Specific questions related to the use of the bypass order marker

09-0128
Type: Rules Notice> Guidance Note
Rule connection:
UMIR
6.2 Designation and Identifiers
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Legal and Compliance
Trading

Contact:

Felix Mazer
Policy Counsel
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Executive Summary

This Rules Notice provides guidance on specific questions related to the use of the bypass order marker under the Universal Market Integrity Rules (“UMIR”).

Background

On May 16, 2008, Market Regulation Services Inc., the predecessor to the Investment Industry Regulatory Organization of Canada (“IIROC”), published Market Integrity Notice 2008-008 – Amendment Approval Provisions Respecting “Off-Marketplace” Trades (“Off-Marketplace Notice”) which provided notice of the approval of various amendments to UMIR by the securities regulatory authorities. Among the amendments approved was a requirement that a “bypass order” contain the appropriate regulatory designation on entry to a marketplace.1

In order to provide Participants, marketplaces and service providers with an opportunity to make changes to their programming to accommodate the introduction of this marker, the Off- Marketplace Notice provided that the implementation date of the required marker would be deferred. On February 3, 2009, IIROC issued notice to industry participants that the Board of Directors of IIROC established June 1, 2009 as the implementation date for the amendments to Rule 6.2 of UMIR that require “bypass orders” be marked on entry to a marketplace.2 In conjunction with the implementation of the bypass designation by Participants, effective June 1, 2009, each marketplace must be able to disclose the designation for the bypass order in the information which that marketplace provides to information vendors for disclosure in a consolidated market display. Participants must ensure that their trading systems and the systems of their service providers have been appropriately modified.

Questions and Answers

The following are specific questions respecting the use of the bypass order marker by a Participant and the response of IIROC to each question:

  1. Is a Participant required to mark all orders entered on a marketplace for “displacement” purposes as “bypass”?

No. However, if a Participant sends an order to a protected marketplace3 to trade with the “disclosed volume”4 (in compliance with its “best price” obligation) on a marketplace, and does not mark the order “bypass”, the Participant takes on the risk of not having the order interact with the intended disclosed volume. To the extent that the protected marketplace supports “full-undisclosed” orders, iceberg orders, or allows orders in the Special Terms Book to “crossover” into the regular trading book, the failure to mark an order “bypass” increases the risk that the order may not trade with the disclosed volume, thereby exposing the Participant to additional displacement obligation. For greater certainty, notwithstanding that a Participant enter an order on a particular protected marketplace that is of a sufficient volume and is at price that will fill the disclosed volume, to the extent that the order is not marked “bypass” and encounters “interference” for undisclosed orders on the marketplace, the Participant insofar as it has traded-through (or “offered-through” or “bid-through”) any portion of the disclosed volume has acted contrary to Rule 5.2.

For the reasons outlined above, if a Participant enters into a “designated trade”5 (including an intentional cross or pre-arranged trade that would be outside the price parameters of a “designated trade”) the use of the bypass marker is recommended on all orders sent to displace better-priced orders on other protected marketplaces to avoid interference from “undisclosed” liquidity.

  1. Will all marketplaces support the inclusion of the bypass order marker on bypass orders on June 1, 2009?

IIROC expects that most protected marketplaces that permit “undisclosed” volume (i.e. “fully-undisclosed” orders, iceberg orders or allowance by the marketplace for the “crossover” of Special Terms Orders) will support bypass orders on, or shortly after, June 1, 2009. To the extent that a protected marketplace with “undisclosed” volume does not support the bypass designation as at June 1, 2009, IIROC is the view that a Participant will have made “reasonable efforts” to comply with its best price obligations if a Participant enters orders on a protected marketplace concurrent with, or immediately following, the trade on another marketplace and such order(s) have a sufficient volume and are at price that will fill the disclosed volume on the protected marketplace.

Alpha Trading Systems (“Alpha”) and CNSX Markets Inc. (“CNSX”) (including Pure Trading, a facility of CNSX) have indicated that they will not support the bypass order marker at June, 1, 2009. Alpha has indicated that it expects to support the bypass order marker on or about June 22, 2009 and CNSX and Pure Trading expect to support the bypass order marker sometime in July, 2009. During this interim period, IIROC expects that Participants will continue to route orders to Alpha, CNSX and Pure Trading in the normal course. The above referenced marketplaces have indicated that during the period that “bypass” is not supported, any order received that is marked “bypass” will not be rejected, and will be handled in the same manner as currently, which may include interaction with hidden orders. In the view of IIROC, the risk that hidden volume on these marketplaces may interfere with incoming orders marked “bypass” is tempered by the fact that any interference would not, from a best execution perspective, disadvantage orders. IIROC will continue to monitor the implementation efforts taken by these marketplaces to ensure that reasonable efforts are being taken to the support the bypass order marker in a timely fashion.

  1. Does the execution of an order marked “bypass” set the “last sale price”?

Depending on the manner in which a bypass order is used it may establish the “last sale price” for the purposes of UMIR. In the view of IIROC, a bypass order entered on a marketplace for the purpose of displacing better-priced orders will set the “last sale price” (at the lowest or highest price traded as a result of the bypass order).

To the extent that a bypass order is part of a designated trade (i.e. an intentional cross), if it is executed at the same time as any displacement trade it will set the “last sale price” for the purposes of UMIR. If the execution of a intentional cross involves a “two- step process”, that is, the intentional cross is executed subsequent to the displacement of better-priced visible orders on any marketplace, the “bypass” intentional cross is in effect an “as of” trade and, as such, would not set the last sale price. This treatment is consistent with the approach currently taken with respect to “as of” orders which do not set last sale price.

  1. Must orders being managed by a Smart Order Router (“SOR”) used by a Participant be marked “bypass”?

Not necessarily. Certain SORs are designed to route orders that will trade only at the best displayed price. If the SOR employs an “iterative” approach, whereby the order is routed to the best displayed quote, and the best bid and best offer then available on each protected marketplace are taken into account and reviewed following each successive fill prior to making the next routing decision, then the bypass marker will not be necessary as there is no risk of trading at a price that is outside the “national best bid or offer”.

However, SORs that utilize a “spray” methodology, whereby orders are simultaneously routed to multiple destinations, must ensure that all orders at prices that may trade outside the “national best bid or offer” are marked “bypass” if the order is sent to a marketplace that permits hidden volume or the “crossover” of Special Terms Orders that are not displayed in the disclosed volume.

  1. Is an order entered on a marketplace for “displacement” purposes exempt from the short sale rule?

Yes. Under Rule 3.1 of UMIR, a short sale entered on a marketplace for the purpose of displacing better-priced orders in satisfaction of a Participant’s “best price” obligation is exempt from the application of price restrictions on a short sale. As such, a Participant should (for those marketplaces that support the “short exempt” marker) mark all short sale orders that are entered on a marketplace for displacement purposes (including bypass orders) as “short exempt”. For greater certainty, to the extent that the trade that gave rise to the displacement was an “improper” short sale, a Participant may not rely on exemption from the short sale rule.

  1. May a bypass marker be used on orders that are for less than a standard trading unit?

Yes. In the view of IIROC, the instances in which a bypass order for less than a standard trading unit will be entered on a marketplace for displacement purposes would be rare. That said, if a marketplace accepts bypass orders that are for less than a standard trading unit, a Participant may mark the order “bypass”.

  • 1Subclause (v.3) of clause (b) of subsection (1) of Rule 6.2.
  • 2 IIROC Notice 09-0034 – Rules Notice – Guidance Note – UMIR – Implementation Date for Marking of Bypass Orders.
  • 3UMIR defines a “protected marketplace” as a marketplace that:
    • disseminates order data in real-time and electronically through one or more information vendors in accordance with the 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.
  • 4The term “disclosed volume” is defined as including 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.
  • 5A “designated trade” is defined as an intentional cross or pre-arranged trade of a security made at a price that:
    • would not be less than the lesser of:
        o  95% of the best bid price, and
        o  10 trading increments less than the best bid price, and
    • would not be more than the greater of:
        o   105% of the best ask price, and
        o   10 trading increments more than the best ask price.