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Protecting Canadian Markets, Protecting Canadian Investors
Le Cercle de la finance internationale de Montréal
The International Finance Club of Montréal
Andrew J. Kriegler
President and Chief Executive Officer
Investment Industry Regulatory Organization of Canada
May 7, 2015
Check against delivery.
Thank you M. St. Arnault for that kind introduction and good afternoon everyone.
It is very good to be back in Montréal and to be here with you in my first public speech since joining IIROC last November.
I am always pleased to be in Montréal in part because my connection with the city goes back many years – in fact my first memory as a child is coming to Montréal from Ottawa to see my grandparents and to experience Expo ’67.
I have been fortunate since then to be able to maintain contact with Québec throughout my career, as a banker and as the country manager for the rating agency Moody’s.
Over those years, then more recently as Deputy Superintendent at OSFI and now in my new role at IIROC, I’ve had the opportunity to work with government, industry and other stakeholders across Québec and particularly with the financial services community here in Montréal.
I see a number of familiar faces in the audience and would like to thank them and indeed all of you for taking the time to be here today.
I would like to particularly acknowledge my colleagues from l’Autorité des marchés financiers (AMF) including Gilles Leclerc, Superintendent, Securities Markets.
The AMF is one of our important regulatory partners; a partner with whom we work closely to protect the quality and integrity of Canada’s capital markets and the interests of Canadian investors.
1 Also here in Québec is an important peer organization to IIROC, la Chambre de la sécurité financière, which is led by Mme Marie-Elaine Farley, who is with us today.
While I am relatively new to IIROC, the importance of healthy capital markets – markets in which investors have confidence and trust – is not new to me at all. Indeed the value of confidence in markets has been important to me in virtually every one of the financial services roles I’ve held since I started in 1987.
Healthy capital markets provide the fuel for economic growth in Québec and across Canada. For markets to function effectively and to deliver the fuel that is debt and equity capital, they must have and maintain the confidence of investors.
So today, I would like to speak to you about the role that IIROC plays in supporting the integrity of markets, in supporting the quality of markets and ultimately in supporting the confidence of investors in our markets.
We play that role across Canada, together with and in support of our partner regulators.
Having set that stage, I will briefly highlight two issues that have our policy attention today and that will make, I believe, the role we play that much more tangible to you.
How IIROC fits into the securities regulatory framework Many of you are already familiar with IIROC but for those who are not, we are a selfregulatory organization that oversees all investment dealers and trading activity on debt and equity markets across Canada.
IIROC carries out the duties delegated to it by each of these authorities by way of “Recognition Orders” across the country and operates under the collective oversight of CSA members. Our regulatory activities include rule making, registration, market surveillance and enforcement.
To carry out pan-Canadian responsibilities we have a pan-Canadian presence, with offices in Vancouver, Calgary and Toronto in addition to the more than 50 colleagues we have here in Montréal.
IIROC employees are on the front lines setting and enforcing rules regarding the proficiency, business and financial conduct of IIROC regulated firms and their registered employees – and setting and enforcing market integrity rules regarding trading activity on Canadian markets.
The importance of regulatory partnership Given that we operate across the country to deliver securities regulation in cooperation with and on behalf of our partners, coordination and cooperation with them is critical.
The more effective our partnership, the more effective our coordination, and the better we can together carry out our shared responsibilities to protect markets and protect investors.
IIROC makes every reasonable effort to collect the penalties imposed on dealers and individual registrants who, through our disciplinary process, have been sanctioned for breaking the rules of good conduct.
While we collected 100% of fines and other penalties levied against firms across the country in 2014, collecting from individuals is much more challenging. Last year we collected only 17% of the penalties levied against individuals nationally.
It’s true; sometimes these individuals have no assets; making it very difficult to collect from them. However, in much of the country, these people can evade payment by simply leaving the securities industry or by operating in an unregistered capacity. This is wrong. If an advisor breaks the rules and abuses the trust their clients have placed in them, they should pay the penalty.
A system that allows IIROC to pursue these individuals, even if they leave IIROC membership or leave the financial services industry entirely sends a clear, deterrent message – and just as importantly demonstrates the integrity of the regulatory system.
And so, the government of Québec on the recommendation of the AMF, amended the Act respecting the Autorité des marchés financiers (the AMF Act) in June 2013.
Quebec and Alberta are two jurisdictions where we have been granted and have used the statutory power to register our disciplinary decisions.
While collection rates for individuals vary significantly over time and based on the number and types of cases prosecuted, last year we had the highest fine collection rate in Quebec - 59% - versus the 17% nationally.
We thank the government of Québec and the AMF for having taken this important step to strengthen investor protection in the province and for helping to give individual investors the confidence of knowing that the regulatory system works to hold participants accountable.
I also want to acknowledge the Alberta Government and our colleagues at the Alberta Securities Commission for their leadership for setting the precedent with this important investor protection initiative in 2002.
We are continuing to pursue as a priority similar measures in the provinces where they don’t currently exist.
IIROC’s unique market surveillance role As I already mentioned, IIROC also plays a unique role in that we conduct surveillance of all Canadian equity markets – including exchanges and Alternative Trading Systems (ATSs) – whether lit or dark.
This data we collect and use from our Surveillance Technology Enhancement Platform – or STEP as we call it – represents a rich repository of information about market behavior and the consequences of how Canada has structured its markets; more on that later.
STEP enables us to monitor trading activity, which helps to maintain fair and orderly equity markets. It is complemented by our Equity Data Warehouse – a four-year database – which enables IIROC to analyze historical trade data. Doing so helps us to better identify patterns and trends including inappropriate trading, and to inform both enforcement actions and policy development at IIROC and at the provincial authorities.
Now that I’ve given you some sense of what our role is, I’d like to turn to some of the changes taking place and how IIROC is responding to protect markets and protect investors.
A view through IIROC’s lens Capital markets have undergone significant and unprecedented change in recent years.
As a result, regulators and market participants alike have been grappling with challenges associated with a proliferation of new products and players, segmentation and fragmentation of markets and the sheer speed of trading, not only in equities, but across all asset classes.
Of course Michael Lewis’s bestselling 2014 book “Flash Boys” fueled media interest but many of us had been keenly watching developments long before “high frequency trading” and “dark pools” became part of the popular lexicon.
In 2012, IIROC launched a multi-year research effort to study high frequency trading.
Consisting of IIROC’s own work, as well as independent academic research using our STEP data, the results have shed significant light on HFT and on the implications for investors of fragmenting markets.
As we consider what, if any, regulatory response might be appropriate to address issues associated with high frequency trading, we have also continued to monitor the evolution of dark trading.
The impact of trading in the “dark” IIROC implemented dark trading rules in October 2012 following a lengthy consultation period in partnership with the CSA.
They said, in essence, that visible orders must get execution priority over dark orders on the same marketplace at the same price.
Another key element of the rules is meaningful price improvement – in order to trade with a dark order, smaller orders must receive a minimum level of improvement over the price quoted on the displayed market, generally at least ½ cent per share.
Prior to implementation of these rules, dark trading in Canada had been increasing with volume hovering around 9.5 %. Published reports have suggested that dark trading may represent as much as half of the trading in the U.S.
We chose to take a pre-emptive approach before the “genie” was completely out of the bottle and as such, were ahead of some other jurisdictions – most of which were seeing even greater flow going into dark pools.
Being one of the first jurisdictions to deal with this issue, our rule, to put it mildly, was not without controversy. This was in part because any rule change creates winners and losers but also because no one could be certain in advance what the impact of the rule would be.
We made a decision to move forward because it was the right thing to do in our view – and we did so based on as much information and analysis as was available at the time.
In addition to making data-driven policy, we believe that it is equally important to objectively measure the results of our policy decisions after the fact – which is what we did.
Earlier today, we published a comprehensive analysis of the impact of our dark rule amendments using our database of regulatory market data.
As expected, implementation resulted in an immediate and dramatic decline in dark trading. While some marketplaces have since increased their market share, dark trading
Today’s paper also demonstrates that dark trading venues and individual brokers experienced different impacts based on their service and business models, which we had also expected.
For example, leading up to the rule, there had been dramatic increases in the use of dark trading venues by brokers to effectively trade internally - that is, with their own clients’ orders. After implementation of the rule, this type of activity declined significantly. Brokers whose models were not dependent on this activity were not as affected by the rule changes.
The analysis shows some positive results in the visible markets – which is where we had hoped to see them and the dark markets returned to their original purpose – a place for institutional investors and others to avoid information leakage and market impact.
Retail investors as a whole did not see an impact to trading costs. However active retail orders did experience increased costs while passive HFT experienced decreases in costs.
By way of example, on a $20,000 trade of 1000 shares of a security at $20, the additional cost for an active retail order would be approximately $1.40 as a result of the rule change.
As I mentioned earlier, we believe that pre-trade price discovery, through the interaction of supply and demand from a variety of market participants, is fundamental to the fair and efficient functioning of markets. The trade-by-trade effects are small, but taken together they would change the structure of Canada’s capital market. Trade-offs are sometimes necessary to ensure that, on balance, the benefits to the market as a whole outweigh the costs.
We can therefore conclude that our regulatory objectives were accomplished with acceptable impacts to market quality.
Order routing to the U.S. is a related concern to us A closely related issue, because it can also drain liquidity from lit markets, is the routing of Canadian retail orders to the U.S., something that is still largely permitted, as long as they go to a foreign regulated market.
Unchecked order flow to the U.S. to avoid Canadian rules could have a significant, long-term negative impact on the Canadian markets, reducing the domestic liquidity which is important to a healthy and robust economy.
That’s why in January we republished for comment a proposed Anti-Avoidance provision. The proposal would permit market participants to execute small client orders on a non-Canadian market only when the order is entered on a foreign market that displays order information – or the order receives meaningful price improvement.
In other words, it would extend the existing dark rules to cross border trading.
This provision would help ensure that orders that contribute to healthy price discovery are not by-passed by orders routed to a foreign jurisdiction -- orders that can step ahead of the Canadian posted orders by an amount that would not be acceptable in Canada.
Orders routed to the U.S. commonly receive 1/10 of a cent per share or less in price
At the same time, we recognize that the proposed provision could reduce the incentive for domestic exchanges and ATSs to innovate and compete. There would be less pressure for Canadian markets to lower trading costs.