Canada Seeks Revamp of Order Protection Rule

Terry Flanagan

Canadian securities regulators have proposed amending the Order Protection Rule to make it easier for marketplaces to ignore, or “trade through,” quotes from other marketplaces that failed to meet a minimum volume threshold.

OPR in its current form was finalized in 2009 and implemented in 2011 in response to the rapid evolution of the Canadian equity market.

A review of OPR by the Canadian Securities Administrators (CSA) led it to publish for comment proposed amendments to National Instrument 23-101 Trading Rules. Concerns were raised by market participants that the costs and inefficiencies of the current OPR framework outweighed the benefits of full protection of displayed orders across all Canadian marketplaces.

“This is a forward-looking set of solutions proposed by Canadian regulators to address structural issues that are affecting lit markets worldwide,” Robert Young, president of Liquidnet Canada, told Markets Media. “Regulators are reacting to distortions arising out of trade-through protection guarantees to de minimis markets, and out of payment for order flow in the form of maker/taker rebates.”

The proposed amendments would establish a market share threshold of five per cent, at or above which a marketplace’s displayed orders are protected under OPR. Exchanges that do not meet the threshold will be protected only for their listed securities. The amendments would also mandate specific dealer disclosure relating to best execution policies.

“Institutional investors in the Liquidnet community will benefit through more orderly markets, but the real prize in this collection is forcing disclosure of brokers’ order handling practices and potential conflicts,” Young said. “This is a practice that Liquidnet initiated with its Community some years ago, and we believe is the cornerstone of investors ability to pursue informed choice.”

The Investment Industry Organization of Canada (IIROC) has proposed amendments to its market integrity rules that align with the CSA proposals related to OPR. IIROC dealer members would continue to have a best execution obligation and would be able to consider whether accessing a transparent marketplace that is not protected would be appropriate for their clients.

“This is obviously a topic we are very interested in,” said a spokesperson for TMX Group. “We will review the proposed amendments and intend to provide the Commission with our comments.”

While it appears that some degree of choice does exist for some dealers to manage access to visible markets and the associated costs (e.g., membership and connectivity costs), OPR compliance necessitates that all marketplace participants must access trading on each visible market either directly or indirectly — ultimately some participant must be a member of a marketplace to facilitate connectivity for themselves and others, said the CSA in its proposing release.

“The primary objective of OPR is to promote confidence in the fairness and integrity of the market by supporting both liquidity and efficiency of the price discovery process,” said Bill Rice, chair of the CSA and president and CEO of the Alberta Securities Commission, in a statement. “After identifying a number of issues associated with the current framework, the proposed amendments are intended to strike a better balance between costs and benefits, while reaffirming the CSA’s commitment to investor protection, innovation and a competitive trading environment.”

Four of the eight visible markets in operation as at the end of 2013 (Alpha, Chi-X, TSX, and TSXV) would have met the five percent threshold based on the average of the volume and value of adjusted trades, according to CSA. One additional marketplace that did not meet the threshold and is a recognized exchange (CSE) would have also been considered a protected market, but only for its listed securities. The CSA also found that slightly over 90% of the volume and value of adjusted trades would have occurred on what would have been considered to be protected markets.

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