Regulators Address Market Structure

Terry Flanagan

Fragmentation of liquidity in equities markets, dark pools, and automated trading are receiving intensive scrutiny from global regulators, resulting in the emergence of new trading venues and order types.

Canada’s Ontario Securities Commission, for example, has established as one of its “priority issues” for 2013-14 “continued rapid evolution of market structures and trading strategies is a potential source of risk.”

Among the action items set by the OSC are to “examine the evolution of the Canadian capital market structure and the impact of the order protection rule, algorithmic and other electronic trading, and market data fees.”

Operators of trading venues are keeping close watch on such developments.

“Any regulatory change has an impact on the business, whether as a broker or a marketplace,” said Dan Kessous, CEO of Chi-X Canada.  “The OSC is examining the Order Protection rule, which only came into existence a few years ago. Whether that will lead to rule changes we don’t know yet.”

The Order Protection Rule provides full depth-of-book protection against “trade throughs,” or the risk that an order sent to an exchange will get executed at an inferior price to an electronic order posted at another exchange.

The Order Protection Rule is similar to Regulation National Market Structure in the U.S., except that Reg NMS only applies to top-of-book.

The trade-through protections work together with the best execution obligations imposed on dealers, according to a consolation report on market structure published earlier this year by the International Organization of Securities Commissions (Iosco).

“Having a trade-through obligation does not weaken the obligation to achieve best execution,” said the Iosco consultation. “The decision of how and where to trade (best execution) continues to be determined by the particulars of the orders and needs of the clients. However, all better-priced orders must be honored at the time of execution.”

BlackRock said that it supports Iosco’s recommendations regarding ongoing monitoring of fragmentation of trade information, order handling rules, best execution, and access to liquidity, but cautioned against making sweeping overhauls.

“BlackRock believes that end-investors would be best served by a targeted and limited adaption of the regulatory framework rather than a radical overhaul,” said Richard Prager, head of trading and liquidity strategies at BlackRock, in a comment letter.

Chi-X Canada ATS has launched its second Canadian trading facility, CX2, which offers a continuous auction market offering on-marketplace internalization opportunities through broker-preferencing for all order types including anonymous orders.

“Given the approval of the Maple transaction, we believed it was important to have a viable competitor in the market offering unique market structure and pricing schedule,” said Kessous. CX2 provides existing Chi-X Canada subscribers with the opportunity to benefit from broker-preferencing while not forfeiting the use of Chi-X Canada technology, order types and features.”

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.

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.

In addition to broker preferencing, CX2 uses a taker-maker, or inverted, rebate system.

Kessous said: “Retail and institutional investors are benefitting from CX2’s unique pricing that rewards liquidity takers.”


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