November 13, 2006
James E. Twiss, Chief Policy Counsel,
Market Policy and General Counsel’s Office, Market Regulation Services Inc.,
Suite 900, 145 King Street West, Toronto, Ontario. M5H 1J8
&
Cindy Petlock
Manager, Market Regulation Capital Markets Branch
Ontario Securities Commission Suite 1903, Box 55
20 Queen Street West Toronto, Ontario M5H 3S8 Dear Mr. Twiss and Ms. Petlock:
ITG Canada is pleased to have the opportunity to offer its comments on the proposed amendments to the Universal Market Integrity Rules to accommodate the introduction of multiple marketplaces trading the same securities.
ITG Canada is a specialized brokerage and technology firm that provides innovative technology solutions spanning the entire investment process. Our sophisticated solutions include pre-trade analytics, advanced trade execution technologies and post-trade evaluation services.
We are pleased to provide the following response to questions posed by Market Regulation Services in the MIN 2006-019 Request for Comments Provisions Respecting Competitive Marketplaces dated October 6, 2006.
Question 1. Should the execution of a Single Price Session Order be exempt from the
“best price” obligations under Rule 5.2?
We support a change to allow for the Single Price Session Order to be exempt from the obligations under UMIR 5.2. The trading in these relatively blind books is similar to call markets that have been exempt from many provisions of UMIR rules. We also view that the “stability period” implies that the price in the security is reasonably stable on that marketplace. The follow-on auction can be compared to the special trading session after market hours where subscribers are bound to trade at the last sale price. However, in this case, they are entering their interests into a blind order book with no certainty of any additional fills. The concern that a
subscriber could be using this session to take advantage of an opportunity to trade through a quote is unlikely as they have already committed to a trade in that security (e.g. a minimum of 25,000 shares for BlockBook). By allowing an ATS to offer a Single Price Session it is likely that clients will get access to hidden liquidity that may otherwise be lost. The success of the iceberg order has demonstrated that clients feel that it is important to have the option of not displaying their entire order.
We believe that Market Integrity Rules should change to accommodate new marketplace models. These rules must allow the flexibility to take advantage of potential benefits that new markets offer to all investors and enable those investors to receive the best execution possible.
Question 2. Should any exemption from the “best price” obligations for a Single Price Session Order be limited:
(a) to the persons who were parties to the original “last sale” trade that gave rise to the procedures to discover additional volume at the price of that trade?
The Single Price Session Order should only be available to the same participants in the trade that gave rise to the session. The market for these trades is not transparent in nature and could not provide for sufficient notification to other participants in order to evaluate a trade decision.
This creates an uneven playing field for the participants and excludes those that were not actively monitoring the activity on this Marketplace. In addition by limiting the Single Price Session Order to the original participants, you will not have any other participants or Access person “free riding” off that trade price that are exempt from trade through or “best price”
obligations.
(b) to trades completed within a prescribed time period after the original match and, if so, what should that time period be?
The time period for order entry should be limited and standardized to minimize the occurrences of trade through. We believe that 60 seconds should be sufficient time to make a trading decision to participate in a Single Price Session. We however do not believe that it would be contrary to public interest to extend the prescribed time up to 2 minutes as proposed by BlockBook.
Question 3. If a Single Price Session Order is not exempt from the “best price”
obligations, should the obligation to better-priced order on other marketplaces be limited to the volume of the Single Price Session Order that executes?
In the event that the decision is made to enforce trade through obligations during the Single Price Session, then we support the view that it should only be limited to the volume that is traded during that session. We however believe that it is impractical to impose this burden on Access persons as they may not have the appropriate access to the market where there are better priced bids or offers posted to meet this obligation. We also suggest that if Access persons are exempt, then Dealers should also be exempt from trade through in the same manner. Further if, the Market Integrity Rules do require participants to fill better priced orders, we expect that this potential liability would discourage participation or even eliminate the use of these sessions. Managing the execution risks of trading often anticipates partial fills but is rarely amenable to obligations above the amount entered in an order.
We would also like to take this opportunity to provide comments on some of the principal impacts noted in the Proposed Amendments.
UMIR Amendments and Definitions
We support RS’s amendments to the definitions and the application of these definitions in UMIR. However, we are concerned about the impact of prescriptive rules on client orders where there are multiple transparent auction markets that have different operating hours. We believe that, under the general principal of “Best Execution”, the dealer should be allowed to evaluate how the order should be executed. For example, the dealer should determine whether to execute the order immediately on an open market or to wait to execute the order on the principal market when it opens. In these situations, the Market Integrity Rules should not hold the dealer to a pre-market quote when they hold a client order with the intent to provide Best Execution. This may require the Dealer to wait until they can properly evaluate and compare liquidity and prices to the principal market when or just before it opens.
Minimum Trading Increments
We support the requirement for a minimum one cent trading increment for orders entered at
$0.50 or more;
Non-standard Trading Reports
We support permitting the identified “specialty trades” to execute at non-standard trading increments. We also believe that when a trade is reported at a non-standard price, the price itself provides an element of valuable disclosure to the marketplace. These non-standard executions will highlight to market participants that there may be price improvement opportunities available in an ATS, such as TriAct Canada Marketplace. In addition, non- standard reports printed in the after hours trading session provide additional transparency of specialty crosses to market participants.
Order Exposure
We support the requirement to expose client orders for 50 standard trading units or less on a marketplace that displays orders in accordance with Part 7 of the Marketplace Operation Instrument. We also agree with the view that a dealer should be able to seek out price improvement opportunities through an ATS like TriAct Canada Marketplace before sending any unexecuted portion of the client order to a marketplace that provides order transparency. We believe that Retail orders should receive the benefits of ATS’ and “dark” liquidity pools. This will improve the quality of execution for all participants in the Canadian Marketplace. In that vein, the final rules of SEC Regulation NMS provide an excellent discussion of a broker-dealer’s duty of best execution:
The duty of best execution requires broker-dealers to execute customers’ trades at the most favorable terms reasonably available under the circumstances, i.e., at the best reasonably available price. The Commission has not viewed the duty of best
execution as inconsistent with the automated routing of orders or requiring automated routing on an order-by-order basis to the market with the best quoted price at the time. Rather, the duty of best execution requires broker-dealers to periodically assess the quality of competing markets to assure that order flow is directed to the markets providing the most beneficial terms for their customer orders. Broker dealers must examine their procedures for seeking to obtain best execution in light of market and technology changes and modify those practices if necessary to enable their customers to obtain the best reasonably available prices. In doing so, broker-dealers must take into account price improvement opportunities, and whether different markets may be more suitable for different types of orders or particular securities.
Access to Marketplaces
We support the removal of access to a marketplace and availability of information as considerations to be taken into account in determining whether a Participant has satisfied its
“best price” obligation. With the recent advancements in technology and order routing, we believe that a broker-dealer has various options for accessing a marketplace where they are not a direct subscriber or member. Broker-dealers should even be able to automate jitney arrangements in order to meet these obligations.
Client Priority
We support the proposed expanded exceptions to the client priority rule, however we believe that RS should go further by adding additional exemptions and regularize the use of information walls. Reliance on Information Walls is currently a common practice within diverse firms to divide their trading desks into separate “aggregation units” that pursue different trading strategies.
We suggest that RS consider including exemptions that are based on the specific trading strategies such as “bona fide arbitrage” (currently a defined term in US Rules and Regulations.) In the Canadian context this would translate to “arbitrage accounts” as defined by UMIR. The current UMIR exemptions have limited application to rules for short sales. These “tick test”
exemptions include but are not limited to program trading UMIR 3.1(2)(a), Market Making obligations UMIR 3.1(2)(b) and interlisted arbitrage UMIR 3.1(2)(c). In addition to extending these exemptions to the client priority rules, we propose that the definition of program trading, for the purposes of client priority rules, be expanded to include automated trading strategies that are computer generated and “basket trades” as defined in UMIR and not necessarily linked to an approved index.
In addition to the exemptions outlined above, we believe there should also be an exemption available where there is no “intentional” trading ahead of a client order when the director, officer, partner, employee or agent of the Participant has no knowledge of the client order. We believe that new methods of trading provided by technology, such as automated program trading or algorithmic trading, create situation where orders are placed on several markets automatically without trader handling. The trader would have no direct knowledge of these orders and therefore should be able to rely on an exemption so long as there are the appropriate information walls. This long standing practice of separating trading desks with information walls should continue to be available. We also believe that, with the introduction of multiple markets, it would be appropriate for the regulators to provide specific guidance as part of a policy interpretation. We suggest that you consider the guidance provided by the NASD to firms in an
interpretive letter dated February 9, 19991 to address the netting requirements within a firm and the conditions for “aggregation units”. The NASD requirements, as outlined by Robert E. Aber, Senior Vice President and General Counsel for the NASD, are provided:
1. The firm must have a written plan of organization that identifies each Aggregation Unit, specifies its trading objective, and supports its independent identity.
2. Each Aggregation Unit within the firm must continuously determine, on a real-time basis, its net position for every security that it trades that is subject to NASD Rule 3350.
3. At least once per day, the firm must reconcile the net positions of all the Aggregation Units with the firm's net position.
4. Individual traders must be assigned to only one Aggregation Unit at any time.
5. Each trader pursuing a particular trading objective or strategy must be included in one Aggregation Unit.
6. If a trader temporarily transfers from one Aggregation Unit to another, the firm must document the beginning and ending dates of the transfer and the business reason that the transfer was made.
7. If a person from one Aggregation Unit coordinates trading of proprietary positions held by another Aggregation Unit (i.e., effectively control trading by another Aggregation Unit in a particular NNM security or securities), the firm must aggregate the positions of those units to produce a combined net short or long position, prior to execution of any trades.
8. As part of its compliance and internal audit routines, the firm must continually maintain and update surveillance and audit procedures that facilitate the review and surveillance programs of the firm, the NASD, the Securities and Exchange Commission ("SEC" or "Commission"), and any other responsible Self-Regulatory Organization ("SRO"). As part of these routines, the firm must:
a. evaluate the trading activities of Aggregation Units undertaken in reliance on this letter for the appropriate characterization of sales treated as long sales;
b. review activities that appear unusual, including, but not limited to:
i. transactions leading to short positions that are unusually large in comparison with an Aggregation Unit's normal pattern of trading, or any series of transactions in a single trading session that together lead to an unusually large short position;
ii. a pattern of transfers of securities between or among Aggregation Units preceding long sales by the Aggregation Units that receive securities;
iii. trading activity that does not appear to be consistent with the stated strategy or objectives of a particular Aggregation Unit; and
1 http://www.nasd.com/RulesRegulation/PublicationsGuidance/InterpretiveLetters/ConductRules/NASDW_002550
iv. frequent movement of traders between or among Aggregation Units;
and
c. review any sale that is unusually large in relation to an Aggregation Unit's normal pattern of trading that merits review on one or more other bases for compliance with the short sale rule.
9. The firm must establish and maintain continuous, written records for each Aggregation Unit that include the following information:
a. the account number of each trading account designated as part of an Aggregation Unit;
b. any permanent or temporary changes in the accounts designated as part of an Aggregation Unit;
c. the name of each trader assigned to an Aggregation Unit;
d. the name of each person that makes trading decisions for an Aggregation Unit;
e. any transfer of securities between Aggregation Units and the reasons for the transfer;
f. any transactions conducted by an Aggregation Unit on an agency basis for another Aggregation Unit;
g. unusual activities that are reviewed in response to paragraph 8 of this letter.
h. the information required by paragraph 6 of this letter regarding the temporarily transfers of traders from one Aggregation Unit to another (e.g., the beginning and ending dates of the transfer and the business reason that the transfer was made); and
i. The records required by this paragraph must be preserved for a period of not less than six years, the first two years in an easily accessible place.
There are specific situations where a dealer, in its process of providing “Best Execution”, may represent a client order on more than one marketplace. At the same time, an automated proprietary order, such as a guaranteed VWAP hedge trade, may be trading on multiple markets seeking liquidity to hedge its contingent liability. If, in this instance, the firm could wall off the proprietary trading for a guaranteed VWAP strategy, they should be able to effectively hedge their risk without disclosing their trading intentions to customers through a request for consent.
The very nature of hedging to a guaranteed VWAP is to have minimal impact to market prices and to as closely track that day’s trading with minimal information leakage.
To further illustrate the challenges that come with client and principal orders being entered into multiple markets, consider a situation where there are two limit buy orders for 1,000 shares at the same price, one an inventory order and the other a client order, which are evenly split by the dealer and represented on two markets (500 in each market). If a market sell order for 1,000 shares filled the inventory and client orders on the one market, that would leave both client and inventory orders on the other market unfilled. It would be impractical for the dealer to systematically give up their fill for 500 shares to the client and notify RS of that give-up as
currently required. Trade through rules would protect the client order and ensure that no other orders receive better prices. It would be equally impractical to wait to the end of the day to evaluate if any inventory orders should be given up to clients as market circumstances often have significantly changed over the day and clients could have adjusted their trading strategies and hedges based on the fills received throughout the day. It would also make it almost impossible for the dealer to manage his inventory positions and hedge strategies if the balances in the account were subject to constant reversal to fill client orders
It should be noted that In this age of electronic trading the number of orders that could be generated by “black box” automated systems could create situations where it is not reasonable to give up inventory orders to clients when there was no intention to trade ahead or alongside and where it can be demonstrated that the inventory trader has no knowledge of client orders.
Client orders can be represented on multiple markets and maintain price priority in each market so that their orders have trade through protection. As long as the dealer had a reasonable expectation that there would be liquidity in those markets, we believe that this is not contrary to the client’s interest.
Dealers must be able to provide evidence of their policies and procedure related to how they manage client orders, whether managed by a trader or entered into an automated trading system. These policies and procedures should outline specific practices related to how client orders are routed to (or split among) multiple marketplaces. As long as those policies and procedures effectively describe how the firm provides Best Execution of client orders, then regulators can be assured that firms are acting in the best interest of their clients.
Yours Truly,
Torstein Braaten
Vice President, Chief Compliance Officer ITG Canada Corp.
Cc: Nicholas Thadaney, Chief Executive Officer, ITG Canada Corp.
Tony Huck, Managing Director, ITG Inc.
P. Mats Goebels, Esq., Managing Director and General Counsel, ITG Inc.
