The introduction of new rules governing dark trading by the Canadian Securities Administrators (CSA) and the Investment Industry Regulatory Organization of Canada (IIROC) will have a profound impact on Canadian marketplaces, according to agency broker and technology company ITG.
A joint paper published by the regulators, titled “Regulatory Approach to Dark Liquidity in the Canadian Market” has previously been criticised for its lack of firm commitment and decisiveness. The reforms included minimum sizes for dark orders, giving matching priority to lit orders before dark orders and establishing a minimum level of price improvement for all orders traded in the dark.
Minimum order sizes for dark trades 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.
Meanwhile prioritising lit orders over dark is in line with the ”Principles on Dark Liquidity” paper published by the Technical Committee of the International Organisation of Securities Commissions (IOSCO) in May 2011. IOSCO presented guidelines for dark trading that would help manage its impact on price discovery, fairness and market quality.
ITG has, however, decried the proposals, particularly the imposition of minimum order sizes for dark orders, stating that it sees “no evidence that this proposal will result in more flow resting on the lit markets”, and complaining that the rule would limit the options available to professional traders entering or exiting a large position.
Likewise, the mandating of minimum price improvement was also criticised on the grounds that it would limit the passive involvement of arbitrageurs, such as high-frequency trading firms, in dark pools, thus turning them into ”bastions of natural liquidity’ that would likely attract even more flow away from the lit markets – a result exactly the opposite of the regulators’ stated intention.
“If implemented, the proposed rules will limit the ability of continuous dark orders to transact limiting the dark space to the large block facilities,” says the ITG report.
The ITG report expresses surprise that, given the significant portion of Canadian trading that is done on stocks that are inter-listed with US venues, the proposed rules would limit the ability of Canadian trading venues to offer pricing and services in line with the US market.
Dismissing the idea that dark liquidity may have a negative impact on market quality and price transparency, the report’s authors were emphatic that the evidence does not support such a conclusion – on the contrary, they argue that academic evidence suggests that dark trading venues enhance market quality.