A new report from ITG Canada Corp. finds that the introduction of new rules on dark pools has had no real impact on market quality, or trading costs, but has benefited high-frequency traders (HFT) at the expense of retail dealers.

In October 2012, new trading rules took effect that were designed to protect small investors from the effects of the growth in dark liquidity, while allowing large, institutional traders to continue to utilize these facilities. The Canadian Securities Administrators (CSA) and the Investment Industry Regulatory Organization of Canada (IIROC) adopted a new regulatory framework for dark orders that requires that visible orders take priority over dark orders on the same marketplace at the same price; and, that smaller orders receive a minimum level of price improvement in order to trade with a dark order.

In a new report, ITG (which operates the Match Now dark pool through subsidiary TriAct Canada Marketplace LP) aims to analyze the impact of those rules, and concludes, “there is little to no evidence that new dark rules significantly impacted trading costs or market quality since their implementation last October.”

It examines measures of market volatility, volume, spreads and transaction costs; and compares post-rule implementation Canadian data with the similar U.S. market metrics. And, generally concludes that there are no significant changes in those relationships since the rules were adopted.

“While it is less satisfying to do this style of analysis and find no evidence of change, we believe that the correct conclusion is that the dark rules have not had a noticeable impact on trading costs in Canada for the average user. It may be the case that some strategies are winners and some are losers, but the aggregate trading performance was not impacted as a result of the change,” it says.

Indeed, the report suggests that HFTs have likely benefited from the change, while retail brokers have suffered, as volume has migrated from dark pools to lit alternatives. It reports that before the new rules, Alpha’s dark pool, IntraSpread, had a market share of approximately 4.5%, which immediately dropped to about 0.3%. Most of this migrated to Alpha’s lit book, which has notably higher fees, it notes.

Based on April trading data, the report estimates that this shift represents “an annualized increase in active trading fees of roughly $9 million.” And, it suggests that more than 50% of the passive flow interacted with high frequency prop strategies, boosting the passive rebates they receive. “At day’s end, the retail brokers have seen an annualized trading cost increase to the tune of $9 million, the HFT community has gained a passive credit windfall of just under $4 million,” it says.

“While these increased exchange fees may appear inconsequential to some, one must consider that IntraSpread was effectively castrated in its infancy and unable to grow in a manner that would have increased the cost efficiencies,” it says, adding that, while Match Now hasn’t seen a similar loss of market share, “it is reasonable to suspect their growth since October has been slower than would otherwise have been the case and thus, they too have not been able to deliver as much savings to retail brokers due to this rule.”

Ultimately, it questions the wisdom of these rules. “While pundits around the globe have hailed the new Canadian rules as the panacea of market structure, a serious analysis of the data leaves us far from convinced,” the report concludes. “The dark rules have limited the trading options available to professional traders charged with a best execution obligation, and done nothing to improve overall market quality or reduce market impact costs. The benefits of the new rules have been largely enjoyed by the lit exchanges and their favoured high frequency clientele, with no demonstrable upside for natural investors or reduction in systemic risk.”

It cautions regulators in other markets from following the Canadian example, noting that if similar rules were implemented in U.S. markets, “we expect the exchange cost impact would be a large multiple of that seen in Canada.”