Banks opt for own exchange

Fed up with high fees and limited competition, Canada’s biggest banks and major investment dealers have announced their intention to establish a new alternative trading system that will compete head to head with the TSX.

The new trading system, which is currently dubbed Project Alpha, is being headed up by Jos Schmitt, who was senior partner at Capco and former head of strategy and market operations on the board of the Brussels Stock Exchange.

With the addition of another trading platform, suddenly the market is looking a bit crowded. The intention to launch an ATS comes just days before Pure Trading, CNQ’s alternative visible auction market in Canada for exchange-listed securities, conducts the final test of its system.

“Global capital markets are changing,” said Schmitt in a release. “The future strength of Canadian capital markets depends on our ability to achieve the same kind of efficiencies already being realized around the world by leveraging today’s technology.”

The ATS is being designed to find efficiencies and increase competitiveness and liquidity on the Canadian market. The new ATS will take advantage of National Instrument 21-101, which was approved by the Canadian Securities Administrators in 2001.

The national instrument laid out a set of comprehensive requirements for order and trade reporting, information consolidation and market integration to ensure fair and transparent trading. It also placed a requirement on traders involving best price obligations and best execution practices.

Before the introduction of the new requirements, dealers’ obligations were limited to the markets where they had actual trading access, which wasn’t an issue when there was only the TSX to worry about. Under the new rules, dealers will be required to get the best price for their clients regardless of whether it’s on the TSX or on another exchange, like Pure Trading, whether they have access to that market or not. In those cases where dealers don’t have access to a market, presumably Pure, the member will have to make arrangements through a jitney to put orders on the exchange if it offers the best price.

As one observer noted, the introduction of yet another exchange to the Canadian market will put a much greater focus on the technology, specifically the backend systems used to manage the trades. With more exchanges, milliseconds count, says Tom Price, senior analyst in the securities and capital markets practice at the TowerGroup.

The more efficient exchanges will have the advantage, he says. Even faint differences in the time it takes for an exchange to react to a sudden price shock could allow dealers to take advantage of “stale” prices on the market.

The Alpha Project will be using the highly regarded but expensive Capco platform. Pure Trading uses OMX X-stream platform, which in use by 12 exchanges worldwide. TSX Group, meanwhile, announced in February that it is acquiring the new trading technology hardware and software licences with a value in excess of $20 million.

Ian Brandeen, CEO and vice-chairman of Pure Trading, is encouraged by the announcement of another ATS. “It sounds counter intuitive to peope who have been used to a a one-horse town,” he says. “There are a significant pockets of latent liquidity both from global players and from some of the foreign and domestic buy-side accounts that have for any number of reasons have been unable or unwilling or incapable of accessing the Canadian capital market.”

For these players to capitalize on this market, they need a multi-market environment, he adds. The closer Canada becomes a multi-market environment, the more that liquidity will be able to interface with the Canadian market, Brandeen says.

There is a limit to this growth, he says, but he’s unsure what that number would be. “I’m sure there is a saturation level beyond which it doesn’t make sense, but to be frank Canada is so far the other direction right now that this isn’t something I’m too focused on.”

While it’s too early to identify the winners and losers from this increased competition, the market was betting heavily against the TSX. Shares in the publicly traded exchange plunged more than 10% following the announcement.

The dealers involved in the creation of the new ATS include BMO Capital Markets, Canaccord Capital Corporation, CIBC World Markets, National Bank Financial, RBC Capital Markets, Scotia Capital Inc. and TD Securities Inc.

The new trading system is expected to launch in 2008 subject to receiving the required regulatory approvals.