Most firms welcome more transparency, but many are concerned about rule clarity and documentation

By James Langton | May 2016

Ensuring that investors are treated fairly when they execute trades in the increasingly fragmented and complex Canadian markets is a fiendishly difficult challenge for regulators. The latest effort to ensure "best execution" - the time and cost involved in making a trade - is sparking concerns that the complexity of the solution may overwhelm the benefits to investors.

Last year, the Investment Industry Regulatory Organization of Canada (IIROC) published proposals to revise the existing "best execution" requirements to take account of some of the major changes in trading practices that have taken place in Canada's markets over the past couple of years.

These proposals include innovative trading models (such as markets that use "speed bumps"); regulatory reforms to accommodate these new models; and growing concerns about the prospect of investment dealers sending much of their retail order flow to U.S. wholesalers in search of more cost-effective execution south of the border.

IIROC's proposals would: establish obligations for dealers to have written policies and processes for pursuing best execution on behalf of clients (including requirements to update these policies regularly and to train employees regarding them); impose new disclosure requirements designed to help clients evaluate the quality of trade execution they receive; and impose an obligation for firms that use other dealers to execute trades for them to assess whether those secondary dealers are complying with the best execution obligations. The proposals also spell out that sending orders to foreign markets in bulk will not meet dealers' best execution obligations.

The comment period on these proposals closed in late March, although comments were submitted after the deadline.

Since then, the Canadian Securities Administrators (CSA) announced its own reforms that will introduce further significant changes to market structure regulation. However, the CSA has yet to finalize its proposed changes to its best execution rules. (See story, below.)

Most of the comments regarding the IIROC proposals endorse the idea of robust and transparent best execution obligations, but some comments raised concerns about the practicalities involved.

For example, there's lack of clarity on what constitutes best execution, how it should be measured and how dealers can demonstrate compliance with their obligations.

Comments from firms on the buy side, including Toronto-based asset-management giant RBC Global Asset Management Inc. (RBCGAM), argue that regulators should impose greater disclosure requirements on dealers regarding their order-routing practices and results, so that investors can evaluate the quality of trade executions they are receiving.

"Without regulator-mandated, standardized order-routing disclosure requirements ... the order-routing information investment managers are currently able to obtain from dealers is of very limited use when trying to assess whether a [dealer] has achieved best execution," RBCGAM's comment states.

This call for the introduction of standardized metrics is echoed in the comment from Toronto-based Aequitas NEO Exchange Inc., which supports greater disclosure of order-routing data, but cautions that this will inevitably lead to "the production of an overwhelming amount of incomprehensible and nonstandardized information that will be of no benefit or use for the vast majority of investors, both retail and institutional."

Instead, the Aequitas comment recommends that dealers be required to provide investors with "a set of simple and standardized metrics" that would enable them to assess the quality of trade execution.

In addition, Aequitas' comment raises the issue of market data, suggesting that the "vast majority" of investment advisors have access to only partial market data, which may lead to poor routing decisions for clients. The exchange's comment recommends that IIROC mandate the provision of consolidated market data to inform these sorts of decisions better.

On the other hand, the Investment Industry Association of Canada's (IIAC) comment argues that best execution data is not the sort of disclosure that most retail investors want or need. Adding this routing and execution data on top of the expanded disclosure about cost and performance mandated under the second phase of the client relationship model is likely to just burden many clients with unwanted information, the IIAC comment states.

Moreover, the IIAC comment raises concerns that the proposed rules will be too costly for smaller, independent firms that don't have the resources to analyze detailed trade execution data closely.

The IIAC comment also raised concern about the requirement for dealers that outsource trade execution to assess compliance by the dealers that execute trades on behalf of the primary dealer. The IIAC comment states that this concern primarily will affect small dealers, which typically use secondary executing brokers.

Many smaller firms are struggling already in the current market environment. The IIAC comment warns that "imposing another expensive and time-consuming regulatory requirement on these dealers" may help to push some of these firms out of business.

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