An order is entered in full but it may be divided into "disclosed" and "reserve" portions. When the disclosed portion is filled, it is refreshed from the reserve
until the whole order is executed. The disclosed portion of other subscribers' orders at the same price have priority over the reserved amounts. Filling priority is
by time of entry of the disclosed portions. The effect of the reserved portion is to dampen the market impact by not having the order fully disclosed, while
allowing it to be protected against a trade-through.
- No indication is given by the system as to the identity of the institution or market-maker behind any order in the order file or on transaction reports.
- Orders can be entered for display to all subscribers or limited to institutions only.
- Unless an order is executed immediately or entered for a specified duration, it becomes inactive after 3 minutes. It remains in the file only as an indication of
past interest.
In light of the above and other types of systems such as crossing systems, please recommend what you regard as an appropriate regime of pre-trade disclosure
fortraditional exchanges and for NETS. Please consider the following questions in yor response:
a) If a NETS is required to provide pre-trade disclosure, should such disclosure be:
i) the same as its customers disclose to each other;
ii) required to meet the present exchange standard; or,
iii) required to meet some other standard?
b) Should the present disclosure regime of the exchanges be maintained or should the requirement to report order size and broker identity be relaxed?
The suggestion has been made that the minimum standard of disclosure of bid and offer information need only extend to the price level that is the best bid or
offer level in the respective system. Presumably, vendors will provide an inter- system montage of existing bids and offers that would be similar to what is now
provided in the United States by the Consolidated Quotation System -- the National Best Bid and Offer ("NBBO").
C. INTEGRATION OF MARKETS FOR TRADING
Several respondents to the Request for Comments pointed to the selection of models proposed by the TSE Special Committee on Market Fragmentation ( the
"Committee"). "Model B" envisioned that any electronic trading systems would connect to a Canadian exchange. Any orders or matched trades coming through
the system would be subject to the exchange's order display and trade matching protocols. In addition, orders coming from the NETS would be subject to
monitoring done by the exchange to manage timely disclosure policy, uncover insider trading and prevent manipulative practices.
Although the TSE has recommended moving forward with Model B immediately, existing NETS and PIAC (on behalf of major institutional investors) have
preferred to search for an arrangement that places NETS outside the orbit of the TSE or other existing trading SRO -- the Committee's "Model C". To define a
regulatory framework with such characteristics certain trading and regulatory issues must be addressed.
To staff, it appears that there are four issues to address (beyond disclosure of pre and post-trade information) in order to determine the degree of market
integration that the Commissions should order. Where there is more than one market to integrate, the issues would seem to be:
a) inter-market linkage;
b) trade-through protection;
c) secondary priority; and,
d) secondary priority by size of transaction or nature of counter party.
1. Inter-market Linkages
Even though many stocks are interlisted and some actually trade actively on more than one exchange, at the present time, competing markets in Canada are not
linked electronically. Present practice requires members handling an order in an interlisted stock to monitor all markets for the best execution opportunity. Most
monitoring remains visual, though some electronic monitoring is being introduced.
The potential addition to the Canadian market of one or more NETS invites re-examination of market linking through automation.
Should a bid or offer in one competing market be available for a transaction with participants in other systems? That is, should Exchanges and NETS be
electronically linked so that a participant in market A is able to reach into market B to effect an execution against bids or offers in market A?
How should the linkages be created and who should operate the system? For example, through exchanges or a new entity which could be independent of the
Commissions or operated by the Commissions.
At least a partial precedent for such linkage has been established in the U.S. where any NASD member can use NASDAQ's Selectnet facility to transact with a
bid or offer in an electronic communication network (such as Instinet).
2. Trade-through Protection
Assuming an inter-market linkage for trade execution, consideration should be given to having that linkage provide "trade-through protection". In other words,
should price priority be enforced between markets? Put another way, for a trade to be valid, must it be at a price that is between the inter-market bid-ask spread?
It has been suggested that a bid or offer in a NETS is created by an order that is purely the property of the investor that entered the order. This view holds that
the extent to which any information contained in the order is disclosed to others must be determined by the originator of the order. Equally, whether a bid or
offer is subject to inter-system execution and on what terms (minimum fill, all or none, any part) should also be determined by the originator.
It is important to note that the choices of the order originator are limited by the variety of facilities made available by the systems that compete to offer services.
Should a NETS (or an Exchange, for that matter) that does not participate in an inter-market linkage and agree to trade-through protection for the bids and
offers that have established better prices in other Canadian markets be permitted to operate in Canada? Is that an appropriate minimum standard? Again, how
should such a linkage be set up and who should operate it?
Should the choice of whether an order participates in inter-market transparency and order linkages be left to investors or should it depend on some objective
criteria such as the size of the order?
3. Secondary Priority
If the competing market systems are linked, is it advisable to adopt some form of secondary priority protocol for declared bids and offers in the market at the
same price whereby one side of a proposed cross may be "displaced" in whole or part by such prior orders?
Displacement entitlements, based on a secondary priority protocol, are intended to encourage investors to enter limit orders in order to compete to be the priority
bidder or offeror. The theoretical work of market-microstructure specialists predicts that such competition will lead to narrow spreads and more robust order
books and greater liquidity.
Discussions of displacement and secondary priority raise the issue of "quote matching" -- a practice whereby brokers with a matching buyer and seller can make
a "cross" at the same price as the best bid or offer in the market. Even though shares have traded at the same price, the order posting the best bid or offer does
not trade1.
There are diverse views on this subject. Some hold that the practice of quote matching is unfair to the bidders and offerors who "make the market" and
moreover, that it discourages investors and professional market makers from competing aggressively and even from bothering to enter orders.
Others hold that allowing crosses to be executed at previous bid or offer prices is an appropriate reward for the broker that either searched out a counter party
or provided the other side of the cross from his own inventory as principal. They note that putting together a large cross frequently involves significant work on
the part of a broker. They submit that the block market is unique and that large trades should not be interfered with by relatively small amounts that are typically
bid or offered in the market at the best bid or offer price. They see preferred treatment for crosses as providing liquidity and that the expeditious provision of
"immediacy", in the case of a principal trade, is a service that justifies any reduction in the attractiveness of participation in an Order Book by limit order traders.
In addition, those who favour quote matching point out that an exchange or NETS has very limited ability to enforce secondary priority against proposed
crosses, when a broker can simply move a proposed cross to a competing market where either quote matching is allowed, there is no pre-existing bid/offer at the
same price or non-standard trading prices are offered.
In the context of inter-market linking and integration, is it necessary for the Commissions to take a position on secondary priority and displacement?
4. Secondary Priority Limited by Size of Transaction or Nature of Counter Party
As noted above, certain respondents have submitted that the nature of a large cross may justify different treatment from that accorded to normal order flow. The
Toronto Stock Exchange has a by-law change currently out for comment [20 OSCB 6217 (November 21, 1997)]. It suggests that for listed securities,
agent-principal crosses ought not to be allowed on a quote matching basis if the bid-ask spread is more than one tick and the transaction is a principal trade for
5000 shares or less. The Vancouver Stock Exchange allows quote matching crosses only to the extent of 50% of the proposed cross irrespective of whether a
dealer is counter party on one side or the trade is agency on both sides. A respondent has suggested that a cross should be submitted to full displacement by the
existing bid/offer up to 10,000 shares.
Should the size of the cross and/or nature of the counter party be a consideration in determining the extent to which a secondary priority protocol be allowed to
displace of all or part of a proposed cross?
D. OTHER ISSUES
1. Minimum Price Variation ("tick size")
The academic literature suggests that tick size must be sufficiently large to make raising or lowering a bid/offer price a significant decision. Otherwise bidders
and offerors will find very little reward in entering orders and making the market.
First, if there is no standard tick size (or it is extremely small), any competing trader can better the existing best bid or offer by a tiny amount and, at very little
cost, become the priority trader. For persons wishing to have priority an insignificant tick size necessitates continual monitoring and adjustment of their prices.
It also means that secondary priority protocols providing for displacement on crosses becomes meaningless, as any price can simply be bettered by a fraction of a
cent per share and the cross completed.
In order to encourage participants to enter bids and offers and to protect the notion of secondary priority, should the Commissions be willing to set standard tick
sizes for a linked Canadian market?
2. Nature of Participants and Transactions in NETS
Should the Commissions have any concern about a NETS with a customer base that includes major Canadian and foreign investing institutions as subscribers
having as additional customers:
a) foreign brokers representing foreign investors;
b) foreign dealers that make markets in Canadian securities; or,
c) Canadian dealers making markets:
i) to institutions only;
ii) to institutions and foreign dealers; or,
iii) to other Canadian dealers.
Would a NETS be a permissible market through which Canadian brokers and dealers could report crosses? Does it make a difference to your answer whether or
not there is:
a) inter-market linking;
b) inter-market trade-through protection; or,
c) inter-market secondary priority?
Questions may be referred to:
Randee B. Pavalow
Policy Coordinator/Advisor
Ontario Securities Commission
(416) 593 - 8257
Hugh Cleland
Executive Director's Office
Ontario Securities Commission
(416) 593 - 8078
Joëlle Saint-Arnault
Chef du Bureau du President
Commission des Valeurs Mobilières
du Québec
514) 873 - 5009 Ext 237
Louyse Gauvin
Executive Assistant
British Columbia Securities Commission
(604) 899 - 6538
Eric Spink
Commissioner
Alberta Securities Commission
(403) 422- 1503
Marcel de la Gorgendière
Chairman
Saskatchewan Securities Commission
(306) 787 - 5645
Dated: February 27, 1998.
PUBLIC FORUM CONCERNING NETS AND MARKET FRAGMENTATION
PRESENTATION AND ATTENDANCE REQUEST FORM
Name(s):
Organization:
Business Address:
Business Telephone Number: ( )
Facsimile Number: ( )
Please Check One of the Following:
I/We Wish to Make a Presentation at the Public Forum
I/We Wish to Attend the Public Forum
Time Required for Presentation (maximum 60 minutes including questions):
Audio-Visual Requirements:
Please return completed form to:
The Commissions
c/o The Ontario Securities Commission
Suite 1800, Box 55
20 Queen Street West
Toronto, Ontario M5H 3S8
Telecopier: (416) 593-824
Attn: Randee Pavalow
Completed forms must be submitted by March 27, 1998.
SUMMARY OF COMMENTS RECEIVED
IN RESPONSE TO THE REQUEST
FOR COMMENTS CONCERNING
NON-SRO ELECTRONIC TRADING SYSTEMS
AND MARKET FRAGMENTATION 22-801
On May 16, 1997 the Ontario Securities Commission (the "OSC") published a request for comments and notice of forum concerning non-SRO electronic trading
systems ("NETS") and market fragmentation (the "Request for Comments"). A notice requesting comments on issues raised in the Request for Comments was
subsequently published by the Alberta Securities Commission ("ASC"), the British Columbia Securities Commission ("BCSC"), the Saskatchewan Securities
Commission ("SSC") and the Commission des valeurs mobilières du Quebec ("CVMQ") after the ASE, BCSC, CVMQ and the SSC (together with the OSC, the
"Commissions") notified the OSC that they were interested in participating in a joint public meeting on NETS.
The Commissions received a total of 12 submissions. Submissions were received from investment dealers, institutional investors, NETS owners/operators, stock
exchanges and one law firm.
Commenters
Of the commenters only the Pension Investment Association of Canada expressly stated its interest in making a presentation at the forum concerning NETS
regulation to be hosted by the Commissions in early 1998. However, each of McDermid St. Lawrence Securities Inc., the Toronto Stock Exchange , Versus
Technologies Inc. and Instinet indicated that they were interested in participating in any further discussions concerning the issues surrounding NETS.
General Comments
The following submissions do not address any one of the specific topics outlined in the Request for Comments but are general comments relating to markets and
market regulation.
- For the protection of the retail investor, the Commissions should give serious consideration to maintaining the health of the continuous auction markets.
- The Commissions should not address the issues of market fragmentation and NETS in isolation, but must first articulate a regulatory regime which addresses
the primary issues as an integrated whole in a manner that will benefit investors and sustain healthy Canadian capital markets. In doing so the Commissions must
keep in mind the guiding principles of regulation set out in the securities legislation to provide protection to investors from unfair, improper or fraudulent
practices and to foster fair and efficient capital markets and confidence in the capital markets.
- Any regulatory concerns regarding market fragmentation and transparency, should not focus on NETS alone. Absent material changes to the trading rules of
the exchanges, irrespective of the introduction of rules regarding NETS, Canadian equity markets will remain fragmented and non-transparent.
- Rules applicable to NETS should also apply to the dealers' upstairs trading desk, including the dealer's internal "off-exchange" order matching and
management facilities or services. This is necessary to ensure that the system of regulation operates as a cohesive, rational, and consistent whole.
A. THE NATURE, CAUSES AND IMPLICATION OF MARKET CONSOLIDATION/FRAGMENTATION UPON MARKET QUALITY
1. The Causes of Fragmentation
Several commenters provided submissions on the types and causes of market fragmentation. The following types of fragmentation were identified by the
commenters:
- the dispersal of the buying and selling interest among competing exchanges resulting from interlisting of securities;
- the "upstairs market" or the dispersal of buying and selling interest within a dealer's internal trading system; and,
- competing liquidity pools in the form of proprietary electronic trading systems.
Foreign Markets
One commenter attributed the dispersal of the buying and selling interest among competing exchanges to Canada's history of being dependant upon foreign
capital flows which leads naturally to the development of foreign secondary capital markets. This type of fragmentation, the commenter submitted, is probably
the least troublesome because it arises out of natural market forces. A second commenter stated that anonymous electronic access systems will attract capital to
those countries and exchanges which allow access directly or through broker guaranteed electronic networks because money managers find that transaction costs
are reduced.
One commenter noted a market should only be considered fragmented when real or artificial barriers prevent it from maximizing its performance in terms of
liquidity and price discovery and, absent artificial barriers, a market is not necessarily fragmented merely because it is not centralized at a single location. The
existence of more than one market access point is not synonymous with fragmentation nor is competition amongst market service providers so long as there is
unrestricted access to all market access points and consolidated market information.
Upstairs Market
A commenter submitted that the development of the "upstairs market" arose primarily out of two concurrent developments, the liberalization of the
agency/principal rule and the sweeping concentration of the brokerage industry as firms merged and/or were swept into the orbit of other financial institutions.
Another commenter noted that the exchange rules have accommodated the "upstairs market" but also attributed the evolution of that market to several other
factors including; the development of order management systems that facilitate the crossing of dealer orders, the development of internal order management
systems which facilitate internal crosses, the institutionalization of the marketplace, and the fee structure of the exchanges which makes upstairs trading more
economical than transacting through the central order book of an exchange.
2. The Impact of Fragmentation
Retail Market
One commenter noted that market fragmentation potentially impacts retail investors in a number of ways, some of which may be considered to be beneficial to
the retail investor. These include providing a choice of markets and currency in which to trade any particular security and potentially increasing the liquidity of
any particular stock. The commenter noted that while multiple markets may result in greater liquidity for any particular security, non-integration of price
discovery mechanisms may prohibit an investor from determining the best market for a particular security at any particular time and may derogate from the goal
of best execution. The commenter also submitted that the internalization of retail order flow denies the retail investor the greatest opportunity for price and time
priority protection without the offsetting benefit of confidentiality and anonymity. Finally, the commenter noted that it would be beneficial for retail investors if
all retail orders under a certain size received by a dealer were required to be automatically routed to the best market and not accumulated for internal execution.
Price Discovery and Viability of Order Book
One commenter noted that the internalization of orders has had a significant effect in reducing the visible liquidity of the central market place thereby
compromising short-run price discovery.
It was noted by one commenter that market fragmentation has many implications including the potential for inconsistent regulation among the growing number
of separate liquidity pools.
One commenter submitted that exchange rules regarding non-displacement of crosses and pro rata priority act as a disincentive for limit traders to place their
orders on the central book of the exchange. The commenter made two suggestions to increase the incentive for a trader to place limit orders in the book. The
first is to change the cross- interference rules to provide that crosses must improve on the best price to avoid interference. The second is to operate the book on
a strict price and time priority basis and to do away with the pro rata rule.
Innovation and Competition
Several commenters provided general responses to this topic. One stated that competition between exchanges would ensure ongoing innovation, enhanced
service levels, and improve cost efficiencies of markets in Canada. It would also allow for the ongoing development of different types of markets including
dealer/ market-maker markets, continuous agency auction markets and call markets and even though each of these types of markets has its disadvantages their
development is valuable as they offer the investor different types of services.
A second commenter submitted that absent a shift in regulatory focus towards encouraging competition and innovation, further fragmentation and a diminished
role for Canadian stock exchanges is inevitable. Fragmented markets tend to benefit intermediaries, while centralized markets tend to favour investors and
issuers. Regulators should concern themselves with the latters' interests; market forces should determine the formers'.
A third commenter noted that alternative trading systems are an opportunity to add new capabilities to a Canadian market system, provided that all of the
components of that system function within a coherent regulatory framework with a level playing field, with free access to the market and market information, and
with the innovation and price reduction benefits of true competition.
B. NETS, THEIR EFFECT ON FRAGMENTATION, RECONSOLIDATION OF MARKETS, AND OTHER ISSUES RELATED TO NETS
1. NETS and Currency
More than one Currency
One commenter stated that a significant priority of the Commissions should be to maximize the liquidity provided by exchanges in Canada regardless of currency
and that Canadian securities quoted in US dollars by a NETS or traditional exchanges in Canada could attract, by virtue of denomination, order flow from the
United States to Canada. While the commenter noted that the quoting of Canadian securities in both Canadian and US dollars could detrimentally affect visible
liquidity in those stocks on Canadian exchanges, it concluded that the benefits of quoting in both denominations outweigh the costs where fair foreign exchange
facilities are available.
One Currency
At the other end of the spectrum, one commenter stated that all prices must be expressed in a common form in all trading systems. Another commenter took a
similar view indicating that the same security in the same country should be quoted in a single currency to avoid the net effect of excessive fragmentation and loss
of liquidity. The customer should not have to deal with currency conversions, or different dealer rates or spreads in order to have true price discovery. The
comments also stated that Canadian listed securities should be quoted on a NETS in the same currency as that of the exchange where the security is listed.
Uniform Approach
One commenter did not provide an explicit view on the currency questions posed but made the general comment that the currency display requirement regarding
bids and offers and transaction reports should be uniform for all dealers and others, including exchanges, that offer "off-exchange" matching services in Canada.
2. NETS and Price Discovery
Integration with Exchanges
One commenter submitted that NETS should be conduits to the exchange on which the security is listed to ensure price discovery and order priority.
Treat the Same as Upstairs Markets - Require Disclosure
One commenter stated that intermediaries should be obliged to disclose fully and accurately all orders unless in receipt of contrary client instructions. Another
commenter submitted that the price matching parameters of off-exchange systems should be regulated to respect cross interference rules to ensure all market
participants of price priority which would require disclosure of the best order price within any particular NETS.
It was noted that unless the traditional upstairs market is subject to the same rules, a regulatory approach which requires full disclosure of order flow on NETS
would defeat the purpose of NETS from the perspective of the institutional investor. If order confidentiality and anonymity are not maintained, the purpose of
both the NETS and the "upstairs market" would be defeated.
Anonymity and Non-disclosure on Exchanges
Two commenters took the view that trades through NETS should be regulated in the same manner as the "upstairs market" which permits dealers to post crossed
block trades while maintaining the confidentiality and anonymity of the client orders.
One commenter expressed the view that the upstairs market may be appropriate for the negotiation stage of large orders. However, the commenter went on to
state that the upstairs market should not be used to avoid displacement of orders in the central market and client orders should not be accumulated and crossed in
the upstairs market in order to avoid exchange trading costs as the price could move away from the client in the interim.
One commenter submitted that inferior bids and offers on NETS should not be required to be displayed to non-NETS participants as long as NETS participants
are not permitted to trade through superior bids and offers existing on the consolidated market. A similar view was taken by another commenter who submitted
that if the "upstairs market" is to be preserved, it should be the client who decides whether a block quote should be published.
One commenter expressed the view that exchange systems can fairly and readily be adapted to meet investors' needs for anonymity and non-disclosure of broker
identification and size of order however, it questioned the need for such adaptation in light of its opinion that from a public interest perspective, there are very
few circumstances which warrant non-disclosure.
One commenter stated that market quality in respect of venture companies would be particularly adversely affected if the true market and its depth are not
consolidated and immediately disclosed. In its view, the public interest would not be served if the "inside market" for an actively traded security could not be
ascertained by investors.
The same view was taken by another commenter who submitted that there should be real time reporting of all pre-trade and post-trade information by all
competing trading systems. Another commenter stated that NETS should be required to post all trade information in a timely manner to ensure the information
is available to all market participants. It is unclear whether the commenter was referring to both pre-trade and post-trade information.
3. NETS and Reconsolidation of Fragmented Markets
Integration of Trading Activity with Exchanges
Three commenters took the view that NETS should be permitted to operate in Canada provided they become a member firm of a recognized Canadian exchange
and their trading activity is integrated with and subject to the rules of that exchange. One commenter noted that this would result in minimum fragmentation and
ensure optimization of the essential attributes of fair and efficient markets such as price priority, price discovery, transparency and liquidity while providing the
potential of attracting increased order flow.
One of the three commenters were of the view that integration with an exchange should be an interim measure and that NETS should eventually be entitled to
operate as entities separate and apart from an exchange subject to appropriate regulatory responses to certain issues including order visibility, order aggregation,
and market surveillance. A second of the commenters stated that it was not in a position to determine whether NETS should be permitted to operate apart from
exchanges until such time as a regulatory regime is determined.
One of the three commenters submitted that if NETS are allowed to operate in parallel to a traditional exchange for trading purposes, this will create further
market fragmentation and dilute the market.
A fourth commenter submitted that the public interest role of a SRO makes it incumbent upon them to accommodate alternative technology initiatives which
offer additional benefits to the investor. SROs should be prepared to welcome alliances with NETS and such alliances should be encouraged by the
establishment of a regulatory framework which puts both the SRO and NETS on a level playing field. The commenter stated further that there is no reason why
an SRO cannot integrate alternative trading facilities via the membership connection.
Independent Operation
One commenter submitted that NETS should be permitted to operate in parallel with exchanges and have the option of being regulated directly by the
Commission as an exchange or by an SRO as a dealer.
4. NETS and Nature of Integration with Traditional Exchanges
Consolidated Tape
Several commenters expressed the view that a consolidated tape should be instituted in Canada and that reporting trade information on such tape should be
mandatory. One of these commenters stated that all post-trade reports should be required to be reported on the consolidated tape.
It was noted that market transparency and market price discovery will be inhibited if trade reporting does not occur. However, the commenter stressed that if
Canadian transactions are permitted to be reported on foreign exchanges, the upstairs trading of all dealers might be reported in such a manner that those dealers
would be able to avoid Canadian exchange rules with respect to displacement of crossing transactions, trade reporting requirements and exchange trading costs
which would lead to diminished transparency and regulatory arbitrage.
Displacement
One commenter submitted that the retail investor would benefit if retail orders are immediately routed to the "best market" for any particular security thereby
preventing the internalization of order flow and ensuring the investor of the greatest opportunity for price and time priority protection. The commenter proposed
that orders above a particular size could be crossed in a NETS or in the "upstairs market".
A second commenter proposed linking the different markets to permit a "seamless" automatic routing of orders to the most competitive trading system (e.g.
lowest transaction cost) while respecting price priority among the competing trading systems. This commenter did not suggest restricting the requirement to
orders under a particular size.
It was also submitted that all trading systems (exchanges and NETS) that are regulated as exchanges should not be allowed to refuse the electronic routing of
orders to their respective marketplaces for immediate execution.
One commenter stated that any details of orders available to NETS participants should be available to all investors to enhance price discovery. In addition, all
investors, whether NETS participants or not, should be able to access the NETS liquidity pools to prevent trade throughs.
5. NETS and Functional Regulation
Participation by Registrants
The comments ranged from the suggestion that registrants be prohibited from trading on NETS and should be prohibited from establishing or maintaining a
NETS to the view that exchange members could be allowed to participate in NETS as long as they continue to be subject to the rules and regulation of their
particular SRO. The former submission suggested that such a prohibition would confine the trading activities of registrants to existing monitored trading
facilities. The latter commenter submitted that imposing restrictions on exchange members' participation in NETS would only encourage further fragmentation
of, and disruption to, the marketplace.
Another commenter took the view that NETS could be of two kinds: ones that are members of traditional exchanges and ones that become regulated as
exchanges. All investors (both institutional and retail) who wish to access exchanges (traditional exchanges, or NETS which become regulated as exchanges)
should be required to do so by transacting through registered investment dealers. Transacting through registered investment dealers puts responsibility on these
dealers to ensure that exchange regulations are followed with respect to all exchange trading, and that the interests of institutional and retail investors are
protected which goes to maintaining the integrity of the regulatory system.
Market Surveillance
Two commenters submitted that the current regulatory structure and the roles of the exchanges and commissions could be expanded to cover NETS and that
surveillance of NETS should be integrated with that of other systems to provide an overall picture of market activity. The exchanges have the infrastructure to
undertake, and should undertake, the market surveillance of all NETS. Surveillance by NETS of their own activity would not present a fair view of the market
and may create the opportunity for manipulative practices on any particular NETS. One of the commenters also stated that NETS should be required to assist the
exchange in exchange trading investigations. A third commenter diverged on the role of exchanges and submitted that supervision and surveillance of NETS
should be undertaken directly by the securities commissions to prevent the possibility of competitive misuse of regulatory authority.
Capacity and Integrity of System
One commenter submitted that as competition becomes the norm, it is reasonable to assume that customers will take the responsibility of ensuring the capacity
and integrity of the systems upon themselves, rather than relying upon regulators to determine and provide the requisite level of assurance. If regulators limited
their role to setting clear minimum standards for transaction processes, it is reasonable to anticipate the development of third-party surveillance firms, analogous
to credit rating agencies, to oversee and report on the integrity of trading systems.
6. NETS and Cross Border Securities Regulation
Home \Host Model
One comment addressing this issue provided that a SRO-sponsored ETS should be able to operate in a Canadian jurisdiction under a "home/host" regulatory
regime provided the commission in the Canadian jurisdiction is satisfied that home jurisdiction regulation meets certain standards for investor protection and
market integrity, that reciprocal information and enforcement agreements are in place, and that exchanges here have reciprocal access to the home foreign
jurisdiction.
A second commenter stated that provided the foreign institution or market intermediary is simply a client of a Canadian broker-sponsor of a NETS, there is no
registration issue arising in Canada. The Canadian broker-sponsor may face a registration requirement itself in the foreign jurisdiction. The situation is different
however for a foreign market intermediary wishing to utilize a NETS in Canada to act in the capacity of broker for a Canadian client as current restrictions
designed to preserve certain Canadian equity business to the Canadian broker would apply and therefore there is no need to revisit the registration regime
applicable to foreign market intermediaries.
The commenter submitted further that in respect of securities, while the means for qualifying securities for trading in the Canadian marketplace may always be
subject to change, they see no reason for introducing change to the existing regime for qualifying securities because of the present initiative. Under the existing
regime, assuming the adoption of an integrated approach to regulation, since NETS operators are brokers, and not markets per se, the securities qualification
requirement would have to be met in each jurisdiction in which trade activity is engaged in by the NETS operator.
Reciprocity
A commenter stated that a great deal of weight should be put on matters of reciprocity between jurisdictions and that concessions should not be granted to
foreign competitors unless Canadian regulators are aware of the positions of the reciprocal jurisdictions.
C. ROLE OF THE COMMISSIONS
Active Role for Commissions
One commenter submitted that the provincial securities commissions should assume the role of primary regulator in respect of "off-exchange" trading systems
offered to market participants to ensure that regulation is impartial and is not motivated by self interest or anti-competitive intent.
Industry Approach
One commenter suggested that while the integration of NETS could be achieved by commission rule-making, allowing the industry to devise appropriate
structures to achieve the objective would be preferable if the industry can comply within a reasonably short time frame. The commenter also added that the
Commissions should set objective operational standards for market centre operators, including a requirement for all bid/offers to meet in a price/time
environment, and then let them operate as they wish without extensive ex ante regulatory approvals. Regulatory oversight should be consolidated in a national
agency to minimize the harmful effects of duplication, regional competition and regulatory arbitrage.
The commenter stated further that technology and market forces, if allowed to evolve freely, will quickly create a range of different trading systems than those
offered by "traditional" markets and suggested that flexible "fair trading" rules that are strictly enforced are a more appropriate and achievable regulatory focus
than "uniform" regulation of market structures. The commenter stated that it wasn't apparent how a securities regulator's mandate is advanced by imposing
SRO requirements on alternative trading systems.
Public Goods
One commenter submitted that the presence of non-integrated NETS should not derogate from the "public goods" types of services provided by an exchange
and an acceptable cost sharing arrangement should be in place to prevent free- riding by NETS.
A second commenter submitted that in a non-integrated scenario it would not be appropriate for private NETS to compensate exchanges for their "public good"
type services. In their view, NETS will also be providing "pubic good" types of services for which they will not be compensated.
