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December 16, 2011

Canada Forges Ahead

Top Stories in 2011

By John D'Antona Jr.

Long a distant relative to its U.S. cousin, the Canadian equities market spread its wings and emerged this year as its own powerhouse marketplace-replete with multiple exchanges, dark pools, alternative trading systems and more algorithms. The country's rise from old-school trading to mainstream among modern global markets has been solidified by its commitment to a solid banking system, transparency and focus on the retail investor.

Against a backdrop of the failed merger of the Toronto Stock Exchange and the London Stock Exchange earlier this year, the Canadian marketplace continued its march toward becoming more like the U.S. There was continued venue growth and fragmentation in Canada, prompted by regulatory changes in 2001-the National Instrument 21-101 Market Place Operations and NI 23-101Trading Rules, together known as the "ATS rules."

One area of growth has been in dark pools. Canada has always been a market dominated by a handful of banks that control trading in the public markets. But times have changed. This year alone, several new dark pools have sprung up, adding to the handful present last year. Goldman Sachs launched its dark pool, Sigma X, in Canada this year. Instinet also brought dark liquidity to the marketplace.

Prior to this year, Liquidnet and ITG were the only dark pool operators in Canada.

Despite the dark venue growth, Canada's main trading exchange remains the Toronto, which still sees nearly 60 percent of all trading volume. But new alternatives, such as TMX Select and Goldman Sachs's dark pool, are posing challenges to current market leaders.

Other dark venues are to come, according to observers, but the Investment Industry Regulatory Organization of Canada, the self-regulator of the Canadian equities markets, recently proposed that dark pools must offer some type of price improvement over the national best bid and offer for trades to take place in unlit venues. Historically, Canadian trading has primarily taken place on the public exchanges.

Until final rules are passed, dark volume will likely stay mired in the 3 to 4 percent range, as it has been for the last few years. But some, such as Mike Bignell, president of Omega ATS, are optimistic that volume could reach upward of 6 or 7 percent in the coming year.

"I'm optimistic growth could climb," Bignell said.

But that growth is expected to be tempered, according to Lida Preyma, director, capital markets research in global finance at the G20 Research Group at the University of Toronto. She said that until Canadian regulators are done passing outstanding rule proposals regarding dark pools, growth could be tepid.

"What we see is that everyone is in a holding pattern to see where regulation is going to wind up-no one wants to spend money to set up a dark pool before regulations are in place," Preyma said.

Venue growth has also prompted liquidity providers to compete more heavily for business. In a bid to grab more market share, Omega ATS recently decided to eliminate taker fees. It eliminated the pass-through fee typically charged to investors who take liquidity from the marketplace, making it the only free ATS for participants in Canada.

As a result of more venues, a need for connectivity solutions has emerged for both the buyside and sellside. Sang Lee, a managing partner at consultancy Aite Group, said U.S. trading solution providers can expect to see increased demand for their services in Canada.

"The Canadian market is going through a tremendous amount of market structure changes-from fragmentation, adoption of more sophisticated strategies and algorithms to smart order routers," Lee said. These technological changes, combined with the growing presence of high-frequency traders, he said, have created a demand for innovation and more product providers.

The buyside is said to be looking at smart order routers and crossing engines, as well as algorithms that will help them keep pace in changing times.

"Canada is an evolving market and on a technology trajectory to be very similar to the U.S.," said Mark Skalabrin, chief executive at Redline Trading Systems.

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