From the Regulators

Retail orders rerouted to U.S. dark pools “could negatively impact price discovery in Canada”

By James Langton |

Securities regulators are moving to stem the flow of Canadian retail orders to U.S. dark pools.

Citing the "emerging threat" of Canadian retail order flow being routed to the U.S., the Investment Industry Regulatory Organization of Canada (IIROC) is reviving a proposed anti-avoidance measure that would limit brokers from sending small, retail orders south of the border unless they are entered on lit markets, or receive "meaningful price improvement" on foreign dark markets.

On Thursday, IIROC issued a notice on the Re-Publication of Proposed Dark Rules Anti-Avoidance Provision, defines retail orders as less than 50 standard trading units, and price improvement is defined as at least one trading increment (or half an increment when the spread is just one increment).

Last month, Canadian regulators signalled their concern about the prospect of brokerage firms sending their retail order flow to the U.S.

See Migrating trades: Southward ho?

In Thursday's proposal, IIROC reiterated those worries about firms sending, or intending to send, their retail orders to be executed by U.S. broker-dealers (wholesalers) typically in dark pools with minimal price improvement because the costs of execution are lower, and the orders may be filled at a superior price.

"We are concerned that if even a small percentage of retail order flow from large dealers is directed to U.S. broker-dealers and by-passes the Canadian market, this could negatively impact price discovery in Canada and in turn, the quality of our equity markets," it says in its rule notice.

The proposed amendments aim to encourage the use of pre-trade transparency in Canada, and to treat orders routed to foreign markets in the same way as they are under the Canadian dark liquidity framework. "We think that price improvement of anything less than what would constitute a ‘better price' is not sufficiently meaningful to deny the Canadian market the benefit of transparency," the notice says. "The proposed anti-avoidance provision would help ensure that small client orders that contribute to Canadian price discovery are not by-passed by orders routed to a foreign jurisdiction that can step ahead of the Canadian posted orders by an amount that would not be sufficient in Canada."

"IIROC's proposal would achieve consistent application of the rules we have designed to incent price discovery on Canadian public markets in order to keep our markets healthy," said Andrew Kriegler, president and CEO of IIROC.

"We believe that Canadians should get the best possible price, but the price improvement must be sufficiently meaningful to forgo the benefits that transparency brings to Canada and to the quality of Canadian markets," he added.

IIROC says that its proposals are intended to foster public debate about the best approach to dealing with the possible impact on Canadian markets of an increase in order routing to U.S. markets.

The deadline for comments on the proposals is March 30.