Canadian dark trading rules coming into force on Monday will cause liquidity shift to the US and pose smart order routing challenges for brokers, industry insiders warn.
In an effort to encourage more trading on lit venues, domestic regulators the Investment Industry Regulatory Organization of Canada and the Canadian Securities Adminstrators will introduce rules that give lit orders priority over dark orders in the same venue.
Furthermore, smaller dark orders will have to offer significant price improvement. Orders under 5,000 shares or C$100,000 dollars in value must offer at least half a tick in price improvement for stocks that have a spread of one tick spread, and a full tick of price improvement for stocks with higher spreads.
Industry insiders say the rules will reduce passive liquidity in dark pools and cause routing issues, as dark orders can only execute after all lit market options have been exhausted.
Agency broker ITG, which operates Canadian dark pool Match Now, expects inter-listed equities trading in Canada to drop by 5% as part of a migration of flow to US venues caused by the new rules.
“We’ll definitely see inter-listed stocks trade more in the US than in Canada because of this rule. Dealers can automatically route inter-listed trades to both US and Canadian venues, so there’s no technological barrier to instantly routing these trades,” said Doug Clark, managing director of research for ITG.
Clark also stated that having to hunt for liquidity across all displayed markets before sending an order to a dark pool would create unnecessary confusion.
“There will be many situations when a buyer and a seller can’t interact because of the way routing works around this rule because they create technical issues regulators don’t understand,” Clark said, adding that smaller and mid-sized dealers will struggle to adjust trading strategies, while institutional traders may eventually find a technology work-around to the routing issues.
In August, dark trading in Canada reached a record high, hitting 5.87% of total trading volume. ITG’s Match Now venue accounted for 2.33% of all Canadian trading volume, and was the second largest dark pool by volume, with Alpha’s Intraspread venue first. Hidden orders on Chi-X Canada accounted for 0.52% of total dark trading in August, according to the figures from boutique broker Rosenblatt Securities.
Dan Kessous, CEO of Chi-X Canada, fears the regulation will limit the use of dark trading, adversely affecting the market.
“There will be less resting liquidity so there will be lower volumes overall, and it will probably get worse over time as people realise they have to change their trading strategies.
“The strength of the dark pool models is based on the price improvement they provide and these new rules will make it harder for those providing passive liquidity,” Kessous said.
Despite the expected migration of inter-listed equities trading to US venues, Kessous believes domestic displayed venues could also see increased volume of Canadian equities.
“There’s a lot of stocks that can only trade in Canada, in which case that flow will go to the lit markets, both exchanges and ATSs like ourselves,” Kessous said.