CSA Updates Status of Market Microstructure Inquiry

The Canadian Securities Administrators have released CSA/IIROC Joint Staff Notice 23-308 – Update on Forum to Discuss CSA/IIROC Joint Consultation Paper 23-404 “Dark Pools, Dark Orders and Other Developments in Market Structure in Canada” and Next Steps. Film of the semi-open meeting is available from IIROC.

Use of SORs by Marketplaces

This issue revolves around the concept of a marketplace-owned smart order router using information about hidden orders on that marketplace when making routing decisions. Although some felt that this practice was not a concern as this is a routing decision only, others thought that all visible orders at a given price should have priority over all hidden orders.

CSA staff are assessing whether the use of marketplace-owned SORs which take into account hidden liquidity available on their own book gives that marketplace an unfair advantage over other marketplaces and SORs. CSA staff are also considering the impact that this practice has on investors and will be examining whether marketplaces that provide information on hidden liquidity to their proprietary SORs should be required to provide the same information to other third-party SORs in order to meet the fair access provisions of NI 21-101.8

I think it’s just disgusting that marketplaces use proprietary information to improve their product and compete. If they want business, they should take their old school buddies out to lunch, just like everybody else.

Market-Pegged Orders

Some forum participants raised concerns over market-pegged orders, specifically whether market-pegged orders have a negative impact on price discovery because they are simply free-riding the quotes from other marketplaces or whether the unrestricted use of such orders created a disincentive to display liquidity. Others were of the view that many order types are variations of pegs, and that the concept was simply centralizing a process which could be, and is currently, done by dealer algorithms or manually, and thus would result in a reduction of message traffic between market participants. This was also consistent with the majority of the responses to the Consultation Paper, which did not raise concerns with pegged orders.We will continue to review proposed order types from marketplaces.

Perhaps not the most ringing endorsement of Pegged Orders, which I strongly endorse (as an option, not as a panacea), but a positive development nevertheless.

High Frequency Trading

It was suggested at the forum that regulators also review high frequency trading, particularly as its growth may have impacted time priority benefits and the ability of some market participants to achieve trade execution. We continue to monitor developments in this area, and particularly recent initiatives in the U.S. aimed at reviewing short-term trading strategies and their impact on the market. A review of issues associated with high frequency trading was also included in the scope of the project to examine electronic trading discussed above.

IIROC staff continue to monitor changes in patterns of trading on Canadian marketplaces, and the impact of “high frequency trading” is included in that monitoring. Changes in technology and the development of competitive multiple marketplaces have significantly increased message traffic and order to trade ratios. Future rates of growth in high frequency trading will be dependent upon decisions which may be made with respect to such issues as sub-penny pricing.

I continue to be dismayed at the fact that High Frequency Trading is considered an actual issue; my reasoning is:

  • A High Frequency Trader requires a 12% return on equity from trading to make it worth their while
  • A long-term investor requres a 0% return on equity from trading to make it worth their while. They make money for their clients from overall market moves, their uncanny ability to assess big picture issues and the impressive depth of their analysis (but mainly overall market moves).
  • Therefore, the established long-term players have a 12% cost of capital advantage over HFT, but cannot compete despite this.
  • Therefore, most institutional money managers are lazy and stupid. Those who complain are lazy and stupid blowhards

I’ve examined every link in this chain of reasoning and have been unable to find a flaw; but perhaps an Assiduous Reader will help me out a bit.

2 Responses to “CSA Updates Status of Market Microstructure Inquiry”

  1. […] is annoying, but not a major issue. As previously noted, a value investor has a cost-of-capital advantage on the order of 12% over a high-frequency-trader […]

  2. […] 23-405 DARK LIQUIDITY IN THE CANADIAN MARKET, which provides an update to 23-308 and 23-404, which have been discussed on PrefBlog. […]

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