The Investment Industry Regulatory Organization of Canada has published new guidance on the use of order types and best execution obligations.
In guidance to firms issued Wednesday, IIROC says that the evolution of the Canadian equity market has created a more complex trading environment, giving rise to new trading dynamics, and has significantly affected the way in which orders are executed.
In recent years, it notes, the Canadian market has seen the introduction of multiple marketplaces; an increase in high speed/high frequency electronic trading; increased order to trade ratios and message traffic; smaller average execution size; and, possible periods of increased market volatility.
“In this increasingly fast-paced environment, the type of orders used can materially impact the quality of trade execution,” IIROC says. It notes that dealers should realize that these conditions can generate executions at unexpected prices.
“Of particular concern are order types without specific execution price limits, such as a ‘stop loss order’ placed without a limit price,” IIROC says. “During periods of liquidity imbalances or fast moving markets, there is heightened risk that an order to sell or buy ‘at any price’ will result in an inferior quality execution.”
IIROC notes that stop loss orders played a big part in the ‘flash crash’ on May last year, and it continues to see rapidly moving prices in individual securities due to the use of multiple stop loss orders without limit prices. It notes that in a number of the recent cases, the price movement has been dramatic enough to warrant regulatory intervention to vary or cancel trades deemed to be ‘unreasonable’. The regulator believes that some of these occurrences should have been avoided, and so, firms are encouraged to place a limit on the execution price of a stop loss order wherever possible, it says.
These same evolutionary forces also affect firms’ best execution and order management obligations, as the way a firm manages its order flows and routing decisions can affect the quality of trade execution. IIROC says that with multiple venues available for order execution, firms must consider the increased market complexity when handling client orders in order to ensure that it continues to comply with its ‘best execution’ requirements. Given the dynamic structure of the market, firms have to regularly review the way they manage orders and order flows to ensure they meet those obligations on an ongoing basis.
The size, structure and complexity of the firm will, to a large degree, determine how a firm demonstrates that its policies and procedures are reasonably designed to ensure compliance with their best execution obligations, it notes.
IIROC says that firms that have automated the order-handling processes should ensure that the technologies employed to manage orders and order flows are designed and calibrated with those obligations in mind.
IE