Canadian buy-side institutions are gearing up for a significant move into electronic trading, suggests new research from Greenwich Associates.

The consulting firm reports that Canadian institutions directed less than a quarter of their overall equity trading volume to electronic and portfolio trading systems between 2005 and 2006. However, when asked how much of total trade volume they would be directing to these systems in three years time, the typical Canadian institution estimated it would be one-third — this would match current electronic and portfolio trading levels in the United States.

Almost two-thirds of Canadian institutions use self-directed electronic trading for some portion of their equity business, Greenwich said. The typical institution executed approximately 15% of its total trade volume as self-directed electronic trades — either with or without algorithms — and 9% as portfolio trades during the 12-month period ending February 2006, for a 24% total that was virtually unchanged from 2005.

Over the same period, the typical U.S. institution did 24% of its equity trading business via self-directed electronic single-stock trades, up from just 18% the prior year, and conducted another 9% of its business via portfolio trading systems.

“Our research suggests that the migration of trading volumes from traditional ‘high touch’ executions to electronic and portfolio trading, which has been a gradual process up to this point, is already accelerating and will speed up even further in coming months,” says Greenwich Associates consultant Lea Hansen. “Indeed, among the largest and most actively trading Canadian institutions, the proportion of total volume done through self-directed electronic trades jumped from 5% in 2005 to 26% in 2006.”

Greenwich Associates says that its research suggests that electronic trading among Canadian institutions might be approaching a tipping point. By 2009, the typical Canadian institution expects to be doing 8% of its total trading volume through algorithmic trades, 12% through non-algorithmic direct-to-market trades, 3% through crossing networks and 10% through portfolio trading systems. This shift will result in considerable cost savings, it says, noting that commission rates on self-directed electronic trades (as disclosed by the institutions interviewed) have fallen from nearly 3¢ per share in 2002 to just 2.2¢ in 2006. Institutions generating more than $10 million in annual equity brokerage commissions are now paying only 1.7¢ per share on their self directed electronic trading business.

In addition to detailing the growth of electronic trading, the report notes an increase in institutional commission allocations to sell-side research, sales and corporate access, a flattening out of average equity brokerage commission rates, a reduction in soft dollar business and an increase in compensation levels for equity professionals at Canadian buy-side institutions.

It reports that average institutional equity brokerage commission rates in Canada were flat at 4.1¢ share from 2005 to 2006. A growing proportion of equity brokerage commission payments (currently more than half) are being allocated by institutions to compensate brokers for research, sales coverage and the facilitation of face-to-face meetings with company management teams. At the same time, Canadian institutions are cutting back on soft dollar allocations, it adds.

The research is based on interviews with 85 portfolio managers and 70 traders at Canadian buy-side institutions.