By Anne Sherry, J.D.
The Investment Industry Regulatory Organization of Canada (IIROC) has concluded that the dark pool liquidity framework it put into place in 2012 has met its objectives with minimal impact to market quality. An IIROC report concludes that the amendments improved lit market depth, furthering the goal of favoring lit markets over dark markets in the absence of a meaningful, consistently defined price improvement while acknowledging the role of dark orders.
Background. IIROC is a self-regulatory organization charged with establishing and enforcing market integrity rules regarding trading on Canadian markets. In October 2012, IIROC implemented the amendments to the Universal Market Integrity Rules to require that small orders interacting with dark receive meaningful price improvement and that visible orders trade before dark orders at the same price on the same marketplace. The goal of the rule change was to establish a framework that recognized the contribution of dark orders to the post-trade price discovery process and their value to certain investors while satisfying the need to protect lit market price discovery, ensure meaningful price improvement, and establish a level playing field between transparent marketplaces and dark pools.
Trading venues. The report points out that only two Canadian marketplaces had models that needed to be changed as a result of the dark amendments. Alpha Exchange Inc. (ALF), a lit marketplace with a dark trading facility, and TriAct Canada Marketplace LP (TCM), a dark marketplace, offered price improvement that did not meet the new definition of “better price” under the rules—at least one trading increment, or half that if the spread is only one trading increment. The other marketplaces, whether lit, lit with dark order types, or dark, were already in compliance with the rule amendments.
Study. IIROC reviewed trading data covering the two months before and the two months after the dark rule amendments. The study analyzed the relative changes in dark to lit trading and market share shifts among trading venues; the impact to market quality; and the use of dark trading venues by brokers to internalize their order flow. Of the two affected marketplaces, ALF saw the greater impacts to dark trading values as a result of the dark rule amendments. Other than return autocorrelation measuring price efficiency, most market quality measures showed no significant impact. The study also revealed that there was no statistically significant deterioration in overall market liquidity as measured by time-weighted average spreads, effective spreads, and realized spreads. As to brokers’ use of dark markets and order types to internalize their retail order flow, IIROC found that market-met internalization, while low to begin with, decreased significantly following implementation of the dark rule amendments. This decrease was driven by a few brokers reducing their liquidity provisioning on ALF’s dark trading facility.
Remarks. Andrew J. Kriegler, IIROC’s president and CEO since last November, praised the SRO for its initiative in taking action on dark pools “before the genie was completely out of the bottle.” As expected, the rule resulted in an immediate and dramatic decline in dark trading, he said. As IIROC had hoped, the analysis showed some positive results in the visible markets and indicated overall that the regulatory objectives were accomplished with acceptable impacts to market quality. In his remarks before the International Finance Club of Montreal, Kriegler also discussed approaches to curb order routing to the U.S. and improving regulatory transparency in the debt market.