Dark Trading Gets Lighter in Canada

Terry Flanagan

Dark trading in Canada is about to get lighter with new regulatory provisions on dark liquidity around the corner.

On October 15, new rules that were approved by Canadian securities administrators and the Investment Industry Regulatory Organization of Canada (IIROC) will go into effect.

The rules require that an order entered on a marketplace must trade with visible orders on that marketplace at the same price before trading with dark orders at the same price on that marketplace.

“October 15 will bring significant changes in the dark trading environment in Canada,” said Robert Young, chief executive of Liquidnet Canada, a buy-side focused block trading broker. “That’s causing marketplaces in Canada to make radical changes in their market structure, or, in some cases, like Goldman Sachs’ Sigma, to be shut down.”

The rules would mandate minimum price improvement by dark orders over the NBBO [National Best Bid and Offer] by one full tick.

Often compared to the trade-at rule in the U.S. markets, the idea is to prevent dark orders from jumping in front of visible quotes by some fraction of a tick, and potentially de-incentivizing investors from placing visible bids and offers in the lit market.

IIROC reports dark trading is now roughly 7% of total daily market volume in Canada, up from 2.2% in 2011.

One of the reasons why dark pool volumes in Canada are so low is the existence of broker preferencing. Broker preferencing is an internalization practice that allows incoming orders to a trading venue to match with other orders from the same dealer ahead of similarly priced orders from other dealers, without concern for time priority.

“Broker preferencing in Canada gives enough functionality of dark pools that brokers will stay in the lit market,” said Jeff Drew, liquidity center program director at NYSE Technologies, the technology arm of transatlantic exchange operator NYSE Euronext.

For example, if a broker sends an order to sell 1000 XYZ at 38.30, under broker preferencing that trade will match up with a bid from the same broker at 38.30, even if another broker had placed a bid at the same price into the book 20 minutes earlier.

“Broker preferencing reduces the incentive to use a dark pool because you know that you’ll be able to do a match against your order flow,” said Drew.

Liquidnet Canada is opening up its trading venue to registered broker-dealers, in an effort to offer more liquidity for its core institutional customers.

“A high component of institutional Canadian equities are held offshore,” said Young at Liquidnet Canada. “A network like Liquidnet, which is geographically indiscriminate, has been successful in building liquidity for the buy side. We are now opening up greater liquidity by allowing brokers to use the network.”

Over 50% of all Canadian assets under management are managed by Liquidnet members, noted Young. “The liquidity discovery rate, on a symbol by symbol basis, has been 20%, and by adding brokers we will bring that rate up.”

Liquidnet has created a new order type for resting blocks.

The Broker Block order type allows brokers to execute blocks through the Liquidnet Canada ATS. The minimum order size from a broker is 50 standard trading units; such orders are referred to as “broker block” orders.

“Liquidnet members will be able to interact with additional agency liquidity submitted by IIROC participates, with both achieving midpoint executions while minimizing market impact,” according to a regulatory filing by Liquidnet.

Liquidnet has launched similar initiatives in the U.S. and Europe. “We are introducing programs globally for bringing in new sources of liquidity, including brokers,” said Young. “The rules and regulations differ from country to country, so this is very much a Canadian-specific initiative.”

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