Canadian dark pool rules designed to improve key functions of the lit market have depressed dark pools’ market share, most keenly felt by a retail-focused alternative trading system (ATS) operated by Alpha Group, a report from TABB Group has found.
Canada last year implemented amendments to the Universal Market Integrity Rules’ (UMIR) dark order definition, limiting the execution of small orders, as it is believed to impair price discovery and unfairly limit interaction for displayed orders.
In the consultancy firm’s ‘Canadian Equity Market Structure: Dark Liquidity’ report, author and senior research analyst Sayena Mostowfi says the new rule crushed the market share of alternative trading system provider Alpha Group’s dark pool Intraspread.
“With the diminished liquidity, retail orders had to be routed to lit marketplaces, where the transaction fees were significantly higher than Alpha Intraspread and internalisation at the National Best Bid or Offer is prevalent,” she said.
“After some initial adjustments, the other dark pools that trade in larger size, namely TriAct’s MATCH Now and Liquidnet, remain practically unscathed.”
The new UMIR rule requires orders under 5,000 shares or C$100,000 in value to offer a full tick of price improvement (reduced to half a tick for those stocks that have a spread of one tick). The rules also give lit orders priority over dark orders that reside in the same venue.
At its peak, dark pools represented 7.3% of the Toronto Stock Exchange-listed share market share in August and September 2012, compared to 2.6% share market share in May 2013.
According to the report, Alpha Intraspread, which focuses on retail investors, saw its market share drop from 46% in March 2012 to 8% in May 2013.
Meanwhile, MATCH Now was open to institutional, retail and proprietary clients offering price improvement mechanisms, leading to a market share increase of 86% in May 2013, from 48% in March 2012.
In the report, Mostowfi said: “Regulators face a tough task in setting market structure rules and responding to unintended consequences. They must maintain a delicate balance between order interaction and competition in order to promote price discovery and market innovation.
“We are keen to see how the Canadian regulators will evaluate the impact of the dark rules and address concerns about the unknown size of dark/inaccessible liquidity pools within the lit marketplaces.”
TABB has also released a report focused on Canadian high-frequency trading regulation, which found regulators continue to face challenges in relation to HFT as they continue to develop rules to limit negative effects on the market.