Last month, some of the biggest players in the Canadian financial services industry, including the Royal Bank of Canada, Barclays Corporation, CI Investments Inc. and Winnipeg-based IGM Financial Inc., owner of Investors Group and Mackenzie Financial, announced their intention to start a new Canadian stock exchange.
The stated intention of Aequitas Innovations Inc., as the new entity is called, is a noble one -- restore the original purpose of an exchange, which is the efficient allocation of capital between issuers and investors.
There is much work left to do before a new exchange may start. The plan is to file a formal exchange-recognition application by the end of the year.
'There are mechanisms that Aequitas will bring that will help deal with some of the inefficiencies and some of the un-level advantages that certain market traders have'
The plan has many features that will define the so-called value proposition, but one of Aequitas's main motivations is to create a level playing field by neutralizing certain predatory high-frequency trading (HFT) strategies which Aequitas says are now compromising the integrity of the markets.
The proposal includes the idea for a trading platform that could provide a secondary trading vehicle for private equities or shares in small- and medium-size companies that have not traditionally had access to such public markets.
Scott Penman is the chief investment officer of Investors Group and has worked for the firm for 32 years. He is vice-chairman of Aequitas.
He sat down with the glow of terminals from Investors Group's trading floor in the background to discuss the high-tech world of HFT, the rationale for trying to start a new exchange and how Aequitas will use its own patented technology to fight back against the use of HFT for evil.
Free Press: Why is there a need for a new Canadian stock exchange?
Scott Penman: Take a step back, the Canadian marketplace -- actually every global market -- has a number of trading venues. The Canadian market has 11. Aequitas would be the 12th. It is dominated, however, by the TMX with 85 per cent market share in terms of trading volume. I guess first and foremost the creation of the Aequitas market exchange was to provide further competition. But in order to differentiate yourself, our value proposition has a number of important differentiating factors to any of the other trading venues, specifically around what is called the ecosystem, the overall trade process and the ordering and priority of trading calls.
FP: Why is IGM Financial interested in this?
SP: We have $125 billion in client assets under management, representing millions of Canadians' savings. If I drill down a bit and look at 2012 as an example, we traded more than $25 billion in Canadian equities between Investors Group and Mackenzie, representing about two billion shares in the Canadian marketplace. So we have a real interest in making sure that in the execution of those trades we are doing the very best for our clients. And again, taking a step back and considering what a stock exchange or market is -- it is an auction process; it brings buyers and sellers together. Unfortunately, there are some characteristics within the marketplace that exist today where it has not been as level a playing field. I do not want to leave anyone with the idea that markets do not have integrity; there is transparency around it. But there are mechanisms that Aequitas will bring that will help deal with some of the inefficiencies and some of the un-level advantages that certain market traders have.
FP: You're talking about high-frequency trading. How does it work?
SP: In the interest of creating liquidity, every day their activity is closed out. Every day they are buying and selling securities, but at the end of the day, they don't own any of those securities. They are shorting stock, buying stock, shorting stock, buying stock. That's compared to Investors Group, where we have a long-term interest. We are not buying stocks for 10 seconds or microseconds, we are buying for the long-term interest. HFT trading in Canada roughly accounts for about 35 per cent of the total market volume. In the U.S., there are studies that show an even greater amount -- up to 60 per cent. They are intense technology users. People design the technology, but there is not someone sitting at a desk watching the tape and offering stock picks -- computers are doing it. It is literally done faster than the blink of an eye.
FP: How does it disrupt trading?
SP: There are recognition patterns that the technology has created that will create trading activity. For instance, if I want to buy 100,000 shares within the auction process -- which is not uncommon, because we manage a large amount of money -- in some cases, with this (HFT) price-pattern recognition, as we go in to buy 100,000 shares, they (the HFT) will identify that a large institution is coming. The stock is trading at $10, the offering is at $10.01, and boom -- the HFT will come in and take out that 100,000-share offering at $10.01, bid at $10.01, have a 100,000-share offering at $10.02. The next thing you know, the stock is trading at 10.05. That is not true price determination; that is interference with price determination.
FP: What is Aequitas's proposal to deal with that?
SP: The best way to deal with it is to offer a competitive alternative where price discovery is purer. These HFT types of transactions with information advantages will not be allowed. Regulators in Canada actually made it a requirement where that type of activity -- where they are buying and selling every day and not going home owning any stock -- has to be electronically marked. We can't see it, you can't see it, but the exchange can see it. Because of that marking, we are actually able, through a patented process that Aequitas has developed, to flag that kind of activity. Those people will not be allowed into a portion of Aequitas's trading platforms.