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In mid-December, the CSA publicized its concerns over dealers sending retail order flow to the U.S.

“[A] number of Canadian investment dealers have entered into, or are considering entering into, arrangements to route Canadian retail investor orders on a broad basis to U.S. dealers for execution,” it said in a release. “Under these arrangements, retail orders are not typically executed on U.S. exchanges, but instead are executed by U.S. dealers off-marketplace. Canadian investment dealers may receive payment or other benefits for sending these orders to the U.S. dealers.”

Read: CSA holds firm on key CRM2 deadline, IIAC responds

The OSC declined Advisor’s Edge Report’s request for specifics on the number of firms involved, and how the regulator became aware of arrangements still in the planning stage.

CSA says the orders don’t always meet Universal Market Integrity Rules (UMIR) price improvement requirements (see “IIROC’s UMIR Rule 6.6,” this page). The regulator also has public interest concerns; specifically, it’s “concerned that widespread routing of retail order flow to U.S. dealers will negatively impact the quality of the Canadian market, and may affect the quality of execution achieved for investors.”

Read: CSA “concerned” about dealers routing equity orders to U.S.

Adds an OSC spokesperson in an emailed response to Advisor’s Edge Report: “We are concerned about the impact on the price discovery process if a significant amount of retail order flow is diverted away from Canadian public markets. A healthy price discovery process involves the interactions of a diverse group of buyers and sellers coming together to determine the price of securities. The widespread loss of retail order flow to the U.S. has the potential to impact the price discovery process in a negative manner.”

Wendy Rudd, IIROC’s senior vice-president of market regulation and policy, echoed these remarks in an emailed statement: “IIROC is concerned about the longer-term impact of order-routing practices on the quality and competitiveness of Canadian markets. A possible effect of the routing of orders away from Canadian markets is less liquidity on Canadian markets, which could lead to less efficient price discovery.”

She adds IIROC is planning a proposal that “aims to ensure that these trades on foreign markets align with Canadian requirements for meaningful price improvement.” (The proposal was released on January 29, 2015. Read it here.)

Better execution?

It’s not clear that routing orders to the U.S. off-exchange necessarily means clients get poorer execution, says a Toronto-based securities lawyer who requested anonymity. It could actually be the opposite, resulting in a win-win situation: the dealer firm gets paid for sending orders to the U.S. and the client gets better execution. He suggests it’s likely smaller dealers who are doing the routing. “They could be having trouble surviving in a tough market and see flipping their orders to the States for a fee as worthwhile.

“I don’t think the big banks would send order flow to a U.S. dark market without meeting all UMIR requirements. I think they understand the nuances of the UMIR rule, whereas a little guy might not know it quite as well.” But, he says, there’s a bigger issue at play, alluded to in the statements from CSA and IIROC: If large dealers start getting more orders executed in the U.S., it could hollow out the Canadian market.

“There seems to be an undercurrent of worrying that, if the big banks started doing this, it could gut trading in Canada, affecting the integrity of our capital markets,” the lawyer says. “If you can’t trade effectively in Canada, then slowly everything will get done in the U.S. You’d eventually have to go there to get listed, and the Americans will do all our deals for us. We won’t have a market.”

Read: Firms failing to grasp compliance basics: IIROC

IIROC’s UMIR Rule 6.6: Provision of price improvement by a dark order

1 If a Participant or Access Person enters an order on a marketplace for the purchase or sale of a security, that order may execute with a Dark Order provided the order entered by the Participant or Access Person is executed:

a at a better price;

b in the case of a purchase, at the best ask price if:

i the order on entry to the marketplace is for more than 50 standard trading units or has a value of more than $100,000, and

ii on the execution of the trade with the Dark Order, no orders for the sale of the security included in the calculation of the best ask price are displayed on that marketplace at that best ask price; or

c in the case of a sale, at the best bid price if:

i the order on entry to the marketplace is for more than 50 standard trading units or has a value of more than $100,000, and

ii on the execution of the trade with the Dark Order, no orders for the purchase of the security included in the calculation of the best bid price are dis- played on that marketplace at that best bid price.

2. Subsection (1) does not apply if the order entered by the Participant or Access Person is:

a a Basis Order;

b a Call Market Order;

c a Closing Price Order;

d a Market-on-Close Order;

e an Opening Order; or

f a Volume-Weighted Average Price Order.

Source: IIROC’s UMIR rule book

Originally published in Advisor's Edge Report

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