Proposed Exchange to Cast Wary Eye on HFT

Terry Flanagan

The new Canadian exchange proposed by Aequitas Innovations has a message for high-frequency traders: you are welcome, but check your bad behavior at the door.

“It is not that we’re against HFT technology or HFT firms, it’s more us being against certain behaviors and certain strategies,” Aequitas Chief Executive Jos Schmitt told Markets Media. “We would welcome any firm that today falls under the definition of an HFT — if they want to play a true role of market maker, that is having the benefits and the obligations that come with it — and they can add true liquidity to the market.”

Earlier this week, Toronto-based Aequitas said it would launch a Canadian exchange to compete with TMX Group, the incumbent exchange whose domestic equity-trading market share is about 80%. The new exchange will differentiate itself by restricting certain high-frequency trading practices that are – to the chagrin of some institutional and other more traditional market participants — condoned at other exchanges.

There is a broad array of HFT practices and strategies, some perceived as harmful to market quality and others that are considered acceptable; some practices fall in a gray area between the two categorizations. Schmitt said one indicator of an unacceptable practice is “any account that doesn’t intend on having a position at the end of the day.”

Schmitt cited latency arbitrage, in which traders seek to exploit differences in the speed of price quotations across trading venues, as an example of an unacceptable HFT strategy. “That is something we intend to help investors and dealers tackle with our smart-order routing technology, which allows them to achieve a form of latency normalization across venues,” he said.

‘Ghost’ orders, or displayed orders that are placed by a HFT practitioner to test the market but aren’t truly available for another trader to take the other side, will also be unwanted at the new exchange, at least in its so-called ‘dark’ book and its hybrid book, which is positioned between dark and lit.

“We’re going to give higher priority to market makers, who have fulfilled obligations and take a commitment to post quotes and fulfill their obligations. They will have the higher priority in execution,” Schmitt said. “That will allow market makers to be successful and be compensated for when they are sitting in markets in periods of stress, or when they are providing liquidity in less liquid securities.”

“We are also not using the typical time parameter, which is one of the differentiating elements,” Schmitt continued. “We are using an approach of combining time and size. This is meant to favor larger orders and larger execution.”

Aequitas is owned by a consortium of large institutional participants in Canadian markets spanning the buy side and sell side, including Barclays, CI Investment, IGM Financial, PSP Public Markets, and Royal Bank of Canada.

Schmitt, who was head of Alpha Trading before stepping down last year after the Canadian alternative trading system was acquired by TMX, said the Aequitas exchange may launch around the end of 2014, after regulatory approvals. The exchange name is to be determined.

By trading on the new exchange, end-user investors can expect deeper, more reliable liquidity, more reliable information, less information leakage, and less intraday volatility.

Added Schmitt, “you create an environment fundamentally that is going to lead to better-quality execution with respect to price, size, and timeliness, which are the core criteria of best execution.”



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