Canada has marketplaces, both “lit” and “dark”, where equity securities are traded. Lit marketplaces, such as TSX and Chi-X, generally display orders to market participants before trades occur, but offer some order types and practices that deviate from the display principle. For example, traders on lit markets can elect to keep a portion of an order dark by entering an “iceberg order.”
Dark marketplaces use a matching protocol to match orders without any pre-trade display to marketplace participants. Dark venues appeal to institutional traders who transact in size and want to trade without letting the world know what they want to accomplish. In Canada, only about 3% of the total value traded in the first quarter of 2012 on regulated equity marketplaces took place on dark pools.
Participants in lit markets are critical of the lack of transparency that characterizes dark pools, which feed off the prices that are visible on lit marketplaces.
Earlier this month, after three years of discussion and public consultation, which produced little consensus, Canadian securities regulators revealed a new dark liquidity regulatory framework (Framework) that will be implemented in Canada effective October 10, 2012. The Framework is designed to enable institutional traders to continue to execute large orders with minimal market impact while ensuring that smaller orders receive meaningful price improvement when they trade with dark orders.
The Framework has three key elements:
- Visible Order Priority: Visible orders will trade before dark orders at the same price on the same marketplace.
- Meaningful Price Improvement: In order to trade with a dark order, smaller orders (less than 50 standard trading units or with a value of less than $100,000) must receive price improvement.
- Minimum Size: Dark orders must exceed a minimum size to be specified later by regulators. Regulators will monitor market developments before establishing a minimum dark order size. Public comment will be invited when a minimum size threshold is proposed.
For the purposes of the Framework, a “dark order” is defined as an order for which no portion is displayed at the time of entry on a marketplace. This includes the hidden portion of reserve/iceberg orders on lit markets if the hidden portion may trade at a price other than that displayed.
Ongoing IIROC Initiatives
IIROC will proceed with various initiatives to resolve issues not addressed by the Framework but which may lead to other rules. These initiatives include:
- monitoring trading trends to assess the impact of dark liquidity on the operation of price discovery and trading costs;
- issuing guidance based on market surveillance as to potentially manipulative and deceptive trading practices; and
- completing a study on the effects of high-frequency trading on both lit and dark markets and the impact of the new fee model (aimed at recovering the technology portion of the IIROC’s costs based on message traffic).