Aequitas says exchanges failing issuers and investors

A new equities exchange in Canada set to launch early next year is hoping to shake up the sector’s business model by focusing on institutions and listed firms, not just in its home country, but globally.

A new equities exchange in Canada set to launch early next year is hoping to shake up the sector’s business model by focusing on institutions and listed firms, not just in its home country, but globally.

Aequitas Innovations is currently in the final stages of achieving regulatory approval to operate a new exchange to compete directly with the country’s incumbent TMX Group and is targeting a March 2015 launch.

Its CEO, Jos Schmidt, is no stranger to taking on Canada’s exchange operator, having founded alternative trading system Alpha ATS in 2008 and building it up to a 22% market share before the venue was acquired by TMX in 2012.

He said the current exchange model common across the world is broken.

“When exchanges demutualise, short-term profit becomes their number one priority and they’ve forgotten who their users are. They no longer serve the needs of investors or issuers,” Schmidt told

In a notable difference from Alpha ATS, Aequitas has applied to become a full exchange with listing capabilities, which will form a key part of its strategy.

It plans to offer two options for issuers, a regular listing process and one aimed at companies that are not ready for the rigours of regular reporting imposed on public companies, but which need to gain access to investment opportunities.

Schmidt explained, “There are many companies at a stage in their development where a listing doesn’t make sense, but which need to be able to access finance. We’ll be launching a private securities market where they can raise capital from accredited investors.”

He added that exchange groups have been guilty of pushing companies to go public too early in order to maximise their revenues, but often this ends up doing more harm than good for growing firms.

To underpin its business model, Aequitas’ ownership structure will give issuers and the buy-side a majority stake in the business. Schmidt calls it remutualising for all users, not just the sell-side.

Tough on HFT

Having a stake in the exchange is not the only way it hopes to pull in the institutional investor community. Similarly to IEX, the alternative trading system operating south of the border in the US that starred in Michael Lewis’ ‘Flash Boys’ book earlier this year, Aequitas wants to take a tough stance on high-frequency trading (HFT).

In the right circumstances, HFT can provide useful liquidity for markets, Schmidt said, so simply excluding market participants based on a rigid definition would ultimately be counterproductive.

“We’ve defined what we consider to be HFT in our trading rules. Market participants identified as HFT will face a randomised ‘speedbump’ of 3-9 milliseconds. We’ll also enable resting orders to jump the queue for execution to make sure latency arbitrage strategies won’t be effective,” he added.

At the same time, Aequitas wants to foster a strong environment for market makers, saying that the heavy focus on attracting HFT business by existing exchange operators had driven away market makers, with a detrimental impact on liquidity.

“Market makers have seen fierce competition from HFT firms and many were not making money any more, which has eroded real market making. To help market makers we will make 15% of our order flow available to them so they can make money again and investors can tap their liquidity.”

Schmidt has been visiting European investors this month to promote Aequitas, and has long-term ambitions to take the concept global.

“There may be scope to take this beyond our borders and into other asset classes as these are globally issues we are trying to solve,” he said.

Aequitas hopes to have regulatory approval next month and is targeting a launch of its trading platform in March 2015, with its listing platform following in May and the private securities market is penciled in for a Q3 launch.

Fragmentation fears

The launch of any new venue can often lead to fears of fragmentation, however recent research in the Canadian market following the launch of Chi-X 2 in May 2013, a new venue from Chi-X Canada, found the addition of new exchange models does not necessarily compromise overall market quality.

The Capital Markets Cooperative Research Centre (CMCRC) found that Chi-X 2, which reverses the market-taker model by rewarding liquidity takers to attract retail investors and smaller brokers, has had little material impact on its competitors despite picking up market share.

“Our analysis demonstrates Chi-X 2’s market share (3-5%) does not appear to have come at the expense of overall Canadian market quality. While the market share of TMX Select and Omega were reduced by around 1% each, this hasn’t negatively affected any of the efficiency or fairness metrics we typically use to assess market quality,” said Professor Michael Aitken, CEO of CMCRC.

He added that debate around market design has been too heavily focused on market fragmentation without empirical evidence, and said CMCRC’s latest research demonstrates that fragmentation need not be detrimental to the market as a whole.