Market regulator advocates temporary trade-through rule

(June 6, 2005) Alternative Trading Systems (ATSs) are coming to Canada, and regulators are working to avoid the problems that have plagued the trading venues in the United States. ATS trading venues like Bloomberg Tradebook Canada and Liquidnet Canada have been operational for some time and the field is about to expand with the introduction of Markets Inc. and TriAct Canada — which was announced on May 24 by ITG Canada.

“We are going to continue to push for effective measures to protect the small Canadian investor from trade-through,” Market Regulation Services (RS) CEO Tom Atkinson told a recent meeting of the Investment Management Association. “Innovation and competition shouldn’t be directed towards finding new ways to exploit regulatory gaps through choices of trading venues.”

The introduction of competitive marketplaces into Canada means the same securities will trade on more than one venue. That raises the possibility of trade throughs — whereby an access person fills an order at an inferior price. An access person is defined as any non broker-dealer, such as a pension fund that through subscription to an ATS has access to a marketplace.

Under current rules an access person who subscribes to one of the new marketplaces is not prohibited from trading through a better price that appears elsewhere. “We believe this poses a substantial risk of material harm to Canadian marketplaces and marketplace participants,” says Atkinson.

RS says it appears provincial regulators don’t think it’s necessary to put a temporary regulation in place while the debate about trade throughs is ongoing. The OSC indicated it plans to produce a concept paper to gather industry input later this summer. But that comment process will take at least a year, so RS wants to apply measures to prevent access persons on new competitive marketplaces from trading through in the interim.

In the U.S., trade throughs often take place because the market centre has prior arrangements with the broker-dealer conducting the trades. In some cases, economic incentives are provided to get firms to direct order flow. The Securities and Exchange Commission (SEC) recently sorted out the bulk of such conflicts by passing its new National Market System Regulation, called Reg NMS. But the creation of that rule followed nearly six years of divisive discussions on U.S. market structure, including a bitter debate over who had ownership of the quote data generated by the various trading venues.

“The U.S. learned that different sets of rules over different trading modalities lead to unforeseen negative results,” says Atkinson. “As we take our first step with competitive marketplaces, let’s not repeat their mistakes.”

Filed by Philip Porado, Advisor’s Edge, philip.porado@advisor.rogers.com