Hedge funds will play a role in determining which of the new alternative trading systems will succeed and survive, as each ATS tries to find its market niche and steal market share from the Toronto Stock Exchange.

“Once you have multiple trading systems, you have arbitrage opportunities or efficiency opportunities,” says Phil Schmitt, chairman of the Toronto-based Canadian chapter of the Alternative Invest-ment Management Association. “Hedge funds do love that space.”

There are now nine ATSes in Canada, five of which are already operating, while four will be launched in the coming months. The latter group includes Project Alpha, the alternative marketplace backed by Canada’s biggest brokerage houses and the CPP Investment Board; and ATX, an alternative system being developed by TSX Group Inc.

Although dwarfed in size by the large pension and institutional funds, and representing a small portion of the overall trading business in Canada, hedge funds are seen to be key players on the “buy” side and will probably factor into the future of Canadian ATSes.

“Hedge funds are the adapters of innovation in the marketplace,” Schmitt says. “If there is something to be gained [from the new ATSes], it’s likely that hedge funds will be the first ones to figure it out.”

Industry insiders agree that hedge funds represent a growing segment of trading business. They also say that the new ATSes will give hedge fund managers more flexibility to develop and execute investment strategies.

“More ATSes will create more competition, more and varied sources of liquidity,” says Chris Jackson, executive vice president of sales and marketing for Toronto-based Perimeter Financial Corp. “That gives anyone who wants to trade an opportunity for more creative or complex trading strategies.”

Perimeter Financial operates BlockBook, a two-year-old ATS that allows traders to trade large equity positions anonymously. Perimeter also plans to launch Omega, an ATS that will focus on speed and low cost for smaller retail orders, by the end of this year.

Jackson notes that hedge funds can differ greatly from one another in investment style. Some, for example, use active trading strategies; others take longer-term positions. Therefore, each might be attracted to one or another ATS for any given strategy or trade, depending on their need for speed, low price or anonymity.

“Hedge funds generally have their own strategies — and keeping them private is crucial to their success,” Jackson says.

Most industry insiders believe Canada is undergoing unprecedented transformation in the exchange marketplace. After decades of status quo, the past several years have seen the consolidation of the Canadian exchange industry to just two major players, TSX Group and the Montreal Exchange, and the public listing of both those exchanges. Now a number of ATSes have emerged, each one targeting its own particular part of the trading market.

“We’re on the verge of massive change in trading,” says Jackson, who adds that it’s now easier for interested backers to get an ATS up and running. “The regulators understand these things more and the technology is better, more flexible and faster. The costs are significantly less than two years ago.”

In the U.S., ATSes began to pop up in the late 1990s and were able to steal significant market share from the New York Stock Exchange. However, after the dot-com bust of the early 2000s, consolidation of several of these alternative marketplaces occurred.

No one can be certain of how things will play out in Canada, where the market is significantly different from that in the U.S. For example, whereas the NYSE was slow to incorporate technological innovations — making it susceptible to competition — the TSX has been aggressive in adopting new technologies and lowering trading fees. Still, many believe Canadian ATSes will be successful in either hiving off some of the TSX’s business or enlarging the trading business overall.

“The alternative marketplace as a group will take off and go mainstream in Canada in 2008,” says Jackie Chung, president and founder of Toronto-based research firm Competitive Metrics Inc. “Hedge funds, like other buy-side institutions, are contributing to this development in their search for liquidity to get trades done.”

ATS executives are also bullish on the new exchanges’ prospects.

“We think, overall, the liquidity numbers will rise because of competitors entering the marketplace,” Jackson says. “We’re not slicing up a finite pie; we’re slicing up a pie that’s increasing in size.”

@page_break@The industry has been ready for ATSes for some time. “Large buy-side accounts in Canada have been waiting for alternative marketplaces. We’ve lagged behind,” says Ian Bandeen, vice chairman and CEO of Pure Trading, an ATS launched in August after several delays. “The more viable, accessible, well-run alternative platforms, the better buy-side institutions can mask their order flow by spreading it over a plethora of venues.”

Pure Trading, a subsidiary of Toronto-based Canadian Trading and Quotation System Inc. (which also operates a junior equity market called CNQ), is a visible auction market that offers trading of 23 TSX-listed stocks as of Oct. 31. It plans to offer trading in all TSX-listed equities eventually.

“We’ve had exceptionally good take-up,” Bandeen says.

Other Canadian ATSes include Liquidnet Canada Inc. , which launched in October 2006, and Match Now, which launched in July 2007. Both are based in Toronto but are owned by U.S.-based firms. Also coming from the U.S. is Instinet LLP, which plans to launch Instinet Canada Cross, or ICX, by the end of 2007.

Jackson believes the ATS marketplace will follow the same expansion and contraction process common to other businesses: “Eventually there will be consolidation. Whether that will be two, three or five years down the road, who knows?” IE