Many aspects of the exchange model being proposed by Aequitas Innovations Inc. are new or different from the way stock exchanges currently operate. Perhaps the most striking invention is the introduction of an entirely new animal: the proposed hybrid book.
At the heart of the Aequitas initiative is a proposal for a so-called “hybrid” market, which would borrow features from traditional lit markets, and the more recently popularized dark pools. Overall, the Aequitas model would include a lit market, a dark market and a hybrid combination of the two.
According to a notice from the Ontario Securities Commission (OSC) that details the proposal and sets out possible regulatory concerns, the proposed hybrid book would display liquidity that’s within the national best bid and offer, but would not provide pre-trade transparency for orders that are outside that range.
Although Aequitas’s lit book would offer a “maker taker” fee model, neither the dark market nor the hybrid would. Both the dark book and the hybrid would share the same matching priority, and only long-term investors would be able to take liquidity in these markets.
The OSC notice indicates that this proposed model gives rise to a number of regulatory concerns: it would further segment order flow; it could allow for orders to be “traded through” (meaning that orders with inferior prices may trade before visible, better-priced orders), which is something regulators have sought to eliminate; and that it appears to violate fair-access requirements by restricting liquidity-taking to long-term investors.
Aequitas has acknowledged the OSC’s concerns but maintains these clashes with the existing rules are justified in the service of the larger goals the model aims to achieve, such as curbing predatory trading and improving overall market quality and investor confidence.
A resolution may come down to the way in which you view the proposed hybrid market: as essentially a dark market that offers some incremental transparency, or as a lit market that limits access and reduces transparency by concealing some orders.
In a comment submitted on the OSC notice, market structure consultant David Lauer of Step Ahead Technologies LLC, suggests that by viewing the hybrid book primarily as a dark pool, it “can be seen as substantially enhancing price discovery by bridging the advantages of dark with those of lit.” However, if the hybrid book is viewed more as a restricted version of the traditional lit model, it is “questionable how successful such a model will be in reducing predatory trading strategies.”
The Canadian Advocacy Council for Canadian CFA Institute Societies views the hybrid book as largely a new sort of dark market. So, the proposed model’s orders don’t need to be protected against trade-throughs, and it shouldn’t have to adhere to the fair-access requirements that lit markets face. Ultimately, this comment concludes, the overall market would benefit from the introduction of this sort of innovation.
“We believe that the foreseeable benefits of hybrid for market participants will outweigh the foreseeable risks,” the CFA group’s comment says. “The main benefit is increased competition and lower costs, while we do not foresee any material new risks being added to the market.”
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