TSX trader watches the actionCHRIS YOUNG
Money managers around the world are worried about the implications of high frequency trading but nowhere more so than in Canada.
That's what marketplace provider Liquidnet found by surveying its clients around the globe.
"It's the No. 1 concern among investors around the world but it's highest in Canada," says Seth Merrin, Liquidnet's founder and chief executive.
Why? Perhaps because, as Mr. Merrin said, Canada's market is the "blockiest" in the world -- meaning it's dominated by large institutions trading big blocks of stocks. Institutions trading big blocks are manna for HFTs, which use sophisticated computer programs to look for signs of a block in the marketplace and try to profit trading against it. For example, if there's a big block for sale, that's likely to drive down the price of a stock, and HFTs try to get in front of the trade.
Canadians "have been used to trading blocks," Mr. Merrin said, and HFT is at "direct odds" with people trading blocks.
It could also be that Canada has been relatively late to get hit by the HFT wave, but it's definitely hitting now.
Estimates vary, but some traders say that as much as 35 per cent of volume on Canadian stock markets is now generated by high frequency trading firms that are jumping in and out of markets with buy and sell orders in hopes of profiting from tiny inefficiencies. In the U.S., some estimates place the amount of volume generated by HFTs at 60 per cent of all trading.
Liquidnet's business is built on trying to keep blocks off the visible stock markets, so that big traders can buy and sell amongst themselves without exposing their orders to HFTs by posting bids or offers on an exchange.
The company operates what's called a dark pool, where blocks can trade with little information leaking. Liquidnet has 26 members in Canada that utilize its trading service.
Canadian regulators are grappling with what to do about dark pools. Who should be allowed to trade on them, and on what terms? While dark pools do allow money managers to avoid high frequency traders, they can also sap volume from stock markets, eroding their value as a place for others to trade. Too many dark pools is most definitely not a good thing. In the U.S., so much trading takes place away from stock markets that what's left on the public markets like NYSE and Nasdaq is "the exhaust," as Mr. Merrin puts it.
Mr. Merrin argues that Liquidnet provides a service that is required for big orders (the average trade on Liquidnet is 70,000 shares) and that "not all dark pools are created equal."
The implication is that dark pools shouldn't allow small orders, and shouldn't be just ways for brokerages to avoid fees on their order flow. They should be reserved truly for orders that can't be efficiently traded in light markets.
"We're feeling more confident that they do understand the needs of our customers," Mr. Merrin said.