 
A pending regulatory change stands to make life more difficult for small equity trading venues in Canada.
Starting in October, institutional traders will no longer be required to do business with market operators that execute less than 2.5% of total Canadian volume. The seven-year-old order protection rule has mandated that trade orders route to the exchange or alternative trading system with the best displayed price, regardless of market share.
Implications of the change extend to the trading venues’ customers, and to the customers of their customers. Sell-side brokers will need to recalibrate their order-routing and best-execution protocols, perhaps passing along some or all of those costs to buy-side investment managers, who in turn will need to adjust their own transaction cost analysis. And with the Canadian Securities Administrators calling for an annual review, it won’t be a one-shot deal.
“This rule change is expected to cause an upheaval in Canada, both with venues gaining and losing protected status (perhaps even causing some to close their doors), and to vendors and participants as they cope with increasingly costly change,” said Martin Hakker, chief executive officer of Fidessa Canada. “In addition, this raises many important questions around the definition of best execution.”
In an April 7 release, the CSA outlined the market-share threshold, along with other OPR amendments pertaining to order-processing delays, or ‘speed bumps’, as well as fees charged for data and active trading. “The final amendments will provide flexibility to market participants in determining if and when to access trading on certain marketplaces, address the level of trading fees in Canada and provide a transparent process for regulatory oversight of real-time professional market data fees,” CSA Chair Louis Morisset said.
The OPR was designed to protect end-user investors by ensuring that their trade orders execute at the best price. As with most regulations enacted in a highly interconnected marketplace, the OPR has resulted in unintended consequences, as participants from Toronto’s Bay Street financial district to Vancouver note that the trade price is just one component of trading costs.
Patrick McEntyre, National Bank
“The historical consequence of protecting all entrants into the Canadian exchange landscape has allowed any newcomer meeting the minimum obligations of an ATS to immediately obtain protected status,” Hakker said. “This has allowed many entrants to continue to operate with minimal market share and has increased costs to all participants who are obligated to connect to these venues. These costs are borne via member fees, market data costs, and vendor fees.”
In the view of Patrick McEntyre, managing director in electronic trading and service at National Bank Financial in Toronto, the CSA didn’t go far enough with the OPR amendments — the ideal scenario would be all markets unprotected and brokers prove best execution. But the net result of the pending changes will be positive overall.
“We appreciate the notion of having a threshold for protection of new markets, because they’re giving us more flexibility with regard to the timing of our rollouts, technology spend and even whether to connect or not,” McEntyre said.
“We’re still held to a best-execution standard, so I can’t logically see us not connecting to new markets, and I can’t see us unconnecting from any existing markets,” McEntyre continued. “But it does allow a little more freedom, a little more bargaining power with those exchanges in terms of timing our changes or accommodating changes they would force onto us.”
Speed bumps, a comparatively new innovation aimed at nullifying the advantage of the shortest-term market participants, present another layer of complexity, as regulators are exempting order-slowing venues from order protection. The eight-month-old TSX Alpha Exchange has a speed bump, as does the Aequitas NEO market, though only for latency-sensitive dealers.
Of 14 equity marketplaces tracked by the Investment Industry Regulatory Organization of Canada, five had market shares of less than 2.5% of volume in the year ended March 31, 2016: TMX Select, Aequitas Lit, Lynx, Liquidnet, and Instinet. Aequitas NEO and CSE were between 2.5% and 3%.
Less than five months ahead of the OPR amendments being implemented, questions abound.
“What will participants do with regards to best execution and general routing policies now that they will not be obligated to transact on those marketplaces that lose their protected status? Will participants start removing venues from their system because of the costs associated with maintaining connections to them or retain them in the spirit of best execution?” Hakker asked.
“How will market data and the definition of the best bid or offer change given quote contributions from protected and non-protected venues?” he continued. “What is the definition of ‘Level 1’ if a participant wants to view a market, but not include it for trading in a smart order router? How will participants handle a market like NEO, where only a segment of users will be affected by the speed bump, but the market itself is non-protected?”
Concluded Hakker, “many participants have only just begun to determine their answers to these questions. They and their vendors will need to make decisions and changes in the way they do business, quickly.”
Featured image by ekostsov/Adobe Stock
