High frequency trading (HFT) and other practices by which traders are leveraging financial and technological advantages for their own gain, are harming small- and mid-cap companies as well as retail and institutional investors, Jos Schmitt, president of Aequitas Innovations Inc. told a meeting of the Economic Club of Canada in Toronto Monday.
Aequitas is in the process of launching an alternative stock exchange to be called the Aequitas Neo Exchange, currently making its way through the regulatory hoops. Backed by a group of the country’s largest firms, including Royal Bank of Canada, BCE Inc., CI Financial Corp. (all of Toronto) and IG Investment Management Ltd. of Winnipeg, the new exchange is hoping to be open for business next year.
“Currently, it is a major problem for small and mid-size companies to raise capital,” Schmitt said. “It is difficult for investors to find liquidity, and who wants to sit in a company for nine years?”
To help small and mid-size issuers and their investors, Aequitas plans to build a private securities platform separate from the exchange to raise needed funding for smaller companies. Only accredited and other qualified investors will be authorized to participate, thereby limiting the marketplace for these higher risk companies to risk-tolerant investors, Schmitt said. The platform will allow companies looking for funding to hook up with investors looking for opportunities, even if the company is based in Ontario and the investors may be in British Columbia, he said.
“We will complement this fund-raising service with a secondary private securities trading platform that will provide these investors with liquidity and transparency,” Schmitt said. “We will do this by acknowledging and embracing the critical role played by dealers, not by enabling disintermediation.”
Debate about such issues as HFT and the “sound bites” that are emanating from it, are stoking a fundamental distrust of the financial industry and a belief that stock markets are stacked against investors, Schmitt said.
“Isn’t it mind-boggling and very telling, that after almost two years now of bullish markets, the retail investor is still only tip-toeing in our markets?” he said.
A practice particularly harmful to long-term investors is technological front running, a predatory HFT tactic that leverages preferential access to information through faster communication networks and internal processing capabilities, he said.
“Long-term investors, remember them?” he said. “They allocate capital to build personal financial security, they provide firms with the means to develop and contribute to economic growth and employment. They are the heart of the markets. It is their confidence that we should be striving to gain.”
He says this kind of damaging predatory trading is also squeezing out legitimate market makers who are committed to liquidity provision, “and they are taking their real and very essential liquidity with them.”
“Let me tell you, issuers are starting to realize something is wrong, particularly the small and mid-sized companies,” he said. “They realize that as a consequence of high frequency trading, the erosion of committed market making and the investor confidence crisis, liquidity is concentrating more and more on a sub-set of large cap stocks, which are already liquid.”
He added that as a result of ongoing cost pressures in the industry, dealers are reducing sales support and research when it comes to small and mid-size companies, despite their critical role in sustaining active markets.
“Companies going public are failing at increasing rates as more deals are withdrawn or priced below their initial filing range, and trading below their offer price,” he said.
Aequitas’ solutions include using order routing technology to protect clients from parties taking advantage of the different speeds at which the marketplace processes orders, as well as providing a “dark pool” to facilitate trading of large orders while minimizing information leakage.