A Bad Day for Canadian Investors

A Bad Day for Canadian Investors

by Jos Schmitt, CEO, Aequitas Neo Exchange

My previous blog on best execution and marketplace speed bumps led to a lot of reactions: mostly positive, one negative (anonymous) and a few along the lines of "interesting, but how do we know you are not just preaching for your own business?"

For the last group, I have good news. Two months before I wrote my blog and it only hit my desk yesterday, Adam Sussman, Head of Market Structure at Liquidnet, and formerly Partner and Director of Research at TABB Group, wrote an article comparing the speed bumps in the Canadian market. In the article, he discusses the differences between the Aequitas NEO Exchange speed bump and the TMX Alpha speed bump, which is set to be introduced on September 21st. For those unfamiliar with Liquidnet, it is a leading global institutional trading network, used for large trades by more than 780 of the world’s top asset managers.

Below are a few quotes from Adam Sussman and I have underlined a few interesting statements:

"Alpha Exchange (owned by a bunch of banks by way of the TMX) has introduced a speed bump that is designed to make sure that strategies that provide liquidity (aka "post-only orders") would have an advantage over any customer attempting to access those quotes. Most of these post-only orders would originate from…you guessed it…HFT firms. The Alpha Exchange speed bump gives HFTs time to see activity occurring in other venues and adjust its orders accordingly. Yes, this is what you think it is – guaranteed latency arbitrage!

The good news is that this was far too obvious a ploy for Canadian regulators to miss. The Alpha Exchange orders will not be covered in the Order Protection Rule, meaning that no one needs to route to Alpha when they are at the top of the book. Put more simply, they’re not the kind of Exchange that matters.

So far, so clear. There are good speed bumps. There are bad speed bumps. Things get more interesting with Aequitas Neo. The Aequitas speed bump is only levied on immediate-or-cancel (IOC) orders sent by firms the Exchange identifies as HFT. Aequitas came up with its idea first and so it’s pretty clear that Alpha was designed to be the exact opposite.

The intent of the Aequitas speed bump is closer to that of the IEX "shoebox." In fact, one could argue that the Aequitas speed bump is more effective in removing the HFT advantage. Because all orders are slowed down at IEX, the HFT firm can still have some advantage as long as it get its order to the shoebox faster than other market participants. Aequitas only slows down HFT orders. It’s a speed bump that applies only to certain market participants under certain conditions.”

Adam Sussman’s take on how the TMX Alpha model works is crystal clear. He is a highly-regarded market structure expert with an unbiased opinion on this particular issue.

What Adam doesn’t cover in his article - Liquidnet being an institutional trading network not focussed on retail investors - are the conflicts of interest that will emerge from TMX Alpha’s suggested fee structure and what this will mean for the retail investor. A few points I’d like to add:

• As I’ve stated in my previous blog, Alpha’s inverted fee structure will lead to “intended” conflicts of interests as liquidity providers (speed-bump protected HFT firms) will have to pay to place their orders, while liquidity takers (dealers representing long-term investors) will be paid a rebate to take liquidity - in simple words, TMX Alpha will pay dealers for exposing their orders to a risk of poor execution; and
• Large asset managers, well aware of the TMX Alpha best execution issues - as demonstrated by Adam Sussman’s article - will instruct their dealers to avoid TMX Alpha: “they’re not the kind of Exchange that matters”; but
• Retail investors in general, uninformed about the details of how markets operate, are left in the dark and subject to the risks of bad executions in an environment that seeks to induce dealers into doing what is wrong for them.

September 21st, or whatever day Alpha ultimately launches its speed bump, considering they still need to provide a 30 day notice about their fees, will be a bad day for Canadian markets. And the world is watching us.

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