TORONTO (Reuters) - Trading experts warned Canadian regulators on Tuesday against clamping down on a practice known as “broker preferencing,” saying that without it the country’s stock marketplace could further fragment and contribute to the growth of so-called dark pools, where trading is done anonymously.
Broker preferencing occurs essentially when brokers match buy and sell orders on stock exchanges or alternative trading venues in-house, disregarding orders from other brokers even though those orders may have come first.
Without broker preferencing, some industry watchers told an industry forum on Tuesday, Canada could quickly follow the U.S. model where several big banks run in-house dark pools, eliminating the need for stock exchanges.
The forum included regulators from Ontario and Quebec and was a result of a 23-page consultation paper released by Canadian regulators in the fall. It coincides with the U.S. Securities and Exchange Commission’s study of dark pools and other market structure issues.
In dark pools, many of which are independent, buy and sell orders are matched anonymously so that traders’ intentions aren’t broadcast to the wider market. Banks that run their own dark pools, such as Goldman Sachs Group Inc, can avoid the fees associated with sending orders to exchanges when they “internalize” orders from their clients, their proprietary trading desks, and from elsewhere.
Much of the concern about dark pools is that their anonymous nature means that stock pricing may not be transparent.
Growth of such trading in Canada would put more pressure on TMX Group, owner of the Toronto Stock Exchange and the small-cap TSX Venture Exchange, which is already losing market share.
“In Canada, we have a group of brokers who have an incredible concentration of order flow within their firms and that makes it easier to internalize flow because they have a higher likelihood of being able to match internally without letting those orders see the light of day, and contribute visibly to the price discovery process,” said Kevan Cowan, president of TSX Markets and group head of equities at TMX Group.
“(Broker preferencing) is helping to slow the pace of internalization, which could pose a greater danger to the public equity markets.”
Broker preferencing has been offered by TMX’s markets since at least the late 1990s, largely to hang on to the big concentration of order flows that come from bank-owned dealers. That concentration is estimated at some 50 percent of orders on the TMX’s markets.
Trading is still being fragmented, however, by the explosion in Canada and around the world of alternative trading systems (ATSs).
Some market participants think broker preferencing results in an uneven playing field for Canadian investors.
“Our rules preference clients of larger brokers, while disadvantaging those of smaller ones,” Nick Thadaney, chief executive of ITG Canada, told an industry forum, which was organized by Canadian regulators to collect feedback on dark pools and other market structure issues.
But Peter Haynes, a leading industry expert and managing director of index products and portfolio trading at TD Newcrest, urged regulators to consider the unintended consequences of tightening rules around broker preferencing.
“I do think that would be a strong catalyst to draw an additional level of dark pools among various market participants in Canada,” Haynes told regulators.
Dark pools such as Canada’s Match Now and Liquidnet currently comprise about 1 percent of market share in Canada.
With additional reporting by Jonathan Spicer; Editing by Jeffrey Hodgson and Peter Galloway