TMX Group Inc. wants to make big changes to how its stock markets operate, to combat what a senior executive says is the "single biggest issue" facing Canadian equity trading – the possibility that more trading migrates to the U.S.
In the U.S., traditional stock markets have become increasingly less relevant as brokers do more and more business in alternative venues. That's driven by what's known as "payment for order flow," which allows trading venues to essentially buy orders from brokers. In Canada, that is prohibited.
That creates a real risk that Canadian brokerages will want to sell their order flow to U.S. venues, steering it away from Canadian markets such as the Toronto Stock Exchange, says Kevan Cowan, head of the equity trading businesses at TMX.
"That's the single biggest issue that we're facing as Canadians – keeping the quality of our markets and ensuring that doesn't happen," Mr. Cowan said in an interview, after TMX announced a raft of planned changes to how equity trading in Canada will work.
He said that TMX has "real concerns that people are looking to [sell order flow to U.S. venues], and that there is a potential gap in the public policy" that will allow that to happen. He said he has heard "chatter on the street" that this is likely to become a bigger issue.
To counter that threat, TMX is looking to change the way its Alpha exchange works. For starters, instead of paying brokers who send passive orders to Alpha (think limit orders to sell a set number of shares at a set price), Alpha will flip to a model where it will pay brokers who send active orders there (think market orders to buy at wherever the stock is trading). That rewards brokers who send active orders to Alpha; these types of orders make up the order flow that could be at risk of heading to the U.S. in return for order-flow payments, Mr. Cowan said.
Of course, some will argue this is payment for order flow in a different guise. However, it's open to anybody who sends an active order there.
TMX also wants to introduce a "speed bump" time delay that will slow down any speed-driven traders trying to work on Alpha. The goal there is to try to make the market more attractive to brokers who are not speed driven – again, aimed at ensuring brokers with order flow that otherwise might go elsewhere are attracted. A final piece of the framework is to have a minimum size for passive orders that the active orders trade against, to ensure that there are big orders brokers can trade against.
The changes aren't just at Alpha. TMX plans to introduce a new order type on its main Toronto Stock Exchange market that will reward investors who put up orders for a longer period of time. This is to combat the so-called "fleeting liquidity" that has drawn criticism – orders that are put up but that vanish in a tiny fraction of a second.
Traders who use the "long life" order type will be rewarded with priority over investors who don't. So if trader A puts in a buy order for 100 shares at $10 for shares of ABC Co. using the long life order, and trader B puts in the same order at the same time using another order type, trader A gets first crack at any shares on offer at that price.
Of course, "long life" is not very long in trading today. Mr. Cowan said it might be something like one second.
"Long life is very relative with today's trading in microseconds," he said. "One second is a significant commitment. That will have a very beneficial effect."
The goal is to reward investors who are not as concerned with speed, and to provide a levelling of the playing field with traders who have invested in technology to get their trades to the market as fast as possible.
This is a growing theme in markets. In Canada, a new market called Aequitas is launching with a similar promise as its rallying cry.
The TMX's final big move is that it is shutting down its Select trading system, a smaller operation that was launched prior to TMX acquiring Alpha. The two markets have a similar appeal to investors, said Mr. Cowan. He said moving to eliminate one of them will help simplify trading. Alpha, being the market with more volume, was the one they decided to keep.
That may cause some grousing on the street, as Select has already been migrated onto the new TMX trading engine known as Quantum XA, and Alpha has not. That means the trading community will have to do it all over again.
Because the TMX is heavily regulated, all the changes will require both regulatory review and comment from market users. That will take months, and so Mr. Cowan said the company is hoping to have the changes in place by June.