Canadian Dark Regs Draw Buy-Side Approval

Terry Flanagan

Six months after Canada implemented new rules to rein in dark liquidity, there are some indications that buy-side investment managers are on board with the plan.

“I’m hearing from buy-side investors who are happy with this,” said Robert Young, chief executive of Liquidnet Canada.

In October 2012, the Canadian Securities Administrators and the Investment Industry Regulatory Organization of Canada implemented rules governing dark liquidity. Key aspects to the regulation include visible order priority, meaningful price improvement, and minimum size.

Young noted that Canadian regulators worked on the dark-liquidity regulations for almost two years before implementation, spanning a concept release, ‘town hall’ and one-on-one meetings with market participants, proposals, and comment periods.

“Generally, the brokerage community has been adamantly against the rule change,” and many brokers shared their opinions with regulators, Young said. “There were a lot of arguments why you should be able to internalize (order flow) and why that’s good for the market.”

While a couple dark pools that had opposed the new rules have either ceased operations or saw business fall off dramatically, “the world didn’t end” since the rules were put in place, Young said.

The buy side retains the ability to tap dark liquidity to trade block orders, and managers are better able to explain their venue choice. “If people from a pension committee are asking do you use dark pools, it can be difficult to say yes with the way it’s portrayed in the media,” Young said. “This really delineates that and helps on the marketing side of business. A manager can say there are new rules and the dark pools we use fit nicely in these rules.”

The new system has also helped stem fragmentation. “Having more block-sized dark liquidity is good, but having more dark pools is not good,” Young said.

In a 2011 comment letter to regulators, Canada’s Buy-Side Investment Management Association spelled outs its stance on dark liquidity. “In general, BIMA members believe that dark liquidity / dark order types are important to a well-functioning marketplace,” the letter stated. “Dark orders can help to minimize market impact and thus can assist a buy-side manager.”

By way of specifics, BIMA noted that its members would generally prefer that regulators not mandate a minimum size, but if there is a minimum size, it should apply to both passive resting orders as well as active orders. BIMA said price improvement isn’t necessary on every dark order without exception, and the organization supported giving visible orders execution priority, assuming same price and marketplace.

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