Securities regulators are once again examining a long-standing issue for brokers and investors—the prevalence of “internalization” in the Canadian equity trading landscape, and its impact on the fairness and efficiency of markets.
In a joint consultation paper published Tuesday, the Canadian Securities Administrators (CSA) and the Investment Industry Regulatory Organization of Canada (IIROC) said they’re seeking industry feedback on the issue of internalization, which generally refers to a broker acting as both buyer and seller on an order.
Among other things, the regulators are looking for insight into how internalization impacts the market overall (weighed against the interests of individual clients and dealers); the conflicts of interest inherent in broker preferencing practices and their impact on liquidity, price discovery and market fairness; and the effects of increasing market segmentation for retail orders.
“Much of the recent concern about increasing levels of dealer internalization is premised on the view that systems are being employed to segment and internalize predominantly retail orders, leaving significantly less opportunity for the broader market to trade with retail clients and potentially resulting in inferior execution results for market participants in aggregate,” the paper noted.
“While there are a variety of competing interests, our underlying goal is to ensure the protection of investors, and to foster fair and efficient capital markets and confidence in capital markets,” the regulators said in the paper.
There are no specific policy responses proposed in the paper, and the CSA and IIROC stressed they haven’t reached any conclusions about whether rule changes are needed.
“We are seeking feedback to consider how current trading practices fit within our rule framework, offer investors protection, and support the evolution and functioning of a fair and efficient market,” said Louis Morisset, chair of the CSA and president and CEO of the Autorité des marchés financiers (AMF), in a release accompanying the regulators’ paper.
The issue of internalization has existed for years in the Canadian equity market. In the days before the advent of alternative trading systems and widespread electronic trading, regulators worried about the role of the “upstairs market” in Canada.
Now, in their paper, the CSA and IIROC are examining the phenomenon in the context of the modern Canadian equity market, which has multiple trading venues—including both dark and lit markets—offering a vast array of trading models. Comments on the paper are due by May 13.