Canadian Dark Rules Shed Light on Prices
Two and a half years after Canadian regulators imposed a minimum price improvement requirement on dark pools, the result has been an increase in price information in lit markets.
“The rules did what regulators wanted them to do,” said Robert Young, head of Liquidnet Canada. “The rules were designed to prevent a rise in internalization type of dark pools that didn’t make a significant contribution to market structure or anything other than the profitability of brokers. Independent research has found that there was no detriment to market quality, and that there was indeed no significant change other than the liquidity that was previously in the dark went to the lit.”
The implementation of IIROC Notice 12-0130, the first mandated limit on dark trading by a regulator, has resulted in increased price information in lit markets, according to research by the Capital Markets Cooperative Research Centre. However, limiting dark trading in Canada has reduced the efficiency of prices in Canada vis-a-vis U.S. markets for cross-listed stocks.
IIROC Notice 12-013 came into force in October 2012, requiring dark trades to trade at either 1 full tick of price improvement, or a half tick if the quotes are at the minimum spread except for block trades of 5,000 shares or more (or $100,000) which are not subject to the rule.
CMCRC found that the introduction of price improvement rules in Canada reduces both the level of dark trading and the information content of dark trades. “Analyzing cross-listed securities, our research shows that limiting dark trading in Canada caused their price discovery to be less efficient compared to U.S. trading, where dark trading caps do not exist,” according to a CMCRC research summary. “While these results demonstrate dark trading offers little in terms of price discovery, there may be a case that it can increase the aggregate price discovery of a markets, especially if there are differences in market regulation.”
A study by Sean Foley and Talis Putnins of the University of Sydney concluded that since the passage of the trade-at rule in Canada, there is no evidence that dark trading with “non-meaningful” price improvement discourages lit liquidity, but that the regulation did reduce the amount of dark trading, ensured that dark trades provide meaningful price improvement, and reduced the amount of internalization in the dark.
“The regulations did achieve some of the more basic and immediate objectives, such as reducing the amount of dark trading, ensuring that dark trades provide meaningful price improvement, and reducing the amount of internalization in the dark,” Foley and Putnins wrote. “However, they do not appear to have been successful in the higher-level objective of encouraging the posting of lit liquidity and thereby improving overall liquidity.”
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