Canada Looks to Limit Dark Trading
Traders Magazine Online News, March 10, 2011
Canadian regulators have peered across the border and don't like what they see.
The countries Canada's three main regulators--Canadian Securities Administrators, the Ontario Securities Regulator and the Investment Industry Regulatory Organization of Canada--are on the verge of jointly proposing new rules that could nip U.S.-style dark pool trading in the bud.
Behind the move is a long history of transparency in the Canadian marketplace and fears that the current trend towards electronic trading will usher in a significant dark market similar to that in the U.S. In Canada, nearly all orders are exposed on an exchange or other "lit" market before trading.
The regulators made plain their concerns in a recent "position paper" published in November.
"In examining the issues and the risks of the expansion of the use of dark orders, we are of the view that the need for providing some limits on their use is critical in maintaining the quality of the price-discovery mechanism and addressing concerns regarding the impact of dark orders on the quality of the Canadian capital market," the regulators wrote.
Of greatest concern to fans of dark pools is the imposition of a minimum-trade-size clause. This would bar the posting of any "passive order" in a dark pool if it fell below a certain size threshold and require the dark pool operator to price improve any "active" order that fell below the threshold. The result would be to force brokers to route more orders away into the lit markets.
Market sources said 5,000 shares is the expected minimum size allotment, but nothing has been announced publicly by Canadian regulators. Currently, small orders may be crossed inside a brokerage house but must be taken to the public markets for the print.
The ruling in question is actually a clarification of Rule NI 21-101 sections 7.1 (1) and (2), which requires pre-trade order transparency. The regulators appear to be leaning towards exempting dark pools from the mandate if they are handling orders in excess of a certain threshold. If the order is under that threshold--say, 5,000 shares--then the orders must be exposed to the light of day.
The clarification to the rule is expected to pass, said Alison Crosthwait, director of research at Instinet in Canada, despite mixed opinions on the matter. She said regulators value a transparent market above all else and a minimum size requirement is consistent with that thinking. A proposal is expected by the end of the second quarter and the revision should go into effect in the second half of the year.
A minimum-order-size rule could stymie growth in the nascent dark pool space, especially for U.S. based brokers that want to set up shop in Canada.
Such is the case for Credit Suisse, which has been considering launching a Canadian dark pool, said Dmitri Galinov, head of liquidity strategy for Credit Suisse's Advanced Execution Services group, operator of the Crossfinder dark pool.
"We have not finalized anything," Galinov said. "We will continue to monitor the regulatory landscape in Canada and revisit the idea of proceeding with a dark pool there after the final rule publishes from regulators and Credit Suisse has an opportunity to view it."
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