This Rules Notice provides guidance on the expectations of the Investment Industry Regulatory Organization of Canada ( IIROC ) regarding compliance with the best price obligations under the Universal Market Integrity Rules ( UMIR ) when entering an order on a protected marketplace that supports hidden order types.
Effective June 1, 2008, Market Regulation Services Inc. ( RS ) merged with the Investment Dealers Association of Canada to form IIROC. IIROC adopted the Universal Market Integrity Rules ( UMIR ) as the rules of IIROC governing trading on marketplaces for which IIROC acts as the regulation services provider and IIROC adopted the guidance on the interpretation of UMIR previously published by RS. As a result of the merger, references to RS in the Market Integrity Notices mentioned in this Rules Notice should also include IIROC.
Market Integrity Notice 2008-008 Request for Comments Provisions Respecting the Best Price Obligation (May 16, 2008) ( Best Price Notice ) set out that the best price obligation of a Participant under Rule 5.2 of UMIR requires a Participant to make reasonable efforts to fill better-priced orders displayed on a protected marketplace at the time the Participant executes at an inferior price on another marketplace or foreign organized regulated market.1 Concurrent with the publication of the Best Price Notice, Market Integrity Notice Amendment Approval Provisions Respecting Off- Marketplace Trades (May 16, 2008) ( Off-Marketplace Notice ) provided notice of the approval of amendments to UMIR which included the definition of a protected marketplace as a marketplace that:
- disseminates order data in real-time and electronically to the information processor or one or more information vendors in accordance with National Instrument 21-101 ( Marketplace Operation Instrument );
- permits dealers to have access to trading in the capacity as agent;
- provides fully-automated electronic order entry; and
- provides fully-automated order matching and trade execution.
As of the date of this Rules Notice, the marketplaces which are regulated by IIROC that qualify as a protected marketplace are: the Toronto Stock Exchange ( TSX ); TSX Venture Exchange ( TSXV ); Canadian Quotation and Trading System ( CNQ ), including the Pure Trading Facility of CNQ; Omega ATS ( Omega ) and Chi-X Canada ATS Limited ( Chi-X ). Alpha Trading Systems LP ( Alpha ) is expected to commence operations as an ATS in the fall of 2008 and to qualify as a protected marketplace.
Fully-Hidden Orders on a Protected Marketplace
Under Rule 5.2 of UMIR, a Participant only owes a best price obligation to the disclosed volume of better-priced orders on a protected marketplace.2 In other words, UMIR does not require a Participant to determine if a better-priced order exists on a non-transparent marketplace prior to executing an order on another marketplace. The ability of a Participant to effectively by-pass orders on a dark marketplace in complying with the best price obligation reflects the policy rationale that provides priority at the same price level to visible orders over hidden orders or hidden portions of visible orders (i.e. iceberg orders). However, a Participant may be required to consider execution opportunities on a non-transparent marketplace in accordance with its best execution obligation under Rule 5.1 of UMIR.
IIROC expects that, in the near-term, one or more protected marketplaces may propose to support the entry of a fully-hidden order type that will be eligible to interact with regular orders on its marketplace.
IIROC will consider a Participant to have undertaken reasonable efforts to comply with its best price obligation if, concurrently with, or immediately following a trade on a marketplace at an inferior price, the Participant enters orders on each protected marketplace and that such orders have a sufficient volume and are at a price that will fill the volume of the better-priced orders on those protected marketplaces that were visible at the time of the trade at the inferior price. The introduction of fully-hidden orders on a protected marketplace would distort the ability of a Participant to effectively displace better-priced orders if fully-hidden orders participate in the trade executions ahead of orders that had been included as part of the disclosed volume.
The amendments to UMIR contained in the Off-Marketplace Notice address this issue with the introduction of the concept of a bypass order which will ensure that an order entered on a marketplace by a Participant to satisfy the best price obligation under Rule 5.2 of UMIR trades only with orders that are included in the disclosed volume . The requirement for a bypass order will come into effect on a date determined by the IIROC board on or after August 14, 2008. IIROC will issue IIROC Rules Notice announcing the date this provision will be implemented at least 30 days in advance of the implementation date determined by the IIROC board.
Until the implementation of the bypass order type on a date established by the IIROC board, IIROC is of the view that the introduction by a protected marketplace of a fully-hidden order type is subject to the following conditions:
- No Priority At the Market For disclosed orders and fully-hidden orders at the same price, the protected marketplace must give priority to the disclosed orders regardless of the time of entry of the fully-hidden order.
- Adequate Notice to Market Participants The protected marketplace must provide at least three months notice of the introduction of a fully-hidden order type to those persons who have access to the marketplace.
- Exclusion from Consideration by a Marketplace Smart Order Router If the protected marketplace offers a smart order router to those persons who have access to the marketplace, the order router should only take account of those orders on the protected marketplace which are included in the disclosed volume . In the view of IIROC, if an order router offered by a marketplace could take advantage of undisclosed volume on that marketplace when making a routing determination, such a router would have an unfair advantage over other routers that would not have access to information regarding the hidden orders.
- Introduction of Bypass Functionality A protected marketplace that proposes to introduce a fully-hidden order type must at the time of the introduction of the fully-hidden order type support an order marker which allows incoming orders to fulfill displacement obligations to bypass hidden volume on the protected marketplace and execute only with the disclosed volume.
- Order Exposure Requirements Rule 6.3 of UMIR requires that client orders for 50 standard trading units or less be immediately entered on a marketplace which displays orders in accordance with Part 7 of the Marketplace Operation Instrument. The intent of this provision is to ensure transparency of retail-sized orders. An exception to the order exposure requirements is provided if the client specifically instructs the Participant to deal otherwise with the particular order. In the view of IIROC, a client entering an order for 50 standard trading units or less must specifically consent to the entry of their order as fully-hidden . A protected marketplace that intends to introduce a fully-hidden order type should consider including a reminder to its subscribers of the order exposure requirements under Rule 6.3 of UMIR as part of the notice provided to Participants (as set out in paragraph 2 above).
- 1The Amendments to the “best price” obligation contained in the Best Price Notice were effective as of May 16, 2008, subject to approval by the applicable securities commissions following public comment. Reference should be made to the Best Price Notice for additional guidance on the principal components of other amendments to “best price”, which include:
- examples of order handling methods that IIROC will automatically consider to be “reasonable efforts”;
- factors that IIROC will take into account in determining whether “reasonable efforts” have been made if a Participant is using an order handling method other than one which is automatically considered “reasonable efforts”;
- the requirement for each Participant to adopt policies and procedures to ensure compliance with the “best price” obligation;
- clarification that “reasonable efforts” does not require a Participant to maintain a connection to each protected marketplace; and
- removal of “transaction costs” as a factor to be taken into consideration in determining compliance with the “best price” obligation.
Reference should also be made to Market Integrity Notice 2008-010 – Guidance – Complying with “Best Price” Obligations (May 16, 2008) which repeals and replaces aspects of previous guidance related to Rule 5.2 under UMIR.
- 2 The term “disclosed volume” includes the volume of orders on a protected marketplace at a price better than the price of the intended trade but excludes:
- the undisclosed portion of any iceberg order;
- a Basis Order;
- a Call Market Order;
- a Market-on-Close Order;
- an Opening Order;
- a Special Terms Order; or
- a Volume-Weighted Average Price Order.