Canadian market seeks clarity on dark order size limits

Market participants have expressed frustration at the lack of clarity from Canadian regulators following the publication of responses to a recent paper on dark trading.
By None

Market participants have expressed frustration at the lack of clarity from Canadian regulators following the publication of responses to a recent paper on dark trading.

On 29 July, Canadian regulators the Investment Industry Regulatory Organization of Canada (IIROC) and the Canadian Securities Administrators (CSA) published a summary of responses to a position paper titled ”Regulatory approach to dark liquidity in the Canadian market', released in November 2010.

As well as detailing the industry's response to the November document, the latest paper affirms the regulators' commitment to implementing the dark trading proposals.

The 29 July paper set out four recommendations, which are amended versions of the initial proposals presented in November. These are: the introduction of minimum order size limits for dark orders; a rule that dark orders meeting the order size threshold should be able to execute at the national best bid and offer (NBBO) with meaningful price improvement; lit orders to trade before dark at the same price; and a definition of ”meaningful price improvement'.

“This new framework for dark liquidity in Canada proposes a balance between recognising the value of dark liquidity to industry participants and ensuring the continued protection of retail investors, pre-trade price discovery and the overall quality of our market,” said Bill Rice, chair of the CSA and chair and CEO of the Alberta Securities Commission.

Lack of detail

However, the new paper has drawn some criticism from market participants for the relative lack of progress in setting dates for implementation and for an absence of detail, in particular regarding a firm minimum dark order size threshold.

According to Alison Crosthwait, director of global trading research at agency broker Instinet, the uncertainty raised by the paper could hold back the development of the Canadian market as market participants remain uncertain about the future shape of the trading rules.

“Not only have they not decided on a figure for minimum order sizes, but we have also been told there will be a further public consultation on that particular issue,” said Crosthwait. “We're a long way away from seeing the end of this – a year out at best. Some market participants are feeling frustrated at the lack of closure.”

Minimum order sizes would in theory help move smaller trades currently executed in the dark onto the lit markets – a move in line with global regulators' pursuit of greater transparency, as exemplified by the MiFID review in Europe. However choosing a level can be a contentious issue – the consultation response notes that some market participants suggested a value of 500 shares, while others thought that 10,000 shares was more appropriate.

“It's the one number that will make a big impact on how dark pools are going to develop,” said Crosthwait. “I'd be happy with 3-5,000 shares. But regulators must be careful – there are many Canadian firms that trade under a penny, so the limit should take account of that.”

IIROC, which oversees investment dealers and equity trading activity, and the CSA, which is responsible for the securities regulations of all of Canada’s ten provinces, have stated that they will continue to examine the Canadian market to determine the appropriate threshold – despite the fact that the consultation response notes the majority of respondents did not support a dark order size threshold at all.

The objections raised included concerns that a size limit would: restrict the options available to traders to pursue best execution; lead to a loss of order flow on inter-listed securities if a Canadian dark regime is more restrictive than the US; drive portions of order flow onto over-the-counter markets; and increase the risk of information leakage, since it could potentially be used in combination with pinging orders to detect the presence of a dark order.

Other proposals in the paper were less controversial, and have drawn comparison with similar initiatives elsewhere, such as the proposed trade-at rule in the US, which would prevent non-displayed venues from matching at the NBBO by requiring operators to either offer significant price improvement or route orders to lit venues.

“The proposals in this consultation essentially mean you can't trade in the dark without price improvement,” said Crosthwait. “The institutional buy-side trader is favoured by this paper, over other market participants such as high-frequency traders. ”Meaningful price improvement' will be bad for them, as they'll have to pay more for every dark transaction they do.”

Prioritising lit orders over dark could also reduce the amount of dark trading in Canada, but seem to be in line with the ”Principles on Dark Liquidity” paper published by the Technical Committee of the International Organization of Securities Commissions (IOSCO) in May 2011. IOSCO presented guidelines for governing dark trading that would help manage its impact on price discovery, fairness and market quality.

Regulatory changes aside, the landscape for dark trading in Canada is set to expand in the near future. Goldman Sachs is currently planning to launch its Sigma X dark pool in Canada, though the firm has declined to confirm when that will take place. Canadian alternative trading system Alpha Group recently launched its own dark pool, Alpha IntraSpread, in June 2011.