In their latest effort to adapt Canadian capital markets to the reality of high-frequency trading (HFT), the Canadian Securities Administrators (CSA) approved amendments to National Instrument 23-101 Trading Rules and its Companion Policy, that came into force in Ontario on April 10, 2017. Following the capping of active trading fees on Canadian exchanges to regulate rebates received by market-making liquidity providers, the latest amendments lowered fee caps for certain non-inter-listed securities while also requiring exchanges to post quarterly lists of inter-listed securities (securities listed in both Canada and the US) and adjust their fee structures accordingly. The new caps represent an attempt by the regulators to fine-tune the Canadian response to HFT activity by further harmonizing trading fees with the US.
Liquidity providers use HFT technology to increase trading volume on exchanges by posting trade orders in anticipation of demand. As an incentive to “make” markets, these liquidity providers are paid a rebate per share or unit traded by the exchange. The rebates earned by market “makers” are then passed on to the “takers” through increased exchange fees, which regulators believe have the potential to distort capital markets. To strike a balance between the benefits of market liquidity and the added cost to other market participants, US regulators set a cap at $0.0030 per unit traded for equity securities and exchange traded funds (ETFs) priced at or above $1. Recognizing the high degree of integration between US and Canadian capital markets as well as the risk of losing HFT liquidity providers due to a significant disparity in available rebates, the CSA instituted an identical cap effective July 6, 2016.
Responding to criticism that the cap was too high, the CSA have now lowered the cap for non-inter-listed equity securities and ETFs from $0.003 to $0.0017 per security traded for equity securities and ETF units with an execution price greater than or equal to $1. Adhering to the widely-held principle that the fee should reflect the underlying value of the security, the CSA assert that the lower cap for non-inter-listed securities is equivalent to the higher fee for inter-listed securities when the volume-weighted average price of each is taken into account; non-inter-listed securities are traded far less than their inter-listed counterparts. The risk of losing HFT market makers is supposedly diminished in this instance because non-inter-listed securities are shielded from the competitive pressures of the US markets.
To effect this lower cap, exchanges must now maintain and update a comprehensive list of inter-listed securities. Once a security is subtracted from the list, exchanges have 35 days to lower the trading fee as applicable. Exchanges, alternate trading systems, and other market participants should familiarize themselves with the details of these amendments. Similar regulations will likely follow as the CSA reckon with wide-reaching effects of HFT activity on modern capital markets.