Dark Order Proposal Triggers Migration Fears

Terry Flanagan

By directly requiring a minimum order-size to execute orders in the dark, Canadian regulators could push orders over the border to U.S. dark pools.

That possibility is “a very key concern,” said Doug Clark, head of research for ITG Canada. “Given the lack of quantitative research [supporting dark liquidity eroding price discovery], we should be careful not to give traders an excuse to trade outside Canada.”

Although only about 5 percent of stocks listed in Canada, or about 300 stocks, are listed on exchanges in both the U.S. and Canada—and could therefore see trading in their shares shift across the border–they make up about 70 percent of the value of stocks traded in Canada, said Clark.

David Panko, managing director at TD Securities, said that requiring submitters of dark orders to provide that level of price improvement would “significantly curtail” dark liquidity in Canada by eroding its economics for orders under 5,000 shares.

“It will drag flow to the U.S. where price improvement is more in line with the economics,” Panko said.

Canadian regulators are proposing the price-improvement requirement to limit broker-dealers’ use of alternative trading systems to execute trades without displaying quotes, for fear that could eventually erode price discovery.

The proposal would enable regulators to put a minimum size requirement into place in relatively short order, with little input from the industry. However, it provides little detail on how regulators would determine the threshold or when could be implemented.

“If I’m going to write a blank check to somebody, I want to have an idea what may happen down the road—the metrics they’ll be looking at and how they’re going to make that decision,” said Clark.

The Ontario Securities Commission (OSC), Canada’s principal regulator, received a mixed bag of comments by the June 16 deadline for its proposal to introduce a minimum size. The Investment Industry Regulatory Organization of Canada (IIROC) was anticipated to spell out the size requirement in more detail in its subsequent proposal, which it released jointly with the OSC July 29.

Instead, it proposed UMIR Rule 6.5, which would provide IIROC—similar to the Financial Industry Regulatory Authority (Finra) in the U.S—with the regulatory framework to designate a minimum size later on, conditional upon OSC approval.

The proposal says that “in the coming months, we will examine the Canadian market and monitor market developments and regulatory approaches in other jurisdictions to determine the appropriate threshold.”

In the meantime, the current proposal would indirectly impose a minimum size requirement for an order to remain dark.

The proposal amends language in existing Rule 6.3, known as the order exposure rule, to require orders under 50 standard trading units—typically 5000 shares—to be entered on a “marketplace ‘for display,’” according to Robert Young, CEO of Liquidnet Canada.

That rule was approved before the emergence of dark pools, so the original language referred simply to “a marketplace,” said Young.

By stipulating a marketplace that displays orders in the current proposal, the regulators have effectively set a order-size minimum for dark orders of 50 standard trading units, the size minimum discussed in a position paper issued by the regulators last November.

“Regulators have clarified that client orders under 5,000 shares can’t be dark, and put in a framework so that if it’s shown to be needed they can quickly insert a rule for a new size minimum,” Young said.


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