New Regs Balance Dark

Terry Flanagan

Canadian regulators have introduced a host of new rules aimed at controlling the effects of dark trading.

“These regulations are good for investors, whether they invest directly in the marketplace or if they invest like most Canadians through mutual funds or pension funds,” said Robert Young, chief executive officer of Liquidnet Canada.

The Canadian Securities Administrators (CSA) and the Investment Industry Regulatory Organization of Canada (IIROC) on October 10 will implement a new regulatory framework for orders sent in the dark.

The new regulations, also known as the Universal Market Integrity Rules, are comprised of several elements. Visible orders are to have execution priority over dark orders on the same marketplace and at the same price. In addition, in order to trade with a dark order, there needs to be a minimum level of price improvement. IIROC will also have the right to implement a minimum size for dark orders. The regulations are intended to protect smaller investors as well.

It’s a substantial departure from what U.S. regulators have done with regards to dark.

“Generally we have a fairly ambitious regulatory agenda here,” said Young. “There’s less of a sense of emulating what the U.S. has done in recent years, whereas in the past it would be let’s copy the SEC, now they think everything through.”

Without these new rules, any retail investor that puts an order on the lit market is effectively competing with an order in a dark market, and those are usually posted by professional traders.

“Retail traders had been competing with (those orders), and losing,” said Young.

Dark pools, such as Liquidnet, allow traders to enter orders without pre-trade transparency, and is relatively small in Canada compared to the U.S. However, it is viewed as an attractive alternative for some large institutional investors because large trades that take place outside lit markets are less likely to trigger swings in the prices of securities.

During 2011, dark trading in Canada grew from about 1.5% to 4.5% in January, according to research from Rosenblatt Securities. Alpha’s Intraspread and ITG’s TriAct Match Now are likely to see significant declines in trading volume and market share following the implementation of the new rules.

“To require a minimum price improvement in dark pools and minimum size, those rules will have a big impact on dark liquidity in Canada,” said Evan Young, head of direct access and electronic trading at Scotia Global Banking and Markets.

Liquidnet’s Robert Young expects to see new members come on once the regulations take effect, which will help to boost its market share.

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