This IIROC Notice provides notice that, on January 28, 2011, the applicable securities regulatory authorities approved amendments (“Amendments”) to the Universal Market Integrity Rules (“UMIR”) that are consequential to the implementation by the Canadian Securities Administrators (“CSA”) of changes to National Instrument 23-101 – Trading Rules (“Trading Rules”) regarding trade-through protection (“Order Protection Rule”).1
In particular, the Amendments which are effective February 1, 2011:
- repeal the rule and policies respecting the “best price” obligation of Participants;
- provide that the Order Protection Rule can not be avoided when a Participant is considering a trade on a foreign organized regulated market;
- require a Participant or Access Person to have adequate policies and procedures for the handling of orders that do not rely on a marketplace to ensure compliance with the Order Protection Rule; and
- make a number of consequential changes to UMIR including:
- repealing those portions of the rules and policies on trading supervision and gatekeeper reports dealing with the “best price” obligation,
- confirming that the “best execution” obligation is subject to the Order Protection Rule,
- introducing a marker for a “directed action order” as defined for the Order Protection Rule, and
- extending the existing provisions of UMIR governing foreign currency translation and the calculation of the value of an order to the determination whether the execution of certain trades on a foreign organized regulated market may give rise to an obligation to fill “better-priced” orders on a marketplace.
The Amendments and the Order Protection Rule come into force on February 1, 2011.
- 1Canadian Securities Administrators Notice, Notice of Amendments to National Instrument 21-101 Marketplace Operation and National Instrument 23-101 Trading Rules, (2009) 32 OSCB 9401. Reference should be made to this notice for particulars on the Order Protection Rule including a discussion of the development of the Order Protection Rule and the policy rationale underlying the rule.
Summary of the Amendments
Repeal of the “Best Price” Obligation
With the adoption of the Order Protection Rule, the “best price” obligation is essentially redundant to the protection of better-priced orders disclosed in a consolidated market display. For this reason, the Amendments repeal Rule 5.2 and Policy 5.2.
Relationship to the “Best Execution” Obligation
The obligation not to trade-through, like the previous “best price” obligation, is an obligation which is owed by market participants to the market generally. UMIR recognizes that the “best execution” obligation is owed by a Participant to its client. The Amendments add Part 4 to Policy 5.1 to confirm that the “best execution” obligation is subject to the “trade-through protection” obligation under the Order Protection Rule (in the same manner that the “best execution” obligation was subject to the “best price” obligation).
Trading Supervision Requirements
The Amendments repeal the requirement under Policy 7.1 that the policies and procedures adopted by a Participant as part of its trading supervision obligation include specific provisions respecting the “best price” obligation. However, this requirement has been replaced by a requirement that a Participant or Access Person adopt policies and procedures to ensure compliance with trade-through obligations under the Order Protection Rule if the Participant or Access Person intends to use a “directed action order” or if a Participant intends to undertake certain trades on foreign organized regulated markets.
The “directed action order” acts as an instruction to the marketplace on which the order is entered not to check for better-priced orders on other marketplaces and to immediately execute or book the order (in which case the Participant or Access Person entering the order assumes the responsibility for the execution or booking of the order not to result in a trade-through). In using a “directed action order”, the Participant or Access Person have assumed the obligation for trade-through protection and the marketplace will be able to execute the order without delay or regard to any other better-priced orders displayed by another marketplace. In order to be able to use a “directed action order”, the Order Protection Rule requires that the person entering the order must “establish, maintain and ensure compliance with written policies and procedures that are reasonably designed to prevent trade-throughs …”2
In the view of IIROC, the policies and procedures which a Participant or Access Person must adopt are comparable to the policies and procedures which a Participant was required to have for compliance with the “best price” obligation under Rule 5.2 of UMIR. The policies and procedures must specifically address the circumstances when the bypass order marker will be used in conjunction with a “directed action order”.3
Each Participant or Access Person must test the adequacy of the policies and procedures in preventing trade-throughs on a regular basis which shall not be less than monthly. IIROC expects that the results of the compliance testing are retained by the Participant or Access Person in order that IIROC would be able to review any test and its results as part of trade desk review or other compliance audit by IIROC.
Condition on the Conduct of Certain Trades on a Foreign Organized Regulated Market
Condition on “Off-Marketplace” Trades
The Amendments buttress the anti-avoidance provisions in the Order Protection Rule. 4 Rule 6.4 of UMIR requires a Participant, subject to certain enumerated exceptions, to execute a trade in a listed security on a marketplace. One of the enumerated exceptions, allows a Participant to execute a trade on a foreign organized regulated market. The Amendments limit the availability of this exception if the order which is to be entered on a foreign organized regulated market would have executed against better-priced orders on a marketplace had the order been entered on a marketplace. The Amendments do not impose the obligation to consider better-priced orders on a marketplace when a Participant executes a trade on behalf of:
- a non-Canadian account; or
- a Canadian account that is denominated in a foreign currency.
The Amendments also limit the types of orders to which the obligation would apply. The obligation to consider better-priced orders on a marketplace only apply when a Participant is executing on a foreign organized regulated market an order that meets on of the following four conditions:
- is part of an intentional cross;
- is part of a pre-arranged trade;
- is for more than 50 standard trading units; or
- has a value of $250,000 or more.
The Amendments do not impose a similar obligation on Access Persons to consider better-priced orders on a marketplace as UMIR does not require that an Access Person execute trades on a marketplace.
Compliance with the Condition on Executing “Off-Marketplace” Trades
For orders which a Participant intends to execute “off-marketplace” on a foreign organized regulated market, the Amendments continue the existing UMIR obligation to consider and honour better-priced orders on a protected marketplace. With the adoption of the Order Protection Rule, a Participant has several means of complying with this obligation, including:
- Continuation of Existing Policies and Procedures of the Participant
If a Participant has access to each protected marketplace, the Participant will be aware at the time that the Participant is considering the entry of the order on a foreign organized regulated market whether better-priced orders are displayed on a protected marketplace. In these circumstances, a Participant would enter a “directed action order” as contemplated by the Order Protection Rule on each of the marketplaces displaying a better-priced order. In order to enter a “directed action order”, the Participant must have in place policies and procedures that, in the opinion of IIROC, are comparable to the existing policies and procedures which a Participant must have for the purposes of complying with the “best price” obligation under Rule 5.2 of UMIR.
Reliance on Marketplace Policies and Procedures
Under the Order Protection Rule, each marketplace must establish, maintain and ensure compliance with written policies and procedures that are reasonably designed to prevent trade-throughs on that marketplace. If at least one marketplace offers trade-through protection by the establishment of direct linkages to all other marketplace that may have a “protected order”, then a Participant would be able to satisfy any obligation that would be imposed by the Amendments by entering a “fill and kill” order on such a marketplace at the intended price that the balance of the order would execute on entry on a foreign organized regulated market. The Participant that entered the order on the marketplace need not have access to all of the other marketplaces or even been aware that better-priced orders were present on other marketplaces in order to be able to comply with the condition under the Amendments. (If no marketplace offers trade-through protection by the establishment of direct linkages to all other marketplaces that may have a “protected order”, a Participant may have to enter orders on one or more marketplaces depending upon the way marketplaces have chosen to provide trade-through protection.)
With the repeal of Rule 5.2 dealing with the “best price” obligation, the Amendments also make several consequential changes to UMIR including:
- Gatekeeper Requirements – The Amendments repeal the requirement under Rule 10.16 that a Participant investigate and report on a possible violation of the “best price” obligation that the Participant becomes aware of as part of its gatekeeper obligation.
- Foreign Currency Translation - The Amendments move the provisions related to foreign currency translation for the purpose of determining when a better-priced order exists on a marketplace from Part 3 of Policy 5.2 (which was repealed by the Amendments) to Part 6 of Rule 6.4.
- Interpretation – Determination of Value of an Order - The Amendments also extend the current methodology used for determining the value of an order for the purposes of Rule 6.3 and Rule 8.1 to the determination of the value of an order in Rule 6.4(3)(d).
- Order Markers – The Amendments introduce a requirement in Rule 6.2 for “directed action orders” entered on a marketplace to carry an acceptable designation. While such designation ordinarily would be displayed in the order information provided to the information processor or information vendors, IIROC has directed, in accordance with the provisions of subsection (6) of Rule 6.2, that the designation not be made publicly available.
Summary of the Impact of the Amendments
The most significant impacts of the adoption of the Amendments are that Participants are relieved of the obligation of ensuring that when an order entered on a marketplace is executed, better-priced order in the disclosed volume of orders on a protected marketplace are not ignored or traded-through. Effective February 1, 2011, this obligation is placed upon the marketplace receiving the order, in accordance with their policies and procedures adopted in accordance with the provisions of Part 6 of the Trading Rules.
However, if a Participant or Access Person has marked an order as a “directed action order”, they have an obligation to ensure that better-priced orders on a marketplace displayed in a consolidated market display are honoured when executing that order on a marketplace. A Participant or Access Person is not be entitled to use the “directed action order” marker unless they have established, maintained and ensured compliance with written policies and procedures that are reasonably designed to prevent trade-throughs. Similar policies and procedures would also apply when a Participant intends to execute certain orders at an inferior price on a foreign organized regulated market.
Designations and Implementation Plan
“Best Price” Policies and Procedures
To the extent that a Participant intends to rely on a marketplace for compliance with the Order Protection Rule, a Participant will be able to delete its policies and procedures that have been put in place to ensure compliance with the “best price” obligation under UMIR. If a Participant or Access Person intends to use the “directed action order”, then the Participant or Access Person must have policies and procedures to reasonably ensure that the entry of their order will not result in a trade-through. These policies and procedures would be essentially the same as those required of a Participant to ensure compliance with the “best price” obligation. A Participant may also have to essentially retain the policies and procedures to ensure compliance with the “best price” obligation if the Participant intends to execute certain types of trades on a foreign organized regulated market.
Gatekeeper Reports on Use of “Directed Action Orders”
Rule 10.16 of UMIR allows IIROC to designate any requirement for which a Participant or Access Person must undertake a review of any activity that may be a violation of the requirement and to provide a report to IIROC if the review finds that a violation has occurred. With the approval of the Amendments, this IIROC Notice constitutes notice that IIROC has designated, effective February 1, 2011, that a “gatekeeper report”5 is required from any Participant or Access Person that determined that:
- an order marked as a “directed action order” did not comply with the policies and procedures of the Participant or Access Person; and
- a periodic test of the policies and procedures adopted by the Participant or Access Person found that the policies and procedures with respect to the use of a “directed action order” were not adequate.
Appendix A – Appendix “A” sets out the text of the Amendments to UMIR that are consequential to changes to the Trading Rules regarding the Order Protection Rule; and
Appendix B – Appendix “B” sets out a summary of the comment letters received in response to the Request for Comments on the proposed amendments as set out in IIROC Notice 09-0328 – Rules Notice – Request for Comments – UMIR – Provisions Respecting the Implementation of the Order Protection Rule (November 13, 2009). Appendix “B” also sets out the response of IIROC to the comments received and provides additional commentary on the Amendments. Appendix “B” also contains the text of the relevant provisions of the Rules and Policies as they read following the adoption of the Amendments.
- 2Section 6.4 of NI 23-101.
- 3For more information on the use of a “bypass order” see IIROC Notice 09-0128 – Rules Notice – Guidance Note – UMIR – Specific Questions Related to the Use of the Bypass Order Marker (May 1, 2009) and IIROC Notice 09-0034 – Rules Notice – Guidance Note – UMIR – Implementation Date for Marking of Bypass Orders (February 3, 2009).
- 4Section 6.7 of NI 23-101. The text of the provision is:
No person or company shall send an order to an exchange, quotation and trade reporting system or alternative trading system that does not carry on business in Canada in order to avoid executing against better-priced orders on a marketplace.
- 5For additional information on the filing of a “gatekeeper report”, reference should be made to Market Integrity Notice 2008-011 – Guidance – New Procedures for Gatekeeper Reports (May 18, 2008).