Canadian stock exchange operators TSX Group Inc. and Canadian Trading and Quotation System Inc. have settled a lawsuit concerning intellectual property, prompting suggestions that CNQ may co-operate with TSX on trading volumes in the future.

The April 10 settlement comes as traditional exchanges such as the TSX find themselves battling to preserve their markets in the face of rising competition from small but agile and technologically advanced new exchanges such as CNQ.

TSX filed the lawsuit against Toronto-based CNQ, which operates the Pure Trading exchange, with the Ontario Superior Court in July 2007. CNQ was accused of misusing TSX’s technical information — provided to CNQ but subject to a 2002 confidentiality agreement — in order to speed up the launch of Pure Trading in the Canadian market.

Under the settlement agreement, CNQ has acknowledged that TSX has intellectual property rights over the disputed technology and information; TSX has agreed to grant licences to Pure Trading for the continued use of the technology. No other terms of the settlement were revealed.

The rivals have also agreed to co-operate in areas related to market access and data delivery to “assist the Canadian securities industry in its efforts to adapt to the evolving multiple-market system,” according to a joint statement.

Specifically, the two exchanges have agreed that Pure Trading will provide its data feeds and supporting gateway access for TSX’s order-routing and other trading initiatives. For its part, TSX will provide its data feeds and supporting gateway access to Pure Trading, enabling the provision of order routing services for CNQ’s participating dealers.

CNQ will also supply the Pure Trading real-time data feeds, including full market depth, to TSX for inclusion in TSX’s Consolidated Data Feed product. “This new feed will be of important assistance to dealers and their clients in achieving best execution for trades in Canadian-listed equity securities,” says the joint statement.

“We believe it is in the best interest of the industry to have access to all marketplaces’ full depth of book,” says TSX interim co-CEO Rik Parkhill, “either directly or indirectly, to ensure best execution is obtained.”

“It is critical that the Canadian capital markets be free of distraction,” adds CNQ CEO Ian Bandeen, “as we collectively embark on the evolution to a more competitive multiple market system.”

Describing the settlement as a win for both exchanges, Bandeen believes “there’s a logic that at this stage in the evolution of the capital markets — we are working in concert with the TSX.”

As algorithmic trading spurs increases in Canadian trading volumes, Bandeen forecasts “a quantum increase” over the decade ahead, a prospect that has attracted a number of alternative trading systems like Pure Trading to test the waters in Canada.

According to TSX spokesman Steve Kee, three more such competitors are expected to enter the market along with Pure Trading.

“People in the U.S. are predicting a trebling in Canadian volumes over the next two years,” Bandeen says. “Personally, I’d be more comfortable suggesting a doubling.” In this environment, he adds, “A rising tide will lift all boats.”

According to a study by Boston-based Tower Group Inc. , a division of MasterCard Worldwide, algorithmic trading will push direct market-access trading (trading without broker intervention) to 38% of total buy-side flow by the end of 2008. In 2006, 27% of U.S. hedge fund trading and 16% of trading by large institutional investors flowed through algorithmic systems.

A recent IBM Corp. study suggests that around 40% of the trades made on the London Stock Exchange may now originate from algorithmic trading systems.

Joe Rosen, president of New Jersey-based RKA Inc. and formerly senior technology manager for the New York Stock Exchange, says algorithmic trading poses problems for traditional exchanges such as the TSX while opening opportunities for alternative trading systems such as Pure Trading.

In a market where automated trading systems are easily able to move among scores of exchanges and electronic trading venues to place orders — or slices of orders — around the globe, says Rosen, “The traditional exchanges are at a technological disadvantage.”

The drive to capitalize on margins offered by shifting currency valuations, split-second market lags or differences in transaction costs is changing the trading landscape by driving volumes to trading systems that offer highly specialized computer software innovations affording ultra-fast, ultra-responsive trading (which attracts algorithmic business) and deep discounts in trading prices. “This is probably not a good thing for the old-line exchanges,” Rosen argues. “Some of the exchanges are going to get killed.”

@page_break@Apart from anything else, Rosen notes, the traditional exchanges will have a tough time competing technologically with technologically advanced specialists. Instead, some exchanges, such as Nasdaq, have been buying up some of the pioneering electronic trading platforms that have threatened to poach large volumes of trading activity from mainstream exchanges. In a recent study, Rosen found: “The handful of larger exchanges that spend the time and money have so reduced the latency that members cannot keep up with them.”

At the TSX, Kee acknowledges no threat. That’s because algorithmic traders, he argues, will always favour highly liquid markets such as the TSX, which he says is investing heavily in speed and volume management technology.

“Our business is 99% of the Canadian market,” Kee says. “We’re in a competitive market, and we intend to compete.” IE