The Investment Industry Regulatory Organization of Canada (“IIROC”) has prepared a study (“Recent Trends Study”) that sets out certain information with respect to recent trends in trading activity of listed securities on Canadian equity marketplaces 1 and, in particular, short selling and failed trades in the period May 1, 2007 to September 30, 2008 (“Study Period”).2 During the Study Period:
- overall, the average number of trades per day increased significantly;3
- the trends in trading activity varied markedly between marketplaces and types of securities with increases in trading activity concentrated on the Toronto Stock Exchange (“TSX”) with securities inter-listed with an exchange in the United States (“inter-listed securities”) and exchange-traded funds (“ETFs”);4
- rates of short sales were relatively constant throughout;5 and
- rates of trade failure declined.6
The Recent Trends Study built on an earlier study of failed trades undertaken by Market Regulation Services Inc. in 2006 (the “RS Failed Trade Study”) that, among other findings, determined that a short sale had a lower probability of failing than trades generally and that the principal reason for trade failures was administrative error.7 Taken together, the Recent Trends Study and the RS Failed Trade Study indicate that the Canadian market has not had the problems with short sales, particularly naked short sales, and failed trades that may have been evident in other jurisdictions.
Purpose of the Recent Trends Study
Securities regulators in Canada and abroad have recently taken regulatory action to protect investors and market integrity in light of the current and unprecedented market turmoil. To address concerns of investors and marketplace participants, IIROC increased its regular monitoring of trading on equity marketplaces in Canada, including heightened surveillance of all short selling activity and rates of trade failure.
The Recent Trends Study relates these trends in trading activity and short sales to trends in trade failures, based on data on trade failures and “buy-ins” provided by the Canadian Depository for Securities Limited (“CDS”). A copy of the Recent Trends Study is available on the IIROC website (www.iiroc.ca) under the heading “News Room” and the sub-heading “Publications”.
The analysis underpinning the Recent Trends Study and the earlier RS Failed Trade Study was used in the formulation of the recent amendments to the Universal Market Integrity Rules (“UMIR”) regarding short sales and failed trades.8 It is expected that the two studies will inform the consideration of other proposals for the amendment of UMIR respecting short sales including:
- the outstanding proposal to repeal price restrictions on all short sales (“tick rule”);
- the outstanding proposal to replace the requirement to file short position reports with the production of summary information on short sales; and
- a possible proposal to preclude additional short sales by a person who has executed an extended failed trade unless arrangements for the borrowing of the securities necessary to settle any resulting trade have been made prior to the entry of the order (“Pre- Borrow Requirement”).9
This information is also intended to assist in focusing discussions on whether initiatives that have been introduced or may be considered by securities regulators in foreign jurisdictions regarding short sales or failed trades would be appropriate in the context of the Canadian market.
Summary of the Findings
During the Study Period, there was no “negative” change in the pattern of short selling or trade failures. In particular, during the Study Period:
- the average number of trades per day increased significantly over the Study Period with more modest and less consistent increases in average daily volume and value;10
- the number of trades in securities listed on the TSX increased throughout the Study Period across all marketplaces trading those securities with the increase concentrated in the trading of inter-listed securities and ETFs;11
- while the number of trades in securities listed on TSX Venture Exchange (“TSXV”) or Canadian National Stock Exchange (“CNSX”)12 varied significantly throughout the Study Period, the overall trend appears to be a reduction in the total number of trades per trading day;13
- in periods of increased “market stress” (“Market Stress Period”)14 trading activity as measured by number of trades and value traded exceeded the average for the Study Period;15
- there was no significant change over the Study Period in the pattern of short selling in comparison with the trading of securities generally;
- the granting in July of 2007 of the exemption from the tick rule for the short sale of an inter-listed security has not had any discernable effect on the pattern or attributes of short sales of inter-listed securities (other than a slight increase in the proportion of trades that are short sales);16
- in a Market Stress Period:
- there is generally a lower than average level of short selling activity on TSXV,17
- there is a slightly higher rate of short-selling on the TSX,18 and
- the average volume and value of a short sale of a security (other than an ETF) tends to be lower than the volume and value of short sales generally;19
- the more “senior” the security, the higher the proportion of short sales;20
- short selling activity accounts for a disproportionate level of the trading activity on the “new” transparent marketplaces (possibly indicating a concentration of arbitrage and algorithmic trading);21
- during the Study Period:
- two-thirds of issues on the TSX reported a month-end short position as compared to only a quarter of the issues on TSXV,
- short positions in TSXV-listed securities “turned over” twice as fast as for TSX-listed securities,22
- monthly short positions amounted to approximately 16% of trading volume in TSX- listed securities as compared to just over 1% of trading volume for securities listed on TSXV and CNSX, and
- the average short position for a security represented the volume of 1,523 average trades on TSX for a TSX-listed security as compared to 18.1 average trades on TSXV for a TSXV-listed security and 2.6 average trades on CNSX for a CNSX-listed security;
- over the Study Period:
- the number of failed trades as a percentage of the overall number of trades has generally been declining,23
- on average, 5.08% of failed trades are closed out through the execution of a “buy- in” on a marketplace, and
- the accumulated value of failed trades as a percentage of the value of trades has generally been declining24 ; and
- “market stress” did not appear to have a negative impact on the rate or value of trade failures.25
- 1The study does not analyze the trading on markets outside of Canada of securities that are also listed on a Canadian marketplace. The study does not analyze the trading of securities “over-the-counter” in Canada or another jurisdiction.
- 2The study does not attempt to specifically evaluate the impact of the orders of the Ontario Securities Commission prohibiting short sales between September 22, 2008 and October 8, 2008 of certain financial sector issuers listed on the Toronto Stock Exchange that were also listed on an exchange in the United States (“Temporary Order”), though a number of the effects on the general trends of the prohibition on short selling are noted throughout the study. IIROC undertook a separate study evaluating the Temporary Order and the results of that study were provided to the applicable securities regulatory authorities and were made publicly available. Reference should be made to IIROC Notice 09-0038 - Administrative Notice – General – Impact of the Prohibition on the Short Sale of Inter-listed Financial Sector Issuers (February 9, 2009).
- 3The average number of trades per trading day increased from 481,041 in May of 2007 to 925,866 trades per day in September of 2008 with an average over the period of 634,330 trades per day.
- 4The TSX averaged 591,760 trades per day over the period (from a low of 445,945 in May of 2007 to a high of 870,290 in September of 2008 with the number of trades in ETFs increasing from 3,706 per day to 15,452 and the number of trades in inter-listed securities increasing from 245,175 to 553,384).
- 5Short sales accounted for 26.1% of trades on the TSX over the period (ranging from a low of 24.0% in May of 2007 to a high of 29.9% in July of 2008 when the proportion of short sales of inter-listed securities peaked at 33.9%) as compared to 4.5% of trades on the TSX Venture Exchange (with a high of 6.2% in September of 2007 and a low of 3.1% in September of 2008) and 4.2% of trades on CNSX.
- 6During the period, the average value of accumulated fails as a percentage of trade value was 2.08% ranging from a high of 2.69% in May of 2007 to a low of 1.31% in August of 2008. In September of 2008, the most volatile trading month in the 17-month period, the percentage increased slightly to 1.43%, which was still significantly below the average for the 17-month period of 2.08%.
- 7For a more detailed discussion of the RS Failed Trade Study and its results, see Market Policy Notice 2007-003 – General – Results of the Statistical Study of Failed Trades on Canadian Marketplaces (April 13, 2007).
- 8For particulars of the recent amendments, see IIROC Notice 08-0143 - Rules Notice – Notice of Approval – UMIR – Provisions Respecting Short Sales and Failed Trades (October 15, 2008).
- 9IIROC is evaluating the merits of the introduction of a “Pre-Borrow Requirement” that would focus any additional restrictions on the particular accounts that had executed extended failed trades rather than impose general restrictions on the dealers as is the case with the “Hard T+3 Close-Out” requirement adopted by the Securities and Exchange Commission in the United States as an interim final temporary rule. See SEC Release 34-58773.
- 10See footnote 2 for information on the average daily number of trades. With respect to average daily volume, the Study Period average was 593,076,770 with a high of 702,836,748 in October of 2007 (when volume peaked at the TSXV at 286,711,600 significantly above the Study Period average of 190,776,779) and a low of 458,400,292 in August of 2008 (when volume on the TSXV was at a low of 107,602,589). With respect to average daily value, the Study Period average was $7.67 billion with a high of $9.59 billion in September of 2008 and a low of $6.30 billion in August of 2008.
- 11See footnote 4.
- 12Prior to November 6, 2008, CNSX was known as Canadian Trading and Quotation System or “CNQ”.
- 13TSXV averaged 29,370 trades during the Study Period (with the number of trades declining from 34,944 in May of 2007 to 17,790 trades per day in September of 2008). CNSX averaged 111 trades per day during the Study Period (with the number of trades declining from 152 in May of 2007 to 71 trades per day in September of 2008).
- 14During the Study Period, the average daily point change in the closing index level of the S&P/TSX Composite was 129.87 points, or 0.958% of the average closing index level, and 28.94 points, or 1.137%, respectively, for the S&P/TSX Venture Composite Index. The average number of points (and percentage) between the average of the daily high and low index levels for the S&P/TSX Composite was 211.43 points, or 1.558% of the daily average of the high/low index level, and 39.88 points, or 1.556%, respectively, for the S&P/TSX Venture Composite Index. Six of the months, August of 2007 and January, March, July, August and September of 2008 experienced elevated levels of market stress across both indexes.
- 15The average daily number of trades in a Market Stress Period was 724,060 or approximately 14% above the overall Study Period average of 634,330 while the average value of trades in a Market Stress Period was $8.01 billion or approximately 4% above the overall Study Period average of $7.67 billion.
- 16For inter-listed securities, short sales generally accounted for between 28% and 30% of trades. With the granting of the exemption from the tick rule, the proportion of short sales in trades of inter-listed securities increased to the 30% to 33% range. This increase in the proportion of short sales was anticipated on the granting of the exemption.
- 17On the TSXV, short sales accounted for 4.1% of trades in a Market Stress Period as compared to 4.5% throughout the Study Period. On CNSX, short sales accounted for 7.3% of sales in September of 2008 significantly above the Study Period average of 4.2% of trades. However, the average for the other five months which are considered a Market Stress Period was only 3.6%.
- 18On the TSX, short sales accounted for 27.5% of trades in a Market Stress Period as compared to 26.1% of trades throughout the Study Period.
- 19During a Market Stress Period, short sales had an average volume which was generally less than the Study Period average for short sales ranging from 15% to 17% less for inter-listed and other securities on the TSX to just 3% to 5% less for securities traded on TSXV and CNSX. During a Market Stress Period, short sales had an average value which was generally less than the Study Period average. The differences ranged from 12% less than the Study Period average in the case of a short sale on CNSX to 20% less in the case of a short sale on TSXV.
- 20Over the Study Period, short sales of securities listed on the TSX accounted for 26.1% of trades (30.5% of inter-listed securities, 17.1% of ETFs and 19.5% of other TSX-listed securities) as compared to 4.5% of trades of TSXV-listed securities and 4.2% of trades of CNSX-listed securities.
- 21For the “new” marketplaces which publicly display order information, the proportion of short selling ranged from 36.7% of trades on Pure Trading, to 43.2% of trades on Chi-X and 56.3% of trades on Omega (which during the Study Period limited trading to securities which were exempt from the tick rule). For MATCH Now, which operates as a non-transparent marketplace, short selling accounted for only 14.6% of trades.
- 22The turnover rate is determined by dividing the volume of short sales during a month by the outstanding volume of short positions at the end of the month. On average over the Study Period, the short position on the TSX turned over every .76 of month as compared to .38 of a month for the TSXV and .63 of a month on CNSX.
- 23Over the Study Period, “initiated buy-in notices” received by CDS represented 0.27% of trades (ranging from a high of 0.38% in December of 2007 to 0.17% in September of 2008). Subsequent to the Study Period, “initiated buy-in notices” reached a low of 0.15% of trades in October of 2008.
- 24Over the Study Period, the value of accumulated fails as a percentage of trade value was 2.08% (ranging from a high of 2.69% in May of 2007 to 1.31% in August of 2008). Subsequent to the Study Period, the value of accumulated fails as a percentage of trade value reached a low of 1.16% in December of 2008.
- 25 During a Market Stress Period, the value of accumulated fails as a percentage of trade value was 1.83% or approximately 12% less than the overall average for the Study Period of 2.08% and the proportion of initiated buy-ins as a percentage of trades was 0.22% as compared to 0.27% for the Study Period overall.