It was a warm, clear morning in Bondi on the 16th of November when veteran mining entrepreneur Blake Cannavo noticed something was wrong.
The one-time Fortescue Metals executive had just finished a swim and excitedly checked his phone. Cannavo’s latest endeavour, small cap gold and copper explorer Native Mineral Resources, was due to list on the ASX that day and he was scanning the order sheets.
“There were some very erroneous numbers, they didn’t make sense,” Cannavo says. “In my own head, I thought something’s not right.”
The number of sellers in the queue was “astronomically high” which didn’t add up because Cannavo owns 60 per cent of the company.
The initial public offering process is “not for the faint of heart”, he says, and his team of 15 had spent the last 12 weeks preparing paperwork for it.
But at 10.24am, the ASX crashed – calling off the IPO and sending billions of dollars of trades into limbo. The system was frozen for four hours before shutting down around 3pm.
It was the third major outage for the exchange in nine years. It came just weeks after the ASX relaunched its website in October, which has been plagued by technical difficulties and is considered an embarrassment within the industry.
The crash is now being investigated by the corporate watchdog and has raised important questions about the national stock exchange, and the tendency of big Australian companies to prioritise dividends over investment.
Has the ASX-near monopoly position bred complacency, and is that leading to bad outcomes for market participants?
The origins of the ASX can be traced to the mid-1800s when there were six separate exchanges listed in each of Australia’s states. At that time, stock exchanges acted like how they’re portrayed in the movies – male brokers, often smoking cigarettes, in a room screaming at one another.
Fast forward to 1987, and the federal Parliament passed amalgamation laws that gave the green light to the formation of the Australian Stock Exchange. The six exchanges still traded independently, but they were managed centrally and a single set of rules governed their operations.
Eleven years later, the Australian Stock Exchange became the first exchange in the world to demutualise and directly float on its own stock exchange (with members awarded shares in a new listed entity). This coincided with the first year electronic trading started.
Today, despite the implementation of a number of new systems, the ASX still uses some of the core technology it was built on. Brokers describe it as antiquated and say the trading outage is evidence the systems are desperately in need of an overhaul.
Ord Minnett chief executive Karl Morris was a young broker on the floors of the ASX on Bridge Street in the 1990s when the clearing and settlements system CHESS, still used today, was introduced.
They’re a well established, well entrenched organisation that doesn’t need to innovate as much as a company like say Xero or Afterpay.Morningstar analyst Gareth James
“Even the great Sydney Morning Herald I reckon have upgraded their Microsoft Word systems since then,” Morris says. “You might have had typewriters 25 years ago, and now you have a different sort of setting. But if you look at the age of some of the systems that they’ve still got in, that says it all.”
Morris estimates he lost “hundreds and hundreds of thousands of dollars” in revenue on November 16 when the ASX’s trading system went down and now he’s calling for the industry to be compensated.
“When we do the wrong thing, we’re penalised,” he says. “ASIC will come to its conclusion and may penalise them but a business such as ours just has to suffer the consequences.
“Our brokerage lost 90 per cent of what an average day was,” he says. “For a medium-sized business, you don’t get that day back. It’s a very expensive day.”
The day after the outage at 11.03am, ASX became aware of “data issues” with its matching system Centre Point and suspended that too. These systems are the engine room of any exchange, matching buy and sell orders to find customers the best price. Eight days later, Centre Point was finally put back online.
The ASX issued an apology to investors, customers and market users for the disruption. Following enquiries by The Sydney Morning Herald and The Age for this article, chief executive Dominic Stevens is now personally reaching out to customers, including Morris, with a mea culpa.
But the ASX has stopped short of offering brokers compensation, and the Australian Securities and Investments Commission says the ordeal proves the need for investors to have more options. Up until now, the ASX retains a near-monopoly position in Australian equities. Some in the industry, including Morris, say this has allowed it to get away without investing adequately in technology.
“Any monopoly is in a privileged position where it can deliver or not deliver whatever it is until it doesn’t work. That’s what’s happened,” he says. “There’s no doubt if you’re in a monopoly position, you don’t have to invest competitively because of that.”
The ASX disputes its status as a monopoly, claiming it “directly competes” with Chi-X on trading in shares, exchange traded funds and warrants. But even its supporters, such as Morningstar equity strategist Gareth James, acknowledge its remarkably dominant position.
“They’ve got this incredibly competitive position where they can keep stuffing up and what are customers going to do? There’s nothing they can do,” James says. “People will keep using the exchange.
“It’s hard to get away from this issue that they’re a well established, well entrenched organisation that doesn’t need to innovate as much as a company like say Xero or Afterpay.”
‘Blind Freddie can figure this out’
Derivatives trader Chris Pederson was a director at the Sydney Futures Exchange around 2000 when the Australian Stock Exchange tried to buy out its last major competitor. The initial offer of $200 million was rejected for being too small, he says.
A few years later, the ASX came back with another offer – $2 billion. It was too good to refuse so in 2006 the two companies merged to become the Australian Securities Exchange – the ninth largest listed exchange group in the world.
Pederson believes this was the beginning of the ASX’s technology woes. Management at the time was under pressure to keep costs down because of the mammoth price tag of the deal, and concerns ASX had overpaid. (ASX says the term ‘overpaid’ is ‘groundless’).
“When you’re a technology company and you underspend on technology, what do you think is going to happen? Blind Freddie can figure this out,” he says.
When the physical trading floors were closed in the six capital cities in 1990, the heyday of a brokers’ success being tied to the volume of their voice was over. It was the beginning of the ASX’s status as a technology company.
For its part, the ASX says it spends almost all of its capital expenditure on technology and completes about 20 technology projects each year. This year, it spent $80.4 million on upgrading ASX Trade, building a new secondary data centre and “continuing to contemporarise platforms”. This was up from $75.1 million the previous year.
People within the ASX also say its monopoly status encourages it to do better, because failures are scrutinised by regulators and politicians and trigger conversations about the need for greater competition.
However, Pederson says many brokers are pulling their hair out. Often derivatives trades need to be organised over the phone, there are pricing problems at the end of the day and the back-end margining system is clunky and needs work, he says.
“If you compare ASX technology to their peers overseas, I’m exaggerating but not too much, they’re in the Stone Age,” Pederson says. “They’re just learning about the wheel. But we live with it here.
The last time the ASX crashed was in September 2016 when a hardware failure “triggered a number of events” that prevented it from opening at 10am.
“It is very unusual for ASX to close the market,” the ASX said at the time. “A decision to close the ASX market is not one that ASX takes lightly.”
The ASX defends its record claiming it is “one of the most reliable and resilient exchanges globally”. Other prominent exchanges have certainly encountered problems.
The NYSE crashed for 3.5 hours in 2015 and had another stumble in 2012 that prevented it from holding its closing auction. Nasdaq had a three-hour shutdown in 2013 but on both occasions, trading was picked up on other exchanges.
A software glitch at the London Stock Exchange in August 2019 delayed market opening by more than 1.5 hours, its worst outage since 2011.
And, just last month, the Tokyo Stock Exchange was shut down for the whole day – the first full-day suspension since the exchange switched to all-electronic trading in 1999.
But critics of the ASX remain concerned. In 2016, ASIC also investigated an ASX outage and came back with a 48-page report that made a series of recommendations.
The regulator suggested that in the event of another outage, the ASX flip from “enquire” to “adjust” mode instead of freezing trades. This would allow brokers to quickly resume business on Chi-X, the ASX competitor that has clawed around 20 per cent of market share since launching in 2011.
Chi-X chief executive Vic Jokovic says four years on, the ASX did not heed the regulator’s advice.
“They did exactly what they did last time,” Jokovic says. “They froze billions of dollars in orders when they could have put it into ‘adjust’ phase and allowed them to move orders from the ASX to Chi-X.”
The ASX says the “enquire” mode locks orders to allow the ASX to “investigate the issue and prepare for a clean recovery”. The exchange can only flip the switch to “adjust” once certain conditions are satisfied, and on November 16 – these were not.
“‘Enquire’ is only relevant to orders that were already in the system up to 10.24am when ASX shut the market trading. There was still the rest of the day’s orders that could have gone to Chi-X,” the ASX said in a statement.
Brokers may be tearing their hair out at the ASX’s technology platforms, but from the perspective of the exchange’s own shareholders, things are not as bad.
ASX Limited shares touched their highest levels since de-mutualisation in August, and the stock remains within striking distance of those highs. The company’s market value at the time of publication stood at $15 billion.
When it was de-mutualised and listed in 1998, all ASX members were given 166,000 shares at $3.97. If an ASX member held onto those shares, that $659,020 award would be worth more than $12.8 million today.
Morningstar’s Evans says the monopoly status has made ASX the single highest quality stock in Australia. “All businesses should try and be a monopoly,” he says. “Competition erodes your margins.”
The share price’s strength is, at least partly, explained by the generous dividends ASX has paid out. The board’s policy mandates it to return 90 per cent of underlying earnings after tax to shareholders in dividends.
This year, shareholders received $23.89 per share, which is higher than last year if you exclude a special dividend paid in September.
This comes at a time when many big Australian dividend payers are massively scaling back shareholder payments, in the case of the banks under guidance from the prudential regulator, or in other parts of the market because the pandemic has spooked directors into conservative capital management.
Pederson says the ASX could only prevent another trading outage by investing hundreds of millions of dollars in technology. But he says the board’s dividend blinkers are getting in the way.
“Its high dividend is the disease of ASX100 companies,” he says. “They pay out a lot of their earnings in dividends so they don’t have retained capital, retained earnings to pile back into their business.”
Another source with knowledge of the ASX, who spoke on the condition of anonymity, said the ASX’s monopoly status or level of investment was not the problem. “This is not a money question, it’s an execution question. They’re willing to spend the money on what needs to be done.”
The ASX hosted meetings with major investors this week after questions were raised about management’s competency. “This is a bit like a mining company blowing up an Indigenous cave, hopefully it’s what they needed to wake themselves up,” said one big investor, who spoke on the condition of anonymity.
ASIC is investigating whether the ASX’s crash breached its market obligations to run an efficient and transparent exchange. While directors of listed companies often feel shareholder returns should be a director’s top priority, Pederson says the ASX is different.
“Certain industry groups, like the stock exchange, have obligations to the country and financial markets as a whole,” he says. “The regulators are there to try to keep on top of them to make sure they’re honouring these obligations.
“But are the regulators tough enough?”
One broker, who declined to be named, says Chi-X has been “handcuffed” because of current market regulations in Australia.
In the US, brokers can lodge an order with the New York Stock Exchange that is then routed across multiple exchanges to find the best price. The NYSE then communicates with other exchanges to route the trade back to the broker’s member platform where it is settled at the end of the day.
But here in Australia, there is no communication between exchanges and brokers have to route trades themselves, requiring multiple memberships.
“That little switching, that communication and linking between the exchanges hurts Chi-X because it forces every broker to become a member of Chi-X,” the broker says.
Australia’s approach is intentional, designed to keep high frequency traders from dominating the market and making money at the expense of long-term investors.
But it’s also stifled meaningful growth of competing exchanges, critics say. Australian brokers don’t make as much money as those offshore so avoid spending money on multiple exchange memberships, according to the broker.
“The regulators here feel it’s perfectly fine to make the brokers route the order rather than making the exchanges route the order,” he says. “It’s minor, but it’s an example of how the ASX uses its clout and ability to manoeuvre with regulators.”
“The ASX is very good with managing relations in government to protect their interests.”
The ASX says its influence on regulators is “unfounded and inaccurate”.
“We work cooperatively and constructively with a variety of regulatory agencies, including ASIC, RBA, Treasury and the ACCC,” it says.
Senior lecturer at the University of Sydney Business School Andrew Grant says competition could be injected into the market if the ASX was forced to spin-off some of its operations.
“You could decouple the exchange from the clearing house or the news source,” Dr Grant says. “They argue the benefits of having it all vertically integrated is there’s one system or place to deal with.
“But on the other hand, the costs of trade clearing and settlement have historically been higher in Australia compared to others,” he says.
Ord’s Morris says the ASX is trying to do too much. “The ASX should not be putting in place a system that can be all things to all people,” he says. “It should stick to the trading and settlement part of their business.”
Dr Grant says new entrants could get an edge through innovation to offer cheaper or faster services. The ASX’s new website faced a rush of complaints on its first day of operation from investors who couldn’t access vital, market sensitive information.
Prior to the October update, Dr Grant says the website was a “dinosaur” but after the long-awaited rebrand, it’s not much better.
“It was old, clunky and not really very user friendly but it did the job,” he says. “What they’ve got now is a bit of a cosmetic makeover.”
Judith Fox, chief executive of the Stockbrokers and Financial Advisers Association, says the latest trading outage highlights the importance of competition in the market.
“Brokers need to have access to a multi-trading environment,” she says. “Because in the long-run, what it comes down to is making sure clients get their trades through.”
Despite the outage, Cannavo has no hard feelings. His mining company ended up listing the following day at 10am and he is thrilled the share price is now up 20 per cent.
“As a new IPO, that’s magnificent,” Cannavo says. “To be really honest, we’re pleased we’re on the ASX, I think it’s a wonderful platform for companies like ours to be admitted to the ASX and have investors buy and sell your shares.”
The ASX was also able to withstand the extreme trading volumes during March, when investor uncertainty triggered the most volatile period of the pandemic so far. Trading volumes eclipsed the previous record by around 3.5 million trades, compared to previous bursts of less than 0.5 million.
It has also helped Australian companies raise $6.3 billion this financial year as they turn to investors to safeguard balance sheets against this unprecedented health and economic crisis.
But others are not so impressed. “It seems like there’s one rule for the ASX and another for the rest of us,” Morris says.
Source: Thanks smh.com