The Ontario Securities Commission (OSC) has published a preliminary proposal for the alternative exchange being proposed by Toronto-based Aequitas Innovations Inc.

The OSC published a notice Tuesday setting out the exchange model that the company plans to introduce, and posing a series of preliminary regulatory questions. The notice indicates that OSC staff will review any proposal “within the context of the principles and objectives of the current regulatory framework” and the OSC’s mandate.

Aequitas is owned by a group institutional and retail brokers, pension funds, mutual funds and Canadian companies. Its founding investors include Barclays Corp. Ltd., CI Investments Inc., IGM Financial Inc. and RBC Dominion Securities.

At this stage, the Aequitas proposal is described as a pre-filing, which is generally a consultation with the regulator before it files a formal application. The OSC notes that before Aequitas receives recognition to operate as an exchange, it would be required to first file an application with the commission, and that there would be an additional public comment period.

The proposal indicates that the model will include distinct order books: dark, lit and hybrid, which will each trade Aequitas-listed, TSX-listed and TSX Venture-listed securities. Most of the unique aspects of the proposed model relate to the proposed hybrid book and the proposed market making program, it notes.

The notice indicates that the hybrid model raises questions due to the further segmentation of order flow it would introduce, along with fair access issues, and its potential impact on market quality and integrity. It says the model “raises questions for a number of fundamental principles underlying the current regulatory framework for visible and dark liquidity, most notably in relation to hybrid”. These issues arise primarily because the hybrid book “shares certain properties of both lit and dark books”, it notes.

According to the notice, the hybrid model will display and disseminate the aggregated volume of orders resting in the hybrid book on a price-by-price level for each price level; executions will occur only at, or within, the national best bid and offer (NBBO) established by other visible markets; any party can post passive liquidity in the hybrid book, but access to removing liquidity is restricted to orders that do not include the short-marking exempt marker (SME marker); the priority sequence for matching passive liquidity is price, broker, market maker, and weighted size/time.

It also notes that Aequitas “has indicated that certain parts of its market making program are central to the success of its model.” The notice says the market making program will allow direct access clients that are sponsored by a registered investment dealer to act as market makers; market makers will have some priority benefit in the dark and hybrid books; and, market makers may be provided additional compensation for meeting performance standards, which may include preferential trading fees. Additionally, the notice indicates that Aequitas intends to offer a “take-take” fee model, with low fees and additional discounts on active fees for retail trading networks.

The market maker aspect of the proposal also raises several issues, the notice suggests, including its proposals for market maker priority, and for allowing direct access clients to serve as market makers.

The notice is out for a 45-day comment period, which will end on Sept. 27.

Aequitas said that it will be conducting extensive industry outreach over the next 45 days to build awareness of the proposal and discuss possible solutions.

“The Ontario securities regulators have laid out a process through which everyone – whether investor, existing or future issuer, or dealer, small and large – should make their voice heard. The transformation of our industry and rebalancing of our public markets begins now,” said Jos Schmitt, CEO of Aequitas Innovations.

“We are developing a leading edge trading eco-system that provides effective options to long term investors who are currently disadvantaged by the dominant market model,” Schmitt added.

“We want to facilitate the role of committed market making – with clear benefits and responsibilities. We will discourage strategies that undermine market fairness and confidence and we want to offer a viable alternative to the rebate incentives and maker-taker pricing model, which have adversely impacted market quality. We have designed the foundations and are now eager to hear from various participants to ensure that we are building the right solutions.”