The Canadian equity trading landscape is on the verge of a seismic shift that critics say is being introduced without adequate public debate, a situation that they warn will harm the quality and integrity of the market.
On Sept. 21, TMX Group Ltd. will launch its new trading model for TSX Alpha Exchange. Among other things, the new model will introduce a systematic “speed bump” to the market that will slow the execution of certain orders. As a condition of approving the new trading model in April, the Ontario Securities Commission (OSC) ruled that orders on the new Alpha exchange would not be subject to the order protection rule (OPR), which aims to protect market quality by ensuring that better-priced orders are executed first.
The OSC’s condition was imposed amid concerns that subjecting orders that are systematically delayed due to OPR requirements would add costs and complexity to routing and execution. Now, however, several industry players complain that this approach will introduce its own complexities and unintended consequences. These critics also complain that this change is happening without a proper public debate.
In the wake of the Alpha decision, the Canadian Securities Administrators (CSA) proposed changes to the policy guidance that accompanies the trading rules in order to reflect the regulator’s policy stance that order protection should not be imposed on markets that use a systematic speed bump to delay executions. In comments on those proposals, several industry players are sharply critical of the CSA.
Critics of the regulator’s approach complain that the introduction of Alpha’s new trading model, and the accompanying regulatory conditions, will change Canadian markets fundamentally, resulting in greater complexity, uncertainty and confusion. Furthermore, critics charge, these changes are coming about without a proper debate on the broader ramifications of these changes.
“It is our view that Alpha was approved through a short-circuited, and therefore inappropriate, regulatory process in which neither the final model itself nor the regulatory framework accommodating it was subject to a proper public comment process,” says RBC Dominion Securities Inc. in its letter to the CSA.
This complaint is echoed in several other comments, which warn that the changes appear to set a worrying precedent of regulators introducing fundamental changes to market structure without genuine policy debate.
These debates are particularly important for market structure, given the complexity of the issues involved, the “zero sum” nature of trading and the outsized importance of regulation in separating winners and losers in such a rule-dependent environment.
For example, the comment from the Canadian Security Traders Association Inc. (CSTA), which represents a cross-section of both buy-side and sell-side traders, expresses “dismay and disappointment” at the lack of debate over the implications for market structure. “To our knowledge, this is the first instance that the CSA has disregarded its usual due process,” the CSTA’s letter says, lamenting the dismissal of the terms of the OPR, which effectively have been changed “without an upfront public discussion.”
The CSA, for its part, points out that some of the issues surrounding the introduction of speed bumps – and the application of order protection to markets that use speed bumps – have been raised and dealt with in other contexts. These include: a review of the OPR, which took place in 2014; the process for approving the Aequitas NEO Exchange Inc., which also uses a speed bump; and the initial review of Alpha’s proposed speed bump.
This stance is echoed in the TMX’s comment on the proposals, which says that TMX views the CSA proposal “as merely formalizing concepts previously publicly addressed and commented on” in the 2014 rule proposal, the recognition process for Aequitas and the process for approving the proposed changes to Alpha.
“In particular, the public comments received in response to the TSX Alpha proposal indicated a high degree of support for the view that OPR should not apply to a speed bump market, given the potential added complexities for order handling and routing, as well as other issues that might arise,” TMX Group’s comment says.
Yet, while there was an opportunity to comment on Alpha’s initial application, critics maintain that the regulators’ decision to require the exchange to operate without order protection represents a significant change that should have reopened the debate.
The Investment Industry Association of Canada (IIAC) says in its comment that this policy will have “significant consequences to market participants.” That comment also says that the decision to allow for both protected and unprotected marketplaces, and determining the criteria for distinguishing between them, “should have been undertaken as a single project, and not on a piecemeal basis.”
The CSA notes that its staff are reviewing the comments that have been submitted on the regulator’s latest proposals.
In addition to all of the criticism of the process involved in approving Alpha’s new model, there also is serious concern about the substance of the CSA’s new policy and its possible impact on Canadian markets. By allowing one market to operate without order protection while the other markets must have it, these fundamental changes to Canadian equities market structure may have far-reaching implications.
The comment from KOR Group LLC, a U.S.-based trading analytics and compliance firm, warns that introducing an unprotected market into a system in which all other markets are protected “will lead to deterioration in Canadian market quality” due to the added complexity of the market structure, the emergence of order-routing conflicts and lack of public disclosure about order routing and execution quality.
Several comments also suggest that regulators now will need to clarify how traders are expected to achieve “best execution” among a host of other questions that are created by the emergence of this new market structure.
Indeed, the regulators may be better off scrapping order protection requirements altogether and moving to a fully unprotected market structure, with a more principles-based approach to ensuring best execution. If regulators decide to entertain that idea, they’d be well advised to ensure there’s a full debate first.
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