A review of the regulatory framework for electronic trading in Canada found no deficiencies in the current system, but makes a series of recommendations to ensure that the regulations keep up with the fast-evolving industry.
The Ontario Securities Commission (OSC) published a staff notice today that provides an update to its ongoing review of the risks associated with electronic trading; and the new rules that came into effect on March 1, which established a framework for managing electronic trading risks.
The notice includes a report from an independent consultant, Fionnuala Martin & Associates, who was retained to conduct an independent assessment of the risks and the current regulatory framework. The report concludes that there are no deficiencies in the current rules, and that they provide a good framework for the industry.
It also found that most of the people interviewed as part of the review felt that “the pace of change in the industry represents the most significant risk to participants and marketplaces, both domestically and internationally”.
“Competing regulatory and marketplace demands to meet, in some cases, short timelines in such a complex environment can result in less comprehensive testing of changes than is desirable, or prudent,” it says.
The report also notes that systems outages are inevitable, and that the response to these outages is critical. “Effective risk management is predicated on understanding the risks and accurately assessing the probability and impact,” it says. “The more consistency and clarity in understanding regulatory and marketplace reaction to events, the better the likelihood that risk mitigation strategies can be developed and issues resolved faster.”
The consultant’s recommendations include: that the OSC should encourage the Investment Industry Regulatory Organization of Canada (IIROC) to make implementation of volatility controls a priority (yesterday, IIROC proposed an expansion of its single-stock circuit breaker program); that it should encourage IIROC and equity markets to be more transparent in the behaviour of their volatility controls; and, that the OSC should consider creating a centralized library of marketplace order types that covers trading engine functionality and expected behaviours.
It also suggests that the OSC consider inviting other Canadian regulators to consider whether higher minimum marketplace standards are required; and, if so, it should form an industry committee to introduce minimum standards for the delivery and availability of testing services by marketplaces.
The OSC says its staff are reviewing the recommendations, and considering possible next steps. “We recognize that as the speed, capacity and complexity of trading securities increase, the OSC must continue to consider the appropriate safeguards necessary to mitigate the risks of changing technologies and continue to gather information and examine whether regulatory requirements are complete, robust and effective,” it says. “We also understand that electronic trading safeguards must continue to evolve as markets evolve and any requirements must be considered in the context of fair and efficient capital markets.”
Any proposed changes to the market oversight framework will be carried out through the normal rulemaking process, as well as the OSC’s ongoing oversight of marketplaces and market participant feedback. The OSC also says that it will continue to work with the Canadian Securities Administrators (CSA) and IIROC to identify and address electronic trading risks through policy development and through consultations with market participants, investors and the International Organization of Securities Commissions (IOSCO).
“The current pace of market evolution requires us to continuously examine and evaluate the policies that safeguard the marketplace and market participants from the risks associated with electronic trading,” said Howard Wetston, chair and CEO of the OSC. “Although the risks of technological failure or human error can never be completely eliminated, we strive to ensure we have robust mechanisms in place to manage risks associated with electronic trading and to foster capital market efficiency and protect investors.”