Block Liquidity on the Rise in Canada

Terry Flanagan

Canada has been slow to adopt dark trading, especially compared to the U.S., where it hit an all-time high market share of 13.5% in January. At the start of 2011, dark trading in Canada was about 1.5% of overall Canadian equities. It currently stands at 4.5%.

“Earlier this year, we saw a pullback by international investors; we saw liquidity fall off from international investors who were less active in Canada as they had been before,” said Robert Young, chief executive of Liquidnet Canada, an operator of dark pools. “However, in March it came back, trading volumes and our market share went up a fair amount.”

Historically, a large amount of trading activity in Canada had come from abroad, particularly the U.S. and Europe, from investors looking for exposure in the nation’s strong energy and materials sectors.

“The tools are getting more sophisticated and clients are getting more sophisticated,” said a Canadian broker-dealer executive. “They are getting more comfortable with dark trading as well.”

While block trading is experiencing a resurgence in recent months, it has been on a wider, long-term decline in recent years.

“Block trading has been a good tool to help keep large orders discreet and extract liquidity,” said a buy-side trader. “Unfortunately, traditional block trading over the years has been evaporating. I hope it can make a comeback, because it was a great way to extract liquidity from the market.

“One of the ways it might make a comeback is if buy-side only firms allow participants to ‘scrape’ each other’s blotter and put up crossing prints. This method, if not controlled, may forfeit the discretion we were trying to contain in the first place.”

Liquidnet posted record growth in Canada during 2011, with trading volume increasing 60% year-over-year, with its client base consisting entirely of institutions. This is in contrast to the Canadian equities market as a whole, which saw a 6% increase. The TSX declined 1% at the same time and the Venture exchange declined 4%.

Liquidnet often touts its large average execution size, which is close to 50,000 shares in the U.S. and about 64,000 in Canada. Large block trading is otherwise difficult to accomplish on a lit exchange without impacting the markets.

ITG Canada subsidiary TriAct runs the Match Now dark pool in Canada, which is currently the largest by market share with 2.2% of consolidated volume, according to data compiled by Rosenblatt Securities.

During the spike in volatility seen during the late summer months, dark trading in the U.S. and, to an extent, Europe saw a substantial decline, as traders returned to the perceived safety of exchanges. In September, dark trading in the U.S. dropped to less than 11% before returning to 13.5% in January.

In Canada, dark trading increased alongside the upshot in market volatility. When the CBOE Market Volatility Index reached highs in August and September, market share went from less than 2% to nearly 4% within a few months.

While this can partially be reasoned on traders becoming more sophisticated and comfortable with the available tools, this jump also coincided with the launch of Alpha Group’s Intraspread dark pool. Being that Alpha is backed by some of the largest financial institutions in Canada, it was quickly able to see significant trading activity shortly after its launch. As of January, it was right behind Match Now in terms of market share at 2%.

Japan, like Canada, has also been slow to embrace dark trading, but that is also showing signs of changing. Dark trading on proprietary trading systems in Japan was about 8% as of late 2011.

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