in the

market.

■ However, ATSs might bring some side effects in terms of market seg-

mentation, transparency of information, and investor protection.

○ Especially individual investors may be hurt more due to low

transparency of information.

○ HFT (High Frequency Trading) is widely used with the growing ATS

industry thus may rise sharply.

■ In the US and Europe, those side effects are being mitigated with the

help of “best execution,” advanced IT industry, information disclo-

sure, etc.

○ If there is a price difference between an ATS and the stock

exchange, the “best execution” allows investors to have the most

favorable price which may reduce the gap between the prices and

protect the investors who cannot have direct access to the ATS.

○ In order to practice the best execution, ATSs and the stock

exchanges need to search the best order price through SOR (Smart

Order Routing) or ITS (Intermarket Trading System).

○ MiFID reinforces ATSs to disclose their information and Regulation

ATS also requires to disclose more information as trading volume

increases.

07

Summary

Ⅴ. Considerations

■ Advanced structure of the best execution

○ If a single security is traded on different trading systems, practical

standards on the best execution should be established.

○ In general, best execution not only denotes the best order price,

but also assures favorable timing, certainty, and explicit/implicit

costs so as to fully meet the customer needs.

○ And it may need to take a further consideration into how and to

whom the best execution responsibilities will be applied.

■ Independent clearing house and market surveillance

○ It may cause various conflicts of interests if the stock exchange

takes the roles for clearing and market surveillance; therefore

needs to have an independent form of a clearing house and

market surveillance.

○ As the fact that the ATS industry has to compete with the existing

stock exchange, the clearing service fees would be imposed based

on the cost price and the service will eventually need to have an

independent form of a clearing house.

■ Transparency of information & fair trade

○ In order to efficiently manage and monitor the securities markets,

both pre-trade and post-trade information need to be released

appropriately.

08


Summary

○ Policy measures need to be brought beforehand so as to minimize

the side effects that arise different trading systems such as

unfairness between investors.

■ Regulations on the tick size and market stability

○ A dual trading system may incur unnecessarily excessive com-

petition in reducing the tick size, so it always needs to carefully

examine its costs and benefits for adequate regulations.

○ However, too much reduced tick size may induce excessive HFT

(High Frequency Trading) which could lead to negative effects in

pricing.

○ ATSs may also need some kind of a control system such as a circuit

breaker in the stock exchange.

■ Transaction fees

○ When ATSs co-exist with the stock exchange, it needs to be con-

sidered how each market will charge the transaction fees.

■ Development of the dark pool

○ The dark pool may cause several issues in terms of fairness; the

financial regulatory authorities should provide various measures in

order to prevent or mitigate such problems.

○ A certain level of transparency needs to be effectively guaranteed

in order to maintain effectiveness and fairness in the market.

○ However, it may need to keep in mind that too high transparency

sometimes reduces the volume of block trades.

09

Summary

○ All of the market participants need to be fully notified about the

advantages and disadvantages that they may get from differences

in transparency between the regular exchange and ATSs.

■ Mid-to-long-term plans for the ATS industry.

○ Considering that the main purpose of adopting ATSs is to boost

competition in the secondary markets, it needs to bring specific

plans and schedules to incur actual competition.

10


Ⅰ. Introduction

■ On the recently proposed FSCMA (Financial Investment Services

and Capital Markets Act) revisions, the introduction of ATSs (Al-

ternative Trading System) is positively being considered to be ad-

opted.

○ An ATS is different from a stock exchange in a sense that

various types of securities are being traded within the system.

○ Also an ATS is different from the regular stock exchange in

terms of the listing service and its regulations.

○ Proposed FSCMA defines an ATS as a financial investment

agent which needs to be approved by the financial authorities.

○ Currently, listed stocks are the target instruments, however,

other securities will be taken under the review on the revised

enforcement ordinance.

* A person can hold up to 15% of stocks of an ATS and financial

institutions can hold up to 30% of an ATS if approved by the FSC.

* The stock exchange is allowed to find an ATS as a form of wholly

owned subsidiary.

■ Internationally, development of the ATS industry has brought

competition in the secondary markets and also effectiveness in

the financial markets as a whole.

○ In the US and Europe, ATSs already takes 40% and 30%,

respectively, in the stock markets.

Ⅰ. Introduction

11

Ⅰ. Introduction

○ As competition between ATSs and the stock exchanges rises,

we may expect more effective capital markets, reduced

transaction costs, and fulfillment of the customer needs.

* Also, various forms of the ATSs promote customer-centered

transaction fees and shortened time of execution.

○ Unlike the ordinary stock exchanges, the dark pools are also

growing where information on the prices or orders is not fully

disclosed.

■ In addition, some of the ATSs (e.g. BATS, Direct Edge) have trans-

formed into the stock exchanges so as to bring competition

among the stock exchanges.

○ Proposed FSCMA would change the laws on the establishment

of a stock exchange to a “permit system” thus another stock

exchange can be established with an approval from the FSC.

○ If any ATS has grown enough to be transformed into a stock

exchange then we may have a dual regular exchanges.

■ In this paper, it looks into the roles of ATSs, international cases,

institutional and functional characteristics along with key factors

in order to adopt the ATS domestically.

12



1. Definition and Recent Trend

■ ATS involves many different types of the securities markets.

○ An ATS is a trading system where brokers, dealers, and invest-

ment banks participate to use as an electronic trading.

* The US SEC denotes ATS as an automated trading system which is

not registered as a stock exchange to the SEC.1)

* The European CESR(Committee of European Securities Regulators)

denotes an ATS as an automated trading system which is not

regulated under the same conditions as the stock exchange.

○ As an stock exchange, an ATS also provides services of exe-

cutions where there are buyers and sellers.

* Makes a trade on behalf of the stock exchange, so called as

“alternative” trading system.

■ Advance in information and communication technology has fos-

tered the ATS industry in the US and Europe.

○ In the US, development of Regulation ATS in the late 1990s

has promoted the ATS industry and as of September 2009, ATS

accounted for 36% of total stock trading in the market.2)

* As the ATS industry grows rapidly, NYSE Euronext’s share of the

European listed stocks’ trades has decreased from 79% in 2005

to 23% in March 2010.

1) SEC release No. 34-38672.2) Concept Release on Equity Market Structure, SEC, 2010.


13


○ In the Europe, establishment of MiFID in 2007 has promoted

growth of the ATS industry, accounting for about 25% of total

European stock trading.

* As of January 2010 Chi-X Europe, the largest ATS in Europe, took

third place in Europe to follow NYSE Euronext in trading volume,

and accounted for 18.4% in total European stock trading as of

April 2010.

* On the other hand, the stock trading volume of the LSE in the

UK, the largest regular stock exchange in Europe, has decreased

from 75% in January 2009 to 53% in February 2010.

<Figure 1> ATS Stock Trading <Figure 2> ATS Stock Trading in the US(2009.9) in Europe(2009)

Note : The US stock exchange includes NASDAQ, NYSE, NYSE Arca, BATS, NASDAQ OMX BX, etc.

Source : Concept Release on Equity Market Structure(SEC, 2010), FESE

■ Asian countries had the difficulty in adopting the system due to

its regulations, even though the system is widely accepted cur-

rently in the region.

14



○ In Japan, JSCC (Japanese Securities Clearing Corporation) be-

gan its clearing service on ATSs3) in July 2010 and Chi-X estab-

lished Chi-X Japan to begin its securities trading.

○ In the case for Australia, the ASX (Australian Stock Exchange)

has a similar monopoly system such as Korea’s KRX, but Chi-X

Australia, Liquidnet, and AXE-ECN already or are planning on

to provide their services.

○ In Hong Kong, the dark pool-centered BlocSec, Liquidnet,

and Sigma-X already provide their services actively. In Sin-

gapore, Chi-East plays a role.

○ In Korea, recently FSCMA is proposing to allow ATS to be ad-

opted and some international ATS companies already take un-

der the review to enter into the Korean securities market.

* The systems of just matching the order of buying and selling

already has been observed in Korea ECN and KoreaCross.

* And the ATS which is thought to be adopted in recently

proposed FSCMA denotes where both execution and price

discovery are possible.

2. Classification

■ According to the regulations, the type of securities, and trading

information, an ATS itself has many different forms.

■ In terms of the mechanism of execution and price discovery, ATSs

can be classified as follows.

3) Called PTS(proprietary trading system) in Japan.

15


○ Bulletin board: Provides a network where investors can start ne-

gotiating through an electronic system. But execution service is

not provided.

* Doesn’t provide the execution service but helps directly, so

classified as a type of ATS.

* e.g. European TradeCross, WETRA

○Crossing system: When an order has been taken, it makes a

trade with the price made from other stock exchanges or the

market.

* Execution is possible but price discovery function is not.

* e.g. POSIT, Liquidnet, E-Crossnet

○Quote-driven system: A dealer, who is the market maker, offers

quotes to make trades with investors.

* Both execution and price discovery function are possible.

* e.g. CTAS-OS, Tradelink, EuroMTS

○Order-driven system: Each investor offers an order and com-

petitive bidding takes place.

* Both execution and price discovery function are possible.

* In the US, most of the ATSs, so called ECN(electronic com-

munications network) are the order-driven systems.

* e.g. Instinet, BondVision, TradeWeb

16



<Table 1> ATS Function

Price discovery Execution

Bulletin board × ×

Crossing system × ○

Quote-driven system ○ ○

Order-driven system ○ ○

■ Not only the stocks, but also the bonds and FX position are ac-

tively traded on the ATSs.

○Instinet and BATS are for stock trade, Tradeweb and Market-

axess are for bond trade, and Currenex and Hotspot FX are for

FX trade.

■ Based on the degree of investors’ public information, ATSs are

divided into lit pools and dark pools.

○As the regular stock exchanges, information on the price, order,

brokers, and other related factors are opened in the lit pools.

○In the dark pools, trades are made with some parts of the

information missing.

* Liquidnet, Pipeline, POSIT, and BIDS are the dark pools.

* A certain crossing system only takes the order and use the price

that is made from outside the market, therefore can be classified

into the dark pool.

17


○The dark pools have developed so as not to give market im-

pacts on the prices, where block trades are made outside the

regular markets.

<Figure 3> ATS Classification

ATS(Alternative trading system)

Bulletin board

Trade Cross E-Crossnet CATS-OS Instinet

BATS

Direct Edge

BondVision

TradeWeb

Currenex

Hotspot FX

TradelinkPOSIT

Liquidnet

Pipeline

BIDS

CreditTrade

Bondscape

EuroMTS

COREDEAL

Eurex Bonds

MarketAxess

WETRA

Crossing system Quote-driven system Order-driven system

Stock ATS, Bond ATS, FX ATS

2) DB Research

3. ATS & Stock Exchange

■ In terms of managing agents, type of securities, listing services,

and market surveillance, an ATS is different from the stock ex-

change.

18



○Investment banks, brokers, and dealers serve a role for the

managing agents in ATSs.

○While only the listed securities are traded in the stock exchang-

es, ATSs include unlisted securities.

* MiFID doesn’t put any limits on the securities.

○The stock exchange has the power to list companies but an ATS

has no authority.

* The stock exchange takes both listing and trading but an ATS

takes only trading.

* So there is no listing requirements nor its regulations under the

ATS.

* An ATS doesn’t take the process of evaluating companies for

listing, which is an debatable issue in considering that whether

ATS needs to pay for the listing service to the stock exchange or

not.

○The stock exchange is responsible for monitoring in order to

protect investors from such as unfair trades in the market but

such role is rather limited for the ATS.

* MiFID requires the role of market supervising but the US

Regulation ATS doesn’t.

* But the US SEC cooperates with the FINRA (Financial Industry

Regulatory Authority) and the stock exchanges so as to protect

from any unfair trades and frauds in the markets.4)

4) SEC release No.34-40760, "Regulation of Exchanges and Alternative Trading Systems"

19


<Table 2> The Stock Exchange and ATS

Stock Exchange ATS

Securities Listed securities * Mostly listed stocks

No restrictions. Includes listed securities, non-listed securities, foreign currencies, etc.

Listing

○ ×1)

Market surveillance Comparatively strong Comparatively weak

Self-regulation Comparatively strong Comparatively weak

Degree of regulations from the supervisory authorities

Comparatively strong Comparatively weak

Note: 1) If ATS transforms into a stock exchange, then acquires the function of listing.

■ In the US, an ATS can transform into a stock exchange by re-

gistering at the SEC; the scope of their business expands but it

has to take additional responsibilities.

○When ATS is transformed into a stock exchange, it can provide

listing service and share profits which came from selling data

through registering at the CTA (Consolidated Tape Association).

○But, becomes subject to the direct regulations of the SEC.

○The ATS should not violate the roles of transparency and also

provide a reasonable level of transaction fees.

○In addition, it has to hold the function of market surveillance

and is not allowed to enact ‘anti-competitive’ rules.

20



■ If an ATS registers as a broker or dealer then Regulation ATS is

likely to handle more responsibility as trading volume expands.

○If any of a single transacting security takes below 5% of the

countrywide trading volume, the ATS has to report its business

contents to the SEC quarterly and cannot use the name

“exchange” or “stock market” in its business.

○If any of a single transacting security takes above 5% then

the ATS has to disclose its order price and follow the rules as a

member of the stock exchange.

○If any of a single transacting security takes above 20% then the

ATS is regulated in the same way as the stock exchanges.

* The ATS needs to obey market fairness and implement some

contingency plans as well.

21


1. Development

■ In the US, the ATS industry has been growing after the legislation

of the Order Handling Rule, Regulation ATS, and Regulation NMS

(National Market System).

○ECNs (Electronic Communication Network) began their services

in 1997 where investors were able to directly trade with each

other and not necessary to go through market makers of the

stock exchanges.

* In the US, an ECN is referred to as an order-driven ATS where

information on the electronic trading system is continuously

disclosed.5)

○In 1998 establishment of Regulation ATS allowed existing

ATS to register at the SEC thus the ATS became a legitimate

securities market in the country.

○Establishment of Regulations NMS in 2007 reinforces trans-

parency of the ATS and effectiveness of “best execution” so

as to capture investors’ confidence on ATSs through Order

Protection Rule or Trade-through Rule.

5) SEC Release No.34-39884(Regulation of Exchanges and Alternative Trading System), 1998.


22



Regulation NMS6)

○Implements unified rules so as to lead free-competition

between markets.

○Rationalizes Order Protection Rule, which is applied mainly

to automated order prices so as to be more strict on the best

execution.

○Other than the existing ITS (Inter-market Trading System),

allows “private linkage” system.

○If the order price is higher than $1, adjusting the price by less

than ¢1 is prohibited so as to protect from delay of a trade.

○Sets upper limit on the access fee so that non-members don’t

have to pay excessively high costs of transaction fees.

○Such as the stock exchange, an ATS is also required to disclose

its information.

■ In Europe, MiFID (Markets in Financial Instruments Directive) was

adopted in 2007 so as to induce “best execution” and officialize

the playground of ATSs.

○The European regulatory authorities suggested MiFID in

2004 in order to expand investors‘ choices of trading sys-

tems.7)

* MiFID refers an ATS as a MTF (multilateral trading facility).

6) KCMI release, "U.S. Securities Market Restructuring due to Regulation NMS," 2007.7) MiFID was officially announced in 2004 by EU, acknowledged for advancing ISD (Investment Service Directive).

MiFID is not a form of law but enacted in each country in 2006.

23


○MiFID treats ATSs on the basis of same-function-same-regu-

lation, thus the roles of disclosing information is reinforced to

ATSs.

○This effort aims advanced customer protection and reduces in-

efficiency from market segmentation.

* As the market is divided into the stock exchanges and ATSs,

inefficiency of market segmentation is the economic costs which

indicates different price discoveries or spreads enlarging in the

markets.

○The roles of disclosing information are reinforced so as to bring

friendly environment for best execution.

MiFID Regulations on ATSs

○Organize trading rules to lead stability in the systems.

○The supervisory authorities should re-check the trading rules

and price discovery function.

○Provide market surveillance.

○Reinforce transparency for both before and after a trade.

○Set conditions on ATSs’ capital to lead overall financial

stability.

○No limits on the kinds of securities so that various financial

instruments can be traded.

24




■ Key factors to the growth of foreign ATSs are ① reduced trans-

action costs, ②more flexible trading settings, and ③diversified

trading systems.

■ First, low transaction costs, shortened execution delay, and less

market impact are the key factors to the success of ATSs.

○In efforts to compete with the stock exchange, ATSs have re-

duced their explicit costs.

○ATSs have also reduced implicit costs which include “timing

cost” and “market impact.”

* Timing cost is the cost that arises from delay of a trade.

* Market impact is the additional cost that has to be paid by

traders when a large order changes price in the market. For

instance, average execution price may be higher than initial

order price if a block trade is involved.

<Table 3> Securities Transaction Costs

Explicit cost Implicit cost

• Transaction fee• Brokerage fee

• Timing cost: Cost if trade delays.• Market impact: Additional cost if execution price

changes.• Opportunity cost: Cost if execution fails due to lack of

liquidity.

25


○ATSs provide more advanced data processing facility than that

of the stock exchange so as to reduce the execution time.

* For those investors who prefer fast execution system can benefit

from the ATS which is very suitable in quantitative strategy,

hedge fund, proprietory trading, etc.

○Some crossing systems or dark pool ATSs take the orders of

block trades so as to reduce the market impacts.

■ Secondly, ATSs involve various securities and flexible trading hours

so as to secure convenience to investors.

○Not only the stocks, but also the bonds and FX position are

traded on ATSs to fulfill the trading demand that the stock ex-

changes may not cover.

○Also, the stocks from different countries can be traded within

an unified system which may facilitate investors to proceed

global investment.

* Instinet can trade stocks of 40 different countries.

○The trading hours in ATSs are more flexible than those of the

stock exchange.

* May proceed a transaction if new information comes out after

the regular trading hours.8)

* Especially for those global investors may benefit from reducing

the gap between the trading hours due to time difference.

* CiticATS: 8 a.m.~10 p.m., Tradelink: 8 a.m.~11 p.m., Liquidnet: 2

a.m.~6 p.m.

8) Barclay, Michael and Terence Hendershott (2003, The Review of Financial Studies) “Price Discovery and Trading After Hours".

26



■ Lastly, diversified execution system is also one of the main reasons

for the growth of ATS as a whole.

○Investors may choose various mechanism in price discovery and

execution.

○For those investors who are engaged in block trades may prefer

quote-driven system rather than the order-driven system; for

those who want to be anonymous may prefer dark pool; and

those investors who only want to reduce the transaction costs

and extend the trading hours usually prefer order-driven sys-

tem.

27


1. History

■ In Korea, monopoly of KRX has hindered the way of developing

ATS industry but there have been instances of infant stage ATSs.

○They use the price from the KRX thereby not violating the regu-

lations of prohibiting other exchanges than KRX.

○Usually they only take orders and their prices are made from

the outside; which is a crossing system.

A. Korea ECN (2001~2005)

■ In efforts to develop the overall trading system and to meet inves-

tors’ various needs, Korea ECN was established in 2001.

○Listed stocks are traded during the after-hours (4:00 p.m. ~ 8:00

a.m. next day).

○Clearing/execution service is provided from the KSD.

○Korea ECN doesn’t have the price discovery function and use

the price from the KRX.

■ Besides the trading hours, there is no distinct difference between

the KRX and also it doesn’t have the price discovery function,

Korea ECN closed its business in 2005.


28



B. KoreaCross (established in 2008)

■ KoreaCross takes an order before the regular trading hours (7:00

~ 8:45 a.m.) and makes execution after the regular trading hours

(3:00 ~ 6:00 p.m.) with a value weighted averaged price(VWAP)

from the KRX.

○It doesn’t have the price discovery function and use the price

from the KRX; also another type of a crossing system.

■ KoreaCross is widely used by foreign investors who are engaged

in the Korean stock market.

○Due to different trading hours between the domestic markets

and foreign markets, foreign investors used to encounter some

difficulties but KoreaCross has provided a solution to the mat-

ter.

○It uses VWAP so as to reduce market impacts.

C. Korea ATS (2011 Proposed FSCMA)

■ Recently proposed FSCMA is suggesting to adopt order-driven

system of ATS in Korea.

○ATS may well be defined as a form of Financial Investment

Agent which needs to be approved by the authorities.

○Clearing and market surveillance service will be provided from

the KRX.

29


○Trading securities are set to listed stocks but on the review

to be changed with revised enforcement ordinance.

■ If the size of ATS industry grows to a certain point, it may be

switched over to a regular stock exchange and will be allowed to

have a multiple-exchange system in the market.

○The regulations on various functions will be adopted based on

the “add-on” method.

○If approved to become a regular stock exchange then it has to

carry out the roles of listing and market surveillance services.

<Table 4> Domestic ATS

Korea ECN KoreaCross Korea ATS

Period 2001~2005 2008~Present 2011 FSCMA

Trading rules Crossing system Crossing system Crossing systemOrder-driven system Quote-driven system

Price discovery ×Execution ○

Price discovery ×Execution ○

Price discovery ○Execution ○

Trading hours 4:00 p.m.~8:00 a.m. (next day)

Order: 7:00~8:45 a.m.Execution:3:00~6:00 p.m.

No specific limits

Trading securities

Listed stocks Listed stocks No specific limits1)

Note: 1) Listed stocks will be used in the early stage.

30



2. Effects of the ATS in the Domestic Market

■ The adoption of ATS in Korea may contribute to advancing do-

mestic capital market, reducing transaction costs, along with the

fulfillment of the market participants’ various needs.

○Customized transaction fees and faster executions play an im-

portant role in competing with the existing stock exchange.

○The improvement in the execution speed and reduced transac-

tion costs is likely to be crucial in meeting the customer needs

in the market.

○The dark pool may cover the customer needs that the ex-

isting stock exchange couldn’t meet.

■ Such as BATS or Direct Edge, if an ATS switches over to a regular

stock exchange, it may bring competition between exchanges.

○As in foreign cases, ATSs could consider to switch over to a

regular stock exchange so as to expand their business scope

and make larger profits.

○ATS could act as a catalyst to boost positive competition and

lessen monopoly of the current stock exchange later on.

■ However, ATSs might bring some side effects in terms of market

segmentation, transparency of information, and investor protec-

tion.

31


○Market segmentation is the inefficiency that arises when

a single market is divided into multiple markets, which is

defined as overall problems on ineffective price discovery

and different pricing among the markets.

○For block trades, an ATS provides low-transparent transactions

in order to reduce market impact, but this may lead to some

disadvantages to a group of investors.

* For those investors who prefer transparency of information may

get losses.

○Especially individual investors may be hurt more due to low


* For instance, ATS’s low transaction fees to large traders could be

a problem on price discrimination but could also thought to be

as a new opportunity to enhance market efficiency.

○HFT (High Frequency Trading) is widely used with the growing

ATS industry thus may rise sharply.

* There could be a problem on “flash order” which is a service

to provide order price to specific traders before opening up to

regular investors.

* Especially individual investors or small-sized investors may have

to bear some losses.

■ In the US and Europe, those side effects are being mitigated with

the help of “best execution,” advanced IT industry, information

disclosure, etc.

○If there is a price difference between an ATS and the stock ex-

change, the “best execution” allows investors to have the most

favorable price.

32


Ⅴ. Considerations

○Which may reduce the gap between the prices and protect the

investors who cannot have direct access to the ATSs.

○In order to practice the best execution, ATSs and the stock ex-

changes need to search the best order price through SOR (Smart

Order Routing) or ITS (Intermarket Trading System).

○MiFID reinforces ATSs to disclose their information and Regula-

tion ATS also requires to disclose more information as trading

volume increases.

■ To sum up, it should definitely need to find legitimate measures

beforehand to make sure the overall conditions of information

disclosure or the effects on individual investors are appropriate in

the current market circumstances.

33

Ⅴ. Considerations

■ In order to stabilize the securities market where the stock

exchange and ATS co-exist, the financial authorities need

to assure transparency of information and protect investors

from any unfair acts.

1. Advanced Structure of the Best Execution

■ If a single security is traded on different trading systems, practical

standards on the best execution should be established.

○The new proposed FSCMA revision enforces best execution to

financial invetment agents thus the investors are able to com-

pare order prices in the markets.

○In general, best execution not only denotes the best order

price, but also assures favorable timing, certainty, and explicit/

implicit costs so as to fully meet the customer needs.

* As for best execution, the US aims at the best order price while

Europe covers overall related conditions.

○In order to carry out the best execution, SOR and ITS have been

widely used abroad, thus the criteria of best execution is to be

defined in terms of practical and technological perspectives.

■ And it may need to take a further consideration into how and to

whom the best execution responsibilities will be applied.

Ⅴ. Considerations

34


Ⅴ. Considerations

○In the US the roles of best execution are enforced to exchang-

es, ATSs, and brokers.

* To do so, SOR, managed by brokers, and ITS, a system among

stock exchanges and ATSs are being used at the same time.

○It is necessary to clarify the responsibility on structuring and

managing the system in advance.

○ Considering that brokers in the ATSs and the stock exchanges

may be different, current regulations of the US are thought to

be appropriate.

○ If best execution is violated, a considerable amount of fines

must be charged.

* For instance, BNY Mellon made fraudulent practices related to

best execution for 8 years, then was imposed $2.4 million fine

and also the board of members were prohibited from getting a

job in all of securities companies.

■ Also there should be concrete measures to take care of errors

which could be made on the prices between ATSs and the stock

exchanges.

○An error can arise from many different factors such as the price

range, tick size, different trading hours, etc.

○If the price on a same security is different between ATSs and

the stock exchanges, rearranging time, price adjustment, and

correcting bodies are to be delineated first.

* This is because if the price is different, ATSs, the stock exchanges

or some brokers may earn risk-free profits.

35

Ⅴ. Considerations

○In addition, computing rules on the NAV(net asset value) of

funds needs to be re-examined.

2. Independent Clearing House and Market Surveillance

■ It may cause various conflicts of matters if the stock exchange

takes the roles for clearing and market surveillance; therefore

needs to have an independent form of a clearing house and mar-

ket surveillance.

○For the efficiency point of view, recent proposition designated

the stock exchange to take the roles of clearing house and

market surveillance services.

○As the fact that the stock exchange has to compete with

ATSs, it may be unfair to ATSs if the exchange sets clear-

ing service fees and takes charge of surveillance services.

○The clearing service fees would be imposed based on the cost

price and will eventually need to have an independent form of

a clearing house.

3. Transparency of Information & Fair Trade

■ In order to efficiently manage and monitor the securities markets,

both pre-trade and post-trade information need to be released

appropriately.

36


Ⅴ. Considerations

○A unified monitoring system is necessary on the investors who

are engaged in both ATSs and the stock exchange so as to pro-

tect from any unfair trades such as manipulation, unfair trades,

etc.

* The information includes all the related contents in the markets

such as order price, execution price, trading amounts, etc.

○In the US, such a role is being taken by Consolidated Tape Sys-

tem which integrates most of trading information and orders,

then usually FINRA monitors the markets on the basis of the

information.

* SEC is also developing Audit Trail System which could monitor

trading orders and execution in real time.

■ Policy measures need to be brought beforehand so as to mini-

mize the side effects that arise from different trading systems.

○If an ATS is adopted and brings competition, welfare of inves-

tors would be upgraded as a whole, but the magnitude of up-

grade will be different among investors.

○Especially in case that a sort of ATS allows only specific traders

or forms of trades, there should be a clear criteria to decide le-

gitimacy of the trades.

4. Regulations on the Tick Size and Market Stability

■ A trading system may incur unnecessarily excessive competition

in reducing the tick size, so it always needs to carefully examine

its costs and benefits for adequate regulations.

37

Ⅴ. Considerations

○An ATS will likely to reduce the tick size in efforts to predomi-

nate over the stock exchange and vice versa.

○Reduced tick size brings competition, thins spread, and cuts

transaction costs.

○However, too much reduced tick size may induce excessive HFT

(High Frequency Trading) which could lead to negative effects

in pricing.

* In the Europe, too much competition over reducing the tick size

has brought a voluntary negotiation(2009) of uniting the tick

size of most securities.

■ ATSs may also need some kind of a control system such as a cir-

cuit breaker in the stock exchange.

○Considering the domestic market characteristics, a review on

implementing adequate control system covering ATSs and the

exchange together should be made.

○Internationally, adopting such control system is different from

place to place.

* In the US, the circuit breaker system is used in all of the markets

including ATS.

* In the Europe, few countries follow the routine of the US but

most countries use different control system according to their

trading markets; thus if a transaction has stopped in one market

the same transaction could keep proceeding in another market.

38


Ⅴ. Considerations

5. Transaction Fees

■ When ATSs co-exist with the stock exchange, it needs to be con-

sidered how each market will charge the transaction fees.

○Different services and transaction fees between ATS and the

stock exchange could influence overall trading behavior in the

market.

* For instance a “maker/taker” way of pricing, which optimizes the

transaction fees in response to supply of liquidity, may have a

chance to change the order timing of market participants.

○Also it needs to take a review on the after-effects of potential

price differentiation in the stock exchange and ATSs.

○Internationally, diversified transaction fees after adopting ATS

is reputed as being very complicated and frequently changed

compared to that from the past.

* Graduated pricing: Lowers transaction fees as trading volume

increases.

* Price differentiation based on order characteristics. (e.g.

proprietary vs. client account)

* Maker/taker pricing: Lowers transactions fees for later orders

and impose higher fees for prompt orders.

6. Development of the Dark Pool

■ It is necessary to consider allowing the dark pool in the domestic

market.

39

Ⅴ. Considerations

○It has been observed that competitive auction trading of listed

securities in order-driven ATSs is basically not different from the

regular stock exchange.

○Development of expertise investments such as hedge funds has

increased the proportion of dark pool in the market.

○It is predicted that an expertise-centered dark pool may be es-

tablished in Asia later on.

■ The dark pool may cause several issues in terms of fairness; the

financial regulatory authorities should provide various measures

in order to prevent or mitigate such problems.

○IOI (indication of interest) is being used to find transacting par-

ticipants without leaking out one‘s information but may have

the problems on fairness.

* Since IOI is not distributed to everyone in the market,

those participants who haven’t received the IOI would get

disadvantages.

* EC, the US SEC, and Canadian Securities Administrators disclose

actionable IOIs to all market participants in efforts to keep


○Sometimes unified trading data service is provided but some

participants are not allow to access on the system thus they

cannot affect price discovery properly.

○Also if development of the dark pool causes the size of lit pool

to shrink, it may bring some inefficiency in price discovery.

40


Ⅴ. Considerations

■ Regulations on transparency and execution should be made in

case the dark pool is adopted.

○A certain level of transparency needs to be effectively guaran-

teed in order to maintain effectiveness and fairness in the mar-

ket.

* Here, transparency includes both pre-trade and post-trade

information.

○However, it may need to keep in mind that too high transpar-

ency sometimes reduces the volume of block trades.

○Thus a moderate degree of transparency needs to be enforced

in each market and also reasonable standards or explanation

should be prepared if the requirements of transparency are be-

ing differentiated in those markets.

* The supervising authorities of each country differentiate the

requirements between lit pools and dark pools, but at the same

time, they put every efforts to keep effectiveness and fairness

among the markets.

○IOSCO (International Organization of Securities Commissions)

gives priority to ‘transparent orders’ whether the orders are

from lit or dark pools.

○All of the market participants need to be fully notified about

the advantages and disadvantages that they may get from dif-

ferences in transparency between the regular exchange and

ATSs.

41

Ⅴ. Considerations

7. Mid-to-Long-term Plans for the ATS Industry

■ Considering that the main purpose of adopting ATSs is to boost

competition in the secondary markets, it needs to bring specific

plans and schedule to incur actual competition.

○For instance, it is not suitable if the stock exchange establishes

ATS on its own in the early stage but will be acceptable when

proper competitive circumstances are settled as a whole.

○In case that international ATS is adopted into the domestic

market in coming days, it needs to take an additional review.

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