Provisions Respecting Unprotected Transparent Marketplaces and the Order Protection Rule

15-0211
Type: Rules Notice> Notice of Approval
Rule connection:
UMIR
Distribute internally to:
Institutional
Legal and Compliance
Senior Management
Trading Desk

Contact:

Sonali GuptaBhaya
Acting Director, Market Regulation Policy
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Executive Summary

On September 18, 2015, the applicable securities regulatory authorities approved amendments to UMIR (the “Amendments”) respecting unprotected transparent marketplaces and the Order Protection Rule.  The Amendments accommodate the terms and conditions under which the Ontario Securities Commission (“OSC”) approved amendments to Alpha Exchange Inc.’s (“Alpha”) trading policies to include a systematic order processing delay (“speed bump”) on all orders other than “post-only” orders.1  Specifically, the OSC imposed a condition (“OSC Condition”) that orders displayed in the Alpha order book will not be considered to be protected under the Order Protection Rule (“OPR”) in Part 6 of National Instrument 23-101 Trading Rules (“Trading Rules”).2  The Amendments also align to proposed amendments by the Canadian Securities Administrators (“CSA”) to Companion Policy 23-101CP regarding the interpretation of “protected order” (“Proposed CSA Amendments”) that were published for comment on June 12, 2015.3

For the first time, as a result of the OSC Condition, there will be a marketplace that displays orders that would not be considered to be protected from trade-through under the OPR. 

In order to accommodate this change, the Amendments:

  • revise the definition of “protected marketplace” to be a marketplace that displays “protected orders” as defined under the Trading Rules.  This revision accommodates any future changes the CSA may implement with respect to the determination of whether an order is considered a “protected order” under the Trading Rules;
  • provide that the “best ask price” and “best bid price” would be determined by reference to orders displayed on a protected marketplace;
  • confirm that a “bypass order” could be entered on any marketplace that displays orders and not just on a protected marketplace;
  • confirm that a Participant should consider, if known or available, displayed orders on a marketplace that is not protected when determining if a client-principal trade will occur at the “best available price”; 
  • make several consequential amendments to certain provisions; and
  • make an editorial change to allow marketplaces to rely on the last sale price on the listing market of a security when determining the standard trading unit size for a security.

The most significant impact of the Amendments is that a Participant or Access Person may take account only of displayed orders on protected marketplaces when determining compliance with a UMIR requirement that makes reference to “best ask price”, “best bid price” or “better price” except in two specific circumstances related to:

  • best execution (see Section 2.5 of this Notice); and
  • client-principal trading (see Section 1.3 of this Notice).

The Amendments are effective immediately.

  • 1. OSC Staff Notice – Notice of Commission Approval of Proposed Changes to Alpha Exchange Inc. published on April 23, 2015 at (2015) 38 OSCB  4045 (“OSC Staff Notice”).
  • 2. IIROC Notice 14-0124 – Rules Notice – Request for Comment – Proposed Provisions Respecting the Order Protection Rule (May 14, 2014) outlined proposed changes to UMIR that would align with amendments to the Trading Rules proposed by the CSA regarding order protection found at (2014) 37 OSCB 487 (“Proposed CSA OPR Amendments”).   The Proposed CSA OPR Amendments, among other things, proposed that visible orders entered on a marketplace that meets or exceeds a market share threshold set by the CSA would be protected.  The proposed changes in IIROC Notice 14-0124 are similar to the Amendments and therefore IIROC has withdrawn the changes proposed in IIROC Notice 14-0124.  
  • 3. CSA Staff Notice – Proposed Amendments to Companion Policy to National Instrument 23-101 Trading Rules: Application of the Order Protection Rule to Marketplaces Imposing Systematic Order Processing Delays (2015) 38 OSCB 5551
Table of contents
  1. Discussion of Amendments

  1. Summary of Amendments

As a result of the OSC Condition, Alpha will be the first transparent marketplace in Canada to display orders that will not be considered to be “protected” under the OPR.  The Amendments ensure that UMIR appropriately accommodates this change primarily by: 

  • aligning the definition of “protected marketplace” to reflect those marketplaces that display “protected orders” as defined under the Trading Rules; and
  • amending the definitions of “best ask price” and “best bid price” to limit their determination to orders displayed on a “protected marketplace”.
  1. Definitions

  1. Definitions of “best ask price” and “best bid price”

Previously, UMIR defined both “best ask price” and “best bid price” in reference to prices on any marketplace as displayed in a consolidated market display.  In light of the OSC Condition and the Proposed CSA Amendments, it is appropriate to limit the determination of “best ask price” and “best bid price” to orders displayed on a “protected marketplace” as those are the orders which a Participant or Access Person must take into account for preventing a trade-through.

The terms “best ask price” and “best bid price” are used throughout UMIR including:

  1. in the following definitions:
    • “best independent bid price” (which is used for determining permitted market stabilization activities under Rule 7.7);
    •  “better price”;4 
    •  “connected security”;
    •  “designated trade”;
    • “market order”
  2. in the following provisions:
    • executing a pre-arranged trade or intentional cross under Part 2 of Policy 2.1;
    • client priority under Policy 5.3;
    • price improvement by Dark Orders under Rule 6.6;
    • the official record of an order under Rule 7.4;
    • client-principal trading under Policy 8.1;
  3. in determining the value of an order for the purposes of:
    • Rule 6.3 (Order Exposure);
    • Rule 6.4 (Trades to be on a Marketplace);
    • Rule 8.1 (Client-Principal Trading); and
  4. in interpreting “best ask price” and “best bid price” under Rule 1.2(8) (Interpretation).
  1. Definition of “bypass order”

A bypass order is designed not to execute against non-transparent liquidity on a marketplace or liquidity on the marketplace provided by various “specialty orders”.  A bypass order may be part of a designated trade or used to satisfy requirements under UMIR (which includes by incorporation the OPR requirement not to trade through).  The Amendments specifically recognize that a bypass order can be executed on a transparent marketplace other than a “protected marketplace”.  While no obligation under the OPR is owed to orders displayed on a non-protected marketplace, a designated trade could be executed on such a marketplace.  Under the Amendments, when executing on such a non-protected marketplace, the order would need to trade against the displayed orders on that marketplace that would have been included in the disclosed volume if that marketplace had been a protected marketplace.

  1. Definition of “protected marketplace”

Under the Amendments, the definition of “protected marketplace” is revised to apply to marketplaces that display “protected orders” as defined under the Trading Rules.  This revision more closely reflects those marketplaces that display orders that fall under the definition of “protected orders” in the Trading Rules.  This revision also accommodates any future changes the CSA may implement with respect to the determination of whether an order is considered a “protected order” under the Trading Rules.

  1. Client-Principal Trading

Under Rule 8.1 of UMIR, subject to certain exceptions, a client order for 50 standard trading units or less with a value of $100,000 or less may execute with a principal order or non-client order of the Participant at a better price “provided the Participant has taken reasonable steps to ensure that the price is the best available price for the client under prevailing market conditions”.

The Amendments require a Participant, when determining the “best available price”, to consider the price and size of orders displayed on marketplaces other than protected marketplaces if such information is available or known to the Participant.  When determining what information is “available or known” to a Participant, we have clarified that an employee of a Participant is expected to use all order price information that is available or known to that employee when determining the “best available price”.  For example, a Participant will not be considered to have complied with Rule 8.1 if:

  • an employee executes a client order against a principal or non-client order at a “better price” as determined from orders displayed on protected markets which is inferior to the price that would have been available to the client on a displayed marketplace that is not a protected marketplace; and
  • an employee executes, in whole or in part, as principal or non-client, with the order on the unprotected marketplace (at a price which is better than provided to the client).
  1. Consequential Amendments

The Amendments make several consequential amendments including:

  1. Interpretation of “best ask price” and “best bid price”

Rule 1.2(8) (Interpretation) of UMIR provides that for the purposes of determining the “best ask price” or the “best bid price” at any particular time, reference is to be made to orders contained in a consolidated market display for a marketplace that is then open for trading and in respect of which trading in the particular security on the marketplace has not been:

  • halted, suspended or delayed for regulatory purposes in accordance with Rule 9.1; or
  • halted, suspended or delayed in accordance with a marketplace rule or a requirement of the marketplace.

For consistency purposes, the Amendments clarify that reference need only be made to orders on a “protected marketplace”.

  1. Clarification of Power of Market Integrity Official

Under the OPR, each marketplace has the obligation to prevent trade-throughs on that marketplace.  If a Participant marks an order as a “directed-action order” the marketplace obligation to prevent a trade-through shifts to the Participant that has entered the order.  The changes to Rule 10.9 clarify that the power of a Market Integrity Official includes requiring a Participant or Access Person to satisfy any outstanding orders included in the disclosed volume that were traded through when the Participant or Access Person did not comply with the requirements under section 6.4 of the OPR to prevent a trade-through. 

  1. Clarification on Executing a Pre-arranged Trade or Intentional Cross

Part 2 of Policy 2.1 sets out the process for executing a pre-arranged trade or intentional cross as a “designated trade”.5  The example of how a designated trade would be handled is premised on every transparent marketplace being a “protected marketplace”.  The Amendments clarify the applicable requirements for the execution of a designated trade, whether the designated trade is executed on a “protected marketplace” or any other marketplace that displays order information in a consolidated market display.  Specifically, the example in Part 2 of Policy 2.1 is revised to clarify that a designated trade may execute on a marketplace if: (i) better-priced orders displayed on that marketplace are filled prior to the execution of the designated trade and (ii) better-priced orders in the disclosed volume of protected marketplaces are filled concurrent with or immediately following the execution of the designated trade. 

  1. Client Priority

The Amendments revise Part 4 of UMIR Policy 5.3 to state that only “better-priced” orders on a protected marketplace would need to be filled prior to the execution of the client order.

  1. Price for Determination of “standard trading units”

Previously, Rule 1.2(5) of UMIR provided that the determination of the price at which a security is trading for the purposes of the definition of a “standard trading unit” is by reference to the last sale price of the security on the trading day prior to the determination.  The last sale price previously could be established by a trade on any marketplace and could include trades that were executed outside of the core trading hours of 9:30 a.m. to 4:00 p.m. ET.

IIROC is aware that marketplaces generally rely on the last sale price on the listing market when determining the standard trading unit size for a security and the Amendments specifically allow for this practice. 

  1. Background

  1. OSC Approval of Alpha Changes

On April 16, 2015, the OSC approved amendments to Alpha’s trading policies subject to certain terms and conditions.  The amendments relate to the implementation of a speed bump on all orders other than “post-only” orders that are received by Alpha.  One of the conditions imposed by the OSC is that orders displayed in the Alpha order book will not be considered to be “protected” under the OPR.  The OPR requires marketplaces to establish, maintain and ensure compliance with written policies and procedures that are reasonably designed to prevent trade-throughs. The OPR also imposes a similar requirement on marketplace participants that have taken on the responsibility of the OPR compliance through the use of directed-action orders.  As stated in the OSC Staff Notice, OSC staff’s view is that the policies and procedures of a marketplace or a marketplace participant would be considered to be “reasonably designed” to prevent trade-throughs if the policies and procedures indicated that orders would not be routed to execute against better-priced orders displayed on Alpha when the speed bump is implemented. As a result of the OSC Condition, Alpha will be the first transparent marketplace in Canada to display orders that will not be considered to be “protected” under the OPR.  The Amendments ensure UMIR appropriately accommodates a market environment with both protected and unprotected transparent marketplaces.

  1. Proposed CSA Amendments

The Proposed CSA Amendments would amend Companion Policy 23-101CP to include an interpretation related to the application of the OPR with respect to marketplaces that impose a speed bump on orders received by the marketplace.  Specifically, the Proposed CSA Amendments would clarify that a marketplace does not provide “automated functionality” where it has implemented a speed bump in order processing (whether for all orders or only certain orders) that prevents an order entered on that marketplace to immediately execute against displayed volume.  As a result, upon implementation of the Proposed CSA Amendments, none of the orders on a marketplace that has implemented a systematic order processing delay would be considered to be “protected orders” under the Trading Rules.  As in the case of the OSC Condition, the Proposed CSA Amendments would allow for the existence of a transparent, unprotected marketplace and the Amendments would amend UMIR to appropriately accommodate for such a scenario.

  1. UMIR Exemption

The OSC Condition required that Alpha not be considered to be displaying “protected orders”, and pursuant to the OSC Notice of Approval6, the OSC would view the policies and procedures of a marketplace or marketplace participant to be “reasonably designed to prevent trade-throughs” if orders are not routed to execute against better-priced orders displayed on Alpha.

However, until such time as the proposed CSA Amendments are implemented, orders on Alpha would still be considered to be protected by the CSA. Therefore, as an interim measure to accommodate the OSC Condition specific to Alpha, IIROC sought an exemption under UMIR 11.1(2) from its Recognizing Regulators to exempt a class of transactions from all applicable provisions of UMIR.   Specifically, all transactions resulting from all orders by Participants required to be sent to Alpha to satisfy their OPR obligations under the Trading Rules are exempted from all applicable provisions of UMIR related to a “protected marketplace”.  This exemption was approved by all Recognizing Regulators on September 18, 2015 and is in effect until the earlier of:

  1. the approval of the Proposed CSA Amendments, and
  2. one year from the date the exemption was granted.

The effect of this exemption is that Participants are fully relieved from treating Alpha as a protected marketplace under UMIR.

  1. Order Exposure Implications

The Amendments do not alter the order exposure obligations of a Participant for certain client orders under Rule 6.3 of UMIR.  Under that Rule, a Participant shall immediately enter for display on a marketplace that displays orders in accordance with Part 7 of National Instrument 21-101 Marketplace Operation a client order to purchase or sell 50 standard trading units or less of a listed security.  Under the Amendments, orders may continue to be entered on any marketplace that displays orders whether or not that marketplace meets the definition of “protected marketplace”.

  1. Best Execution Implications

Whether a marketplace is “protected” for the purposes of the OPR is separate and distinct from the determination by a Participant of whether a marketplace needs to be considered for the purposes of achieving best execution of client orders in accordance with Rule 5.1 of UMIR.

Best execution will be achieved by a Participant adhering to the policies and procedures which the Participant has adopted to pursue “the execution of each client order on the most advantageous execution terms reasonably available under the circumstances”.7  The policies and procedures must be reviewed at least annually and more frequently if circumstances warrant, such as when there have been changes in marketplaces or market structure.  This review may rely on historic order and trade data from marketplaces, including those marketplaces for which the Participant does not receive real-time data nor otherwise have access as a member, user or subscriber.

Part 2 of Policy 5.1 (Best Execution of Client Orders) specifies that one factor in determining whether a Participant has diligently pursued the best execution of a client order is whether the Participant has considered orders on a marketplace that has demonstrated a reasonable likelihood of liquidity for a specific security relative to the size of the client order.  With the emergence of unprotected, transparent marketplaces, a Participant therefore needs to consider in its policies and procedures for best execution of a client order whether a transparent marketplace that is not a “protected marketplace” needs to be taken into account if that marketplace has demonstrated a reasonable likelihood of liquidity for a specific security relative to the size of the client order.

Neither the Trading Rules nor UMIR requires a Participant, directly or indirectly, to access trading on all marketplaces – it is a decision to be made by the Participant in the context of obtaining best execution of client orders while complying with other applicable regulatory requirements including the OPR.  Each Participant may have different business models and different types of clients and, as such, the policies and procedures may vary across business lines or trading desks of a Participant.  Order routers used by a Participant or Access Person would not be required to take into account displayed orders on an unprotected marketplace when determining compliance with the OPR.  However, if a Participant determines that compliance with best execution requires the Participant to access displayed orders on an unprotected marketplace, the order router would need to make its decisions including data of displayed orders on that unprotected marketplace.

  1. Changes from the Proposed Amendments

Non-material changes were made to the proposed changes published for comment on June 12, 2015. The changes are as follows:

  • Drafting changes were made to clarify the meaning around “available or known to the Participant” in Part 3 of Policy 8.1.  Specifically, language has been added in Policy 8.1 Part 3 to explain that the information “available or known to the Participant” can be interpreted to mean the information available or known to an employee of a Participant rather than to the Participant as a whole.  The Amendments now include IIROC’s expectation that an employee of a Participant use all order price information that is available or known to that employee when determining the “best available price”.
  • The proposed definition of “protected marketplace” was revised from “a marketplace that displays orders, that for the purposes of the Trading Rules, are considered to be ‘protected orders’” to “a marketplace that displays ‘protected orders’ as defined under the Trading Rules”.  This amendment ensures that the UMIR definition fully aligns with the definition in the Trading Rules.
  1. Summary of the Impacts of the Amendments

  1. Participant and Access Person Impacts

The most significant impact of the adoption of the Amendments on Participants and Access Persons is to allow a Participant or Access Person, except in two specific circumstances related to best execution and client-principal trading,8 to take account only of displayed orders on protected marketplaces when determining compliance with a UMIR requirement that makes reference to “best ask price”, “best bid price” or “better price”.9 

Generally speaking, a Participant or Access Person may modify its systems, including automated order systems, to take account only of displayed orders on protected marketplaces.  However, depending on the business of the Participant and the available liquidity in particular securities on a marketplace that is not protected, a Participant may determine that it needs to continue to consider orders on a non-protected marketplace to meet its best execution obligations.  In addition, if a Participant is executing a client order with a principal order or non-client order, the Participant should consider the price and size of orders displayed on marketplaces other than protected marketplaces, if available or known to an employee of the Participant, when determining whether the client is receiving the “best available price”.

The most significant impact of the Amendments on marketplaces would be that the UMIR definition of “protected marketplace” would specifically align to the definition of “protected orders” under the Trading Rules.  The operation of unprotected, transparent marketplaces will cause each marketplace to review and modify the policies and procedures it has established to reasonably prevent trade-throughs.

  1. Marketplace Impacts

IIROC must make compliance and surveillance system changes to address the operation of transparent, unprotected marketplaces.

  1. Implementation

The Amendments have been approved by the applicable securities regulatory authorities as of the date of this Rules Notice.  The Amendments are effective immediately.

Appendix A – UMIR Amendments

Appendix B – Text of UMIR to Reflect Amendments

Appendix C – Comments Received in Response to Request For Comments

  • 4. For the purposes of UMIR, “better price” means, in respect of each trade resulting from an order for a particular security:

    a) in the case of a purchase, a price that is at least one trading increment lower than the best ask price at the time of the entry of the order to a marketplace provided that, if the best bid price is one trading increment lower than the best ask price, the price shall be at least one-half of one trading increment lower; and

    b) in the case of a sale, a price that is at least one trading increment higher than the best bid price at the time of the entry of the order to a marketplace provided that, if the best ask price is one trading increment higher than the best bid price, the price shall be at least one-half of one trading increment higher.
  • 5. As part of the proposed consolidation of IIROC Rules (see IIROC Notice 13-0275Republication of Proposed Consolidation of IIROC Enforcement, Procedural, Examination and Approval Rules (November 14, 2013)) (“Consolidated Enforcement Rules”), Rule and Policy 2.1 of UMIR would be repealed and replaced with: (i) a new Consolidated Rule 1400 that would incorporate the existing Dealer Member Rule 29.1; and (ii) a new Rule 2.1 of UMIR. The new Rule 2.1 of UMIR would move certain specific examples of unacceptable activities, currently set out in Policy 2.1, into Rule 2.1 of UMIR. The portions of Part 2 of Policy 2.1 that are changed under the Amendments provide detail that is not included in the proposed Rule 2.1 set out in IIROC Notice 13-0275. Thus, the changes to Policy 2.1 under the Amendments will ultimately be replaced by less detailed language in Rule 2.1 of UMIR when the Consolidated Enforcement Rules come into force.
  • 6. OSC Staff Notice – Notice of Commission Approval of Proposed Changes to Alpha Exchange Inc. published on April 23, 2015 at (2015) 38 OSCB  4045 (“OSC Staff Notice”).
  • 7. We note that IIROC completed a survey of Participants and other investment dealers that execute or handle marketplace trades in listed securities on behalf of clients to gauge their practices employed to achieve best execution of client orders in 2013 and that we are using the results of the survey to develop proposed amendments related to best execution practices.
  • 8. In particular, reference should be made to:
    • Section 2.5 of this Notice regarding Rule 5.1 of UMIR dealing with the best execution obligation; and
    • Section 1.3 of this Notice regarding Rule 8.1 of UMIR dealing with client-principal trading.
  • 9. For example, price improvement requirements under rules related to exposure of client orders and trading of Dark Orders will no longer be based on the best bid/best ask derived from every transparent marketplace but by reference solely to orders on protected marketplaces.