Equity wholesaling in Canada anyone?
On April 1, TMX announced they are proposing new trading fees for the TSX Alpha marketplace. It is common place for marketplaces to change fees in order to compete for order flow, but this is anything but your everyday pricing change. The TMX proposal will put the Canadian equity markets on an express train to extreme segmentation of order flow. What is not surprising is that TMX buried their real intentions, instead touting the benefits of stimulating liquidity and delivering savings for cost-sensitive retail flow.
So…let’s look at what is really going on here.
The current market design of the Alpha market was purposely built as a mousetrap to make retail flow trade with opportunistic High Frequency Traders (HFTs), protecting these opportunistic HFTs with a speedbump and minimizing interactions with the more informed flow from institutional investors. A perfect example of a market segmenting order flow to the benefit of a few participants. The institutional trading community firmly believes this model is having a negative impact on the quality of the Canadian market overall.
The latest proposal for TSX Alpha is taking that segmentation of order flow to the next level. And they have done so in the least transparent way possible, without any industry consultation. Under their new proposal, they apply different fees for retail and institutional flow. While institutional traders are already disadvantaged on Alpha, they are making it now also totally unattractive economically. The ultimate wedge between retail and institutional flow. TMX will cite that, as TSX Alpha is an unprotected market, it will only impact those who choose to go there and refer to a fee model precedent from Nasdaq that was approved at the end of last year. The first argument is nonsense as further segmentation of retail flow makes the Canadian market overall more toxic for everyone else – and it has nothing to do with the fact that Alpha is unprotected. While the second argument is factually correct, the revised Nasdaq fee model is not on top of a market design that already fosters segmentation. That being said, we do have to question why the regulators approved the Nasdaq fee model, also without any industry consultation.
At NEO, transparency is one of our core values. Listening to stakeholder concerns and acting in their best interests is our main priority. A few years ago, we proposed a fee model where HFTs would be disincentivized and it was published for public comment. Based on industry feedback that it would set a bad precedent, we did the right thing and withdrew our proposal.
This latest proposal from TMX Alpha is the most blatant attempt to end-run the Canadian rules which explicitly do not allow for wholesaling of orders (i.e. brokers selling their retail order flow to market makers, a practice common in the US.) Admittedly, it is also far from the only example. Virtually every single new piece of functionality or fee change introduced by marketplaces in Canada over the past number of years all try to accomplish the same thing: how to create the optimal structure where opportunistic HFTs get to interact with predominantly retail flow? This is why there is a race amongst marketplaces to pay the highest rebate possible for retail orders, why marketplaces are introducing special order types targeted at opportunistic HFTs that guarantee retail interaction only or give them execution priority over long-term investors, and the list goes on and on.
Our understanding is of the regulatory objective is to prevent equity wholesaling in Canada because, contrary to the US, the Canadian market is too small to sustain that level of segmentation. As we have told the regulators, we need clarity! The industry is spending an enormous amount of time and effort on “innovations” that are just wholesaling-solutions in disguise.
We are at a critical juncture. From where we sit at NEO, segmentation of order flow is the most important market structure issue the regulators must address (rivalled only by the lack of consolidated market data for retail investors). With that backdrop, it has been disappointing to see the regulators focus the debate mainly on “internalization” – a topic that focuses too much on the internal activities of dealers and is far less impactful on the market overall than retail segmentation.
If segmentation of flow is not truly a concern for Canadian regulators, then they should simply allow equity wholesaling in Canada and stand up for the consequences. If not, let’s stop this absurdity.