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October 19, 2006

Canadian Liquidity Woes

By Nina Mehta

Canada's dealers may gradually lose their grip on institutional trading. Crossing networks haven't yet succeeded in penetrating the market, but electronic trading is on the rise.

The signs of change can be startling. In the three and a half years that trading supervisor John Spitman has been at AIC Limited, his desk has gone from 100 percent phone trading to 60 percent electronic trading-"primarily because of anonymity and the lower cost," he says.

AIC has some $7.5 billion Canadian in equities, mostly in mutual funds and closed-end funds with a limited number of holdings. As a result, the value-oriented money manager often executes large trades. AIC is based in Burlington, Ontario.

The desk currently pays half a cent or 1 cent per share for electronic trades. In 2003, AIC's average commission was 6 Canadian cents per share.

That said, finding liquidity in Canada can be tougher than in the U.S., Spitman observes. "In U.S. stocks, you can get a fill on 1 million shares by going 500 shares at a time, as long as you're willing to sit out there all day," he says. "For some stocks in Canada, you're probably only going to get filled if you do a 50,000-share block."

The Toronto Stock Exchange has been electronic since 1997, but large institutional orders are still usually executed in the upstairs market and printed to the tape. That makes relationships important. "It's good if you need to get a fill on a thin name," Spitman says. "But it's bad because people you're dealing with know what you're doing."

The TSX's rules also make it harder to trade some stocks in an automated fashion. The exchange requires a minimum display quantity of 2,000 shares for "iceberg," or reserve, orders. "For a thinly traded stock, that's a lot, so you end up working those orders yourself electronically," Spitman says. Alternately, a buyside trader may call a broker instead of posting on the exchange and showing his hand.

However, the TSX is good at providing transparency into what's going on in the market and who's trading large blocks of stocks, Spitman notes. With a couple clicks, he can pull up information on which brokers handled the largest blocks in a stock over a given period. "So if Royal Bank of Canada has done 60 percent of the block trades on a name, I can just phone them and see what they've got."

AIC's largest brokers are Merrill Lynch, Royal Bank of Canada, Raymond James and Instinet. The desk uses Instinet's Newport platform for the bulk of its electronic trading.

Spitman says he hopes to see successful crossing networks develop in Canada. "Ideally, we would also be able to do more algorithmic and electronic trading in Toronto the way we can with Nasdaq stocks," he says. In addition to overseeing equities and options trading, Spitman is a portfolio manager for five of AIC's closed-end funds.

AIC Limited Equity AUM: Can. $7.5 billion Desk: 3 traders Broker List: 15 Firms Avg. Comm.: 3.5 Canadian cents OMS: Proprietary system Trade-Cost Analysis: Instinet