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Australian study shows messaging tax hurts liquidity

First Published 12th March 2013

A study by the CMCRC looked at top Canadian stocks and found that a messaging tax resulted in lower quote submission, trades and volume as well as worse liquidity.

New York - A study by the Capital Markets Cooperative Research Centre (CMCRC) found that one of the world's first implemented messaging taxes has harmed market quality as it led to a decline in quote submission, trades, volume and deteriorated liquidity.

The study, by Alexander Sacco and Andrew Lepone, looked at Canada's recently implemented Integrated Fee Model.

The study used raw measures of message traffic, trades and order-to-trade ratio to examine the association between message traffic, trading and liquidity. It employed regression analysis to examine the relation between order-to-trade ratio and market quality using a sample of the top 60 stocks by market cap for Chi-X Canada over a period from the beginning of 2011 running into 2012.

"Messaging tax-style regimes have been talked about in various jurisdictions both to quell HFT and to appropriate funds to use for more regulation," said Professor Mike Aitken, chief executive of the CMCRC. "The problem is that these proposals haven't been tested or modeled before being implemented, leaving whole markets open to the law of unintended consequences."

Aitken noted that only two regulators had implemented a messaging tax model so far: IIROC in Canada and ASIC in Australia.

The CMCRC said results suggested that the implementation of the Integrated Fee Model resulted in a statistically significant decline in message traffic, trading volume, the order-to-trade ratio measure, the algorithmic trading proxy, and liquidity measures.

"Many studies from all around the world have concluded that algorithmic and high-frequency trading add liquidity to markets and make them more efficient," Aitken said. "So it makes sense that anything that acts to reduce that activity would decrease liquidity."

He added: "Policy makers around the world recognise the benefits of encouraging efficiency proxied by liquidity, and legislate broad policy objectives accordingly. Our research shows that implementing messaging taxes inhibits these macro policy objectives, and suggests that the imposition of messaging taxes is a retrograde step, damaging to market quality."

The CMCRC said the full study was available on request.