This Rules Notice provides guidance to Participants on the use and management of stop loss orders.1 IIROC issued prior guidance respecting a Participant’s best execution obligations and the management of orders (“Prior Guidance”).2 The Prior Guidance specifically addressed a Participant’s obligations with respect to the execution of a triggered stop loss order. Since issuing the Prior Guidance, IIROC continues to note a number of specific circumstances in which trades resulting from the execution of stop loss orders have required regulatory intervention by IIROC.
This Rules Notice supplements the Prior Guidance and provides additional guidance to Participants on the use and management of stop loss orders. This guidance also takes into account requirements under the UMIR electronic trading rule amendments (“ETR”),3
hich became effective March 1, 2013, and reminds Participants that the ETR requirements are applicable to all orders electronically sent to a marketplace, including orders entered as stop loss orders and the triggering and subsequent execution of stop loss orders.
- 1A stop loss order is an order which is entered to buy or sell a particular security with a pre-determined “trigger” price and which becomes executable once the trigger price has been reached.
- 2See IIROC Notice 11-0113 – Rules Notice – Guidance Note – UMIR – Guidance on Best Execution and Management of Orders (March 30, 2011). In particular, reference is made to the guidance provided in response to questions 5, 6 and 7.
- 3See IIROC Notice 12-0363 – Rules Notice – Notice of Approval – UMIR - Provisions Respecting Electronic Trading (December 7, 2012)
Prior Guidance on Best Execution and Management of Orders
In the Prior Guidance, IIROC stated:
- Participants are reminded that they continue to have “best execution” obligations when managing stop loss orders. Participants who use technology solutions for the management of stop loss orders must ensure that their “best execution” obligations are considered in the technology design such that orders are not being entered on marketplaces that would execute at “clearly erroneous” prices. Participants are encouraged to require limit prices on stop loss orders. This recommendation is particularly applicable to those Participants who have automated the handling of stop loss orders and the technology has a limited ability to prevent unintended execution outcomes.4
Rule 5.1 of UMIR requires that a Participant “shall diligently pursue the execution of each client order on the most advantageous execution terms reasonably available under the circumstances”. While a Participant’s order management procedures may favour “immediacy of execution” over “price of execution” for a particular transaction, as noted in the Prior Guidance, the orders cannot be executed at “clearly erroneous” prices.
Application of Provisions Respecting Electronic Trading
Under ETR, trading supervision of electronic access to a marketplace must be performed by a Participant or Access Person in accordance with a documented system of risk management and supervisory controls, policies and procedures. The risk management and supervisory controls, policies and procedures employed by the Participant must include, among other requirements, automated controls that examine each order before entry to a marketplace which prevent the entry of an order that is not in compliance with the Requirements.5
The obligations of a Participant under ETR extend to all orders entered on a marketplace by a Participant, including orders:
- entered by a client using an “order execution service”, commonly referred to as a “discount brokerage” account;
- entered by a client using “direct electronic access”;6 and
- entered or transmitted by a Participant on behalf of another Participant or investment dealer, including a “discount broker”.
ETR also recognizes the potential heightened risk of the entry of orders to a marketplace through the use of an automated order system. The term “automated order system” is defined to include a smart order router.7 ETR requires that the parameters, policies and procedures related to an automated order system be designed with due consideration to potential market impact. IIROC expects that these parameters are reasonably designed to prevent the entry of any order that would interfere with fair and orderly markets.
Price Parameters of a Fair and Orderly Market
Generally speaking, IIROC considers that the execution of an order could be disruptive of a fair and orderly market if the execution would:
- result in the triggering of a Single Stock Circuit Breaker;8 or
- exceed the “no touch zone” limits that are publically disclosed by IIROC for price movement for which there would be no regulatory intervention for the variation or cancellation of trades.9
Questions and Answers
The following is a list of the most frequently asked questions regarding the management of stop loss orders:
- Are there any regulatory considerations when a stop loss order that does not contain a limit on the execution price is triggered?
Yes. When a stop loss order is triggered, the Participant must ensure that the resulting execution does not interfere with a fair and orderly market.
Participants must be cognizant of the potential impacts when accepting a stop loss order to be held by the Participant or entering a stop loss order on a marketplace that, when triggered, will become a “market order”. IIROC believes that all stop loss orders without a reasonable limit price are inherently risky in fast moving markets. Participants are encouraged to require limit prices on all stop loss orders. This recommendation is particularly applicable to those Participants who have automated the handling of stop loss orders, for which the technology has a limited ability to prevent unintended execution outcomes. If a Participant continues to permit the use of market stop loss orders, the use should be limited to orders for the purchase or sale of a particular security which meets all of the following conditions:
- the security:
- is very liquid, and
- displays relatively low historic price volatility; and
- the market stop loss order has a:
- trigger price that is near the prevailing market price for the particular security at the time of entry or acceptance of the stop loss order, and
- volume that is not appreciably greater than the average trade size for the particular security.
- Are there any regulatory considerations when a stop loss order that contains an execution limit price that is far away from the trigger price is triggered?
Yes. Even when a stop loss order contains a limit price, the Participant must ensure that, once triggered, the resulting execution does not interfere with a fair and orderly market. As noted in question 1 above, IIROC believes that stop loss orders without reasonable execution limits are inherently risky in fast moving markets. Even with an execution limit price, a Participant that employs an automated order system to manage the execution of the order has a continuing obligation to ensure that sufficient controls are in place to manage the potential impact of the execution of the order and that the execution of the order is not disruptive of a fair and orderly market.
In terms of a Participant’s best execution obligations, a Participant that favours “speed of execution” over “price of execution” in a particular transaction must take steps to ensure that the execution does not occur at prices that are disruptive to fair and orderly markets and that may require regulatory intervention.
- What are the expectations when “booking” a stop loss order on a marketplace?
Before a stop loss order is entered by a Participant on a marketplace as a Special Terms Order10 the expectation is that the order must pass through the various pre-entry order filters and controls required by ETR. The functionality of the marketplace on which the order is entered will then determine if and when the stop loss order is triggered. Not all marketplaces offer stop loss orders and the functionality for the handling of a stop loss order may vary among those marketplaces that offer this order type.11 IIROC expects a Participant to fully understand how triggered stop loss orders are treated by different marketplaces and to take these differences into account in developing its policies and procedures for the handling of stop loss orders.
- What are the ongoing regulatory expectations respecting stop loss orders that have been booked on a marketplace?
Participants are expected to monitor outstanding stop loss orders previously entered on a marketplace (including other stop loss orders entered for the particular security by the same client or other clients of the Participant) to ensure that if a trigger price is reached, the resulting orders would not be expected to execute at prices which would interfere with fair and orderly markets. Participants are encouraged to regularly review older outstanding stop loss orders entered on a marketplace to ensure that they have not become “stale”, and that the terms of the orders, if triggered, do not pose a risk to fair and orderly markets under current market conditions.
Participants should ensure that unfilled portions of a triggered stop loss order that are returned by a marketplace for handling by a Participant are not simply re-routed back to a marketplace (as such routing may simply result in executions at prices which interfere with fair and orderly markets). In these circumstances, the client may be required to reconfirm trading instructions or the balance of the order may be sent to the Participant’s trade desk for “special handling”. If a Participant relies on technology, the design of the system must ensure the triggered stop loss orders are executed in an orderly manner and do not interfere with fair and orderly markets.
- What are the expectations if the execution of a triggered stop loss order is handled manually by a trader on a Participant’s trade desk?
When the order is manually managed by a trade desk, the requirements applicable to automated order systems specific to the client order are not applicable. The trader managing the order acts as a “gatekeeper” and is responsible to ensure that the execution of the order does not interfere with fair and orderly markets. The Participant continues to be subject to all ETR obligations applicable to the trade desk respecting the Participant’s risk management and supervisory controls, policies and procedures.
- 4IIROC Notice 11-0113, op. cit. The quoted passage is part of the IIROC response to question 5 (How should a Participant handle “stop loss” orders in fast moving markets?)
- 5“Requirements” means, collectively:
(b) the Policies;
(c) the Trading Rules;
(d) the Marketplace Rules;
(e) any direction, order or decision of the Market Regulator or a Market Integrity Official; and
(f) securities legislation,
as amended, supplemented and in effect from time to time.
- 6Presently, these arrangements are commonly referred to as “direct market access”. For the proposed amendments to UMIR dealing with “direct electronic access”, see IIROC Notice 12-315 – Rules Notice – Request for Comments – UMIR – Proposed Provisions Respecting Third-Party Access to Marketplaces (October 25, 2012).
- 7National Instrument 23-103 defines an automated order system to mean a system used to automatically generate or electronically transmit orders on a pre-determined basis.
- 8See IIROC Notice 12-0040 – Rules Notice – Guidance Note – UMIR – Guidance Respecting the Implementation of Single-Stock Circuit Breakers (February 2, 2012). Until changed with the issuance of a future Rules Notice, Single-Stock Circuit Breakers:
• apply to:
◦ each security that is a constituent of the S&P/TSX Composite Index, and
◦ each Exempt Exchange-traded Fund the assets of which is comprised principally of listed securities;
• provide for a trigger level such that there would be a halt in the event of a price increase or decline of at least 10% in a 5 minute period;
• apply from 9:50 a.m. to 3:30 p.m.;
• provide an initial halt of 5 minutes that may be extended for a further 5 minute period;
• exclude from the trigger calculation prices of trades that may execute outside the “best bid – best ask” spread; and
• would result in the cancellation of any trade that executes at more than 5% beyond the trigger price.
- 9See IIROC Notice 12-0258 – Rules Notice – Guidance Note – UMIR – Guidance on Regulatory Intervention for the Variation or Cancellation of Trades (August 20, 2012). As a general guideline, there will be no regulatory intervention by IIROC to vary or cancel a trade unless the price difference between an “erroneous” trade and the current fair value of the security exceeds the greater of 10% of the price of the security or 10 trading increments.
- 10A stop loss order entered to a marketplace is considered a Special Terms Order as the execution is subject to a condition imposed by the marketplace on which the order is entered as a condition for the entry or execution of the order.
- 11For summary information, see Table 3 of Summary Comparison of Current Equity Marketplaces.