Republication of Market Regulation Fee Model

Transcription

1 Administrative Notice Request for Comments Please distribute internally to: Senior Management Finance Contact: Keith Persaud Senior Vice President, Finance and Administration April 14, 2011 Republication of Market Regulation Fee Model Executive Summary IIROC s Recognition Order requires that an integrated fee model be developed and submitted to the Canadian Securities Administrators ( CSA ) for approval. IIROC issued a Request for Comments with a proposed Dealer Regulation fee model in April 2010 (IIROC Notice ). On November 30, 2010, IIROC published for public comment a proposed Market Regulation fee model (IIROC Notice ). Commenters were generally supportive of the proposed Market Regulation fee model, but many commenters requested that the discount from Market Regulation fees for market makers be continued. IIROC is proposing to modify the proposed Market Regulation fee model to maintain the discount for market makers, consistent in scope and scale with the existing discount.

2 Proposed Market Regulation Fee Model IIROC Notice proposed the following structure for Market Regulation fees: a minimum monthly fee of $4,800 per Marketplace Member; a fee charged to each marketplace based on that marketplace s share of the total number of messages processed by IIROC s surveillance system during the month this component recovers the IT costs of the surveillance system; a fee charged to each marketplace based on that marketplace s share of the total number of trades during the month this component recovers all other regulation costs; and IIROC will continue to recover Marketplace-Specific Costs directly from the marketplace that incurs such costs. The rationale for each of these elements was set out in detail in IIROC Notice Commenters were generally supportive of the proposed Market Regulation fee model (see the attached summary of comments and IIROC responses), but many commenters requested that the discount from Market Regulation fees for market makers be continued. Market Maker Discount Market makers have a number of obligations in their stocks of responsibility, including maintaining a two-sided market, maintaining the bid-ask spread within a certain target range, assisting during the opening and with inquiries and anomalies, providing guaranteed fills for small orders and servicing odd lot orders. In exchange for assuming these obligations, market makers are entitled to direct benefits that include discounted trading fees charged by the marketplace for active trading and the right to participate in trades. Market makers also benefit from their status by attracting increased order flow for their stocks of responsibility because of their expert status in those stocks. The Universal Market Integrity Rules ( UMIR ) define the term Market Maker Obligations as follows: Market Maker Obligations means obligations imposed by Marketplace Rules on a member or user or a person employed by a member or user to guarantee: (a) a two-sided market for a particular security on a continuous or reasonably continuous basis; and IIROC Notice Administrative Notice Request for Comment Republication of Market Regulation Fee Model 2

3 (b) the execution of orders for the purchase or sale of a particular security which are less than a minimum number of units of the security as designated by the marketplace. Among marketplaces, only exchanges and Quotation and Trade Reporting Systems may have market makers as defined above. Currently, TSX and CNSX use market makers. Under the current IIROC Market Regulation fee model (which is based solely on shares traded), market makers receive a discount on trading activity in their stocks of responsibility: 70% of the volume of shares traded pursuant to market maker obligations is excluded from a Dealer Member s volume and the overall adjusted volume of IIROC-regulated marketplaces for the purposes of calculating the Market Regulation fee. The volume of shares traded on the other side of any trade involving a market maker is included in the calculation of overall total volume of shares traded. Presently, the average aggregate annual amount of the market maker discount is approximately $160,000. Commenters presented the following arguments in favour of retaining a market maker discount: market makers performance of their obligations provides liquidity, promotes price discovery, mitigates price volatility and supports order flow for retail investors; and removing the market maker discount may create an unintended incentive for Dealer Members to internalize order flow. IIROC agrees with these comments and proposes to retain the market maker discount on a similar scope and scale as the present discount. IIROC will apply the proposed market maker discount to the fee charged to each exchange based on that exchange s share of the total number of trades (the component by which IIROC recovers regulation costs other than IT costs). The number of trades by a market maker in its stock of responsibility will be discounted by 70%. The number of trades on the other side of any trade involving a market maker in its stock of responsibility will be included in the calculation of the overall total number of trades. IIROC does not believe it is appropriate to apply a discount to the fee charged to each exchange based on that exchange s share of the total number of messages processed by IIROC s surveillance system (the component by which IIROC recovers the IT costs of its surveillance system) as market making activity is not message-intensive, resulting in lower technology costs for such activity under the proposed model. IIROC Notice Administrative Notice Request for Comment Republication of Market Regulation Fee Model 3

4 Market makers so designated under the Marketplace Rules (as defined in UMIR) of any exchange that offers this feature will be entitled to the discount; that is, the discount will be limited to those Dealer Members that guarantee both a two-sided market for a particular security on a continuous or reasonably continuous basis, and the execution of orders for the purchase or sale of a particular security which are less than a minimum number of units of the security as designated by the marketplace. Impact of Revised Proposal on Dealer Members The table below outlines the impact of the market regulation fee proposal, as revised to incorporate the market maker discount described above, on current Dealer Members grouped by CIPF category: IT cost allocated by messages Participating Non IT cost allocated by :0% Orders 100% Trades Organization No Market Maker With Market Maker by CIPF Discount Discount % change Category Integrated Dealers Apr/ Mar/2010 w ith Capital >=$75 million $ 9,847,372 $ 9,875, % Retail Dealers Apr/ Mar/2010 w ith Capital < $5 million $ 703,165 $ 662, % Retail Dealers Apr/ Mar/2010 w ith Capital betw een $5 and $75 million $ 3,488,756 $ 3,381, % Institutional Dealers Apr/ Mar/2010 w ith Capital < $5 million $ 2,225,619 $ 2,253, % Institutional Dealers Apr/ Mar/2010 w ith Capital betw een $5 and $75 million $ 6,786,117 $ 6,878, % Under the Market Regulation fee model as proposed, 88% of Dealer Members that are market makers would have seen their Market Regulation fees decrease, even without the market maker discount. Maintaining the market maker discount will result in 92% of such firms seeing a decrease. The reason a small number of firms with market making activity did not see a fee decrease is likely due to market making being a small portion of their trading activity, and their remaining trading activity being message intensive. Additionally, maintenance of the market maker discount still results in approximately 25% of all dealer members who trade on marketplaces seeing a fee increase, and the remainder a fee decrease. Based on IIROC s analysis of historical trading data, the discount as applied to the number of trades will result in an aggregate annual discount roughly equal to the present average aggregate annual IIROC Notice Administrative Notice Request for Comment Republication of Market Regulation Fee Model 4

5 discount ($160,000), although the amount of the discount in any period will be dependant on the actual trading activity and IIROC costs that occur. Request for Comments IIROC seeks written comments on the proposed retention of the market maker discount within the proposed Market Regulation Fee Model. Comment letters should be delivered by May 13, 2011 (30 days from the publication date of this notice) addressed to the attention of: Keith Persaud Senior Vice President, Finance & Administration 121 King Street West, Suite 1600 Toronto, ON M5H 3T9 IIROC Notice Administrative Notice Request for Comment Republication of Market Regulation Fee Model 5

6 Appendix 1 Summary of Comments and IIROC Responses Market Maker Discount Impact on Inter-listed Stocks Several commenters requested the continuation of the market maker discount to recognize that performance of market makers obligations provides liquidity, promotes price discovery, mitigates price volatility and supports order flow for retail investors; and because removing the market maker discount may create an unintended incentive for Dealer Members to internalize order flow. One commenter argued that the proposed model will result in negative competitive positioning of Canadian markets with migration of order flow for inter-listed stocks to US markets. Asymmetrical costs for messages could reduce the quantity of shares traded in Canadian markets for these stocks when arbitrage strategies are employed. IIROC agrees with these commenters and proposes to maintain the market maker discount on the same scope and scale as the present discount IIROC notes that the concern expressed by the commenter is theoretical, as some market participants will enjoy lower trading costs under the proposed model. IIROC will monitor the impact of the new fee model on these and other measures, in order to make any adjustments that are necessary to address unintended consequences. However, IIROC also notes that US authorities are considering charging fees for orders, following the recommendation of a Joint CFTC-SEC Advisory Committee on Emerging Regulatory Issues that the SEC and CFTC explore ways to fairly allocate the costs imposed by high levels of order cancellations, including requiring a uniform fee across all Exchange markets that is assessed based on the average of order cancellations to actual transactions effected by a market participant. IIROC Notice Administrative Notice Request for Comment Republication of Market Regulation Fee Model 6

7 Impact on Liquidity Commenters suggested that the increased costs to liquidity providers would reduce orders and therefore impair price discovery reducing the depth and quality of Canadian markets. A further unintended consequence could be increased internalization of trading activity by Dealer Members. One commenter also suggested that the proposed model would (i) increase costs for issuers of high-priced, less liquid securities by widening spreads; (ii) subsidize less message-intensive marketplaces as regulatory costs will be lower in these venues; and (iii) provide no incentive for marketplaces or regulators to reduce surveillance costs. The proposed model is based on cost recovery, as required by IIROC s recognition orders, and within that framework is neutral as between liquidity providers and liquidity takers, with the same cost per message for each type of trade on each marketplace. It does not favour one trading strategy, message type or order-to-trade ratio over another. Increased costs to liquidity providers should be balanced by decreased costs from Dealer Members who experience fee reductions. Lower costs for less messageintensive marketplaces are an outcome of the model, but the cost per message is the same regardless of the marketplace. With respect to incentives to reduce surveillance costs, IIROC does not believe that the market regulation fee model is the best vehicle to control surveillance and other regulatory costs, although ensuring that surveillance is performed in the most cost-effective way possible is a critical priority for IIROC, which IIROC is pursuing through the STEP project and other initiatives. IIROC Notice Administrative Notice Request for Comment Republication of Market Regulation Fee Model 7

8 Impact on Dealer Members Impact on High- Frequency Traders ( HFT ) One commenter (a Dealer Member) argued that Dealer Members have no ability to control how their customers use marketplaces and therefore cannot control the related costs. On the other hand, another commenter (a marketplace) argued that Dealer Members, and not marketplaces, control the extent of messaging and trading activity. Two commenters noted that a messagebased fee is not aligned with the revenue model of Dealer Members, who charge on the basis of shares traded. Commenters noted that the proposed model shifts the burden of Market Regulation fees towards liquidity providers, including HFT. Commenters argued that HFT provide increased liquidity, reduction in spreads, acceleration in price discovery and reduction in market volatility, and that increased costs for HFT could lead these firms to leave Canadian markets or increase costs to investors in quoted prices, negatively affecting Canadian marketplaces and investors. IIROC believes that the correct level at which to calculate Market Regulation fees on a cost recovery basis is at the marketplace level, as this is the level for which data is most readily available (as opposed to tracking messages by Dealer Member, or Dealer Members clients). Furthermore, marketplaces are best positioned to provide incentives and disincentives for certain types of trading activity, through trading fees and other means. IIROC does not believe that Market Regulation fees must be aligned with a Dealer Member's or marketplace s revenue model. IIROC developed the proposed fee model to be neutral as between liquidity providers and liquidity takers, with the same cost per message for each type of trade on each marketplace. It is not intended to favour one trading strategy, message type or order-to-trade ratio over another. IIROC acknowledges that HFT could pass on cost increases in quoted prices. However, Dealer Members that experience a reduction in Market Regulation fees could pass that decrease on in quoted prices as well. IIROC will monitor the impact of the new fee model on these and other measures, in order to make any adjustments that are necessary to address unintended consequences. IIROC Notice Administrative Notice Request for Comment Republication of Market Regulation Fee Model 8

9 Message Types Alternative Approaches One commenter argued that message types should be distinguished for their contribution to price discovery and liquidity. One commenter suggested that IIROC should recover its technology costs through a surcharge by marketplaces on consumers of market data, and that this approach would ensure that all market participants pay their fair share of regulatory costs. The proposed fee model is intended to be neutral in its application as among messages and trading strategies, and IIROC believes that it would be difficult to develop a consensus view among market participants as to the messages that should be encouraged, and to administer such an approach on an ongoing basis. IIROC does not believe that the comment establishes a clear nexus between IIROC s IT costs and the consumers of market data, which would be required to comply with the principle of Fairness (i.e. fees should be based on usage or consumption of IIROC s regulatory services). In addition, Dealer Members raised concerns that the principles of Fairness and Transparency could be compromised by the billing practices of marketplaces. IIROC Notice Administrative Notice Request for Comment Republication of Market Regulation Fee Model 9

10 Minimum Monthly Marketplace Fee Guiding Principles and Cost Recovery Cost Recovery One commenter did not believe that any rationale was provided for the minimum monthly marketplace fee. One commenter argued that the proposed model does not follow the guiding principles of Fairness and Industry Competitiveness, and is not superior to the current model as the current model has been continuously refined. One commenter acknowledged that the proposed model would allow IIROC to continue to operate on a cost recovery basis in aggregate, but the commenter argued that the proposed model does not match fees with costs incurred, and that the objective of tying fees to the cost drivers of the regulatory activity is likely unachievable given the difficulties in matching any measures of trading activity with the actual costs of the regulatory activities undertaken by IIROC. The Request for Comments stated that IIROC determined the minimum monthly fee by combining (a) the minimum effort of approximately 25 hours per month for market regulation activities, multiplied by a fully-loaded hourly rate for the personnel resources required; and (b) third-party IT costs for hosting and connectivity. The guiding principle of Fairness requires that these demonstrated fixed costs of providing regulation services to a marketplace be recovered, regardless of the amount of trading activity on that marketplace. The last change to the Market Regulation fee model was in 2004 when the market maker discount was introduced by the predecessor organization Market Regulation Services Inc. The Market Regulation fee model has been static since then, despite the dramatic changes in trading patterns and market structure that have taken place. IIROC s cost driver analysis showed that the key drivers of our costs are messages for technology, and trades for other costs. Consequently, using these two cost drivers for billing market regulation costs helps IIROC to achieve a better match between costs and fees. IIROC Notice Administrative Notice Request for Comment Republication of Market Regulation Fee Model 10

11 Disparate Treatment of Marketplaces Cost Drivers One commenter argued that the proposed model displays a bias in favour of TSX Venture, which will see its Market Regulation fee reduced without a reduction in IIROC s Market Regulation staff in Vancouver. Two commenters disagreed with the use of messages to allocate IT costs on the basis that the commenters did not believe that all IT costs are correlated to messages. The connection drawn by the commenter between the Market Regulation fee charged to TSX Venture and Market Regulation staff in IIROC s Vancouver office is misguided. The responsibilities of Market Regulation staff in IIROC s Vancouver office go beyond the regulation of trading activity on TSX Venture, and include the monitoring of trading activity in TSX Venture stocks on all marketplaces, as well as trade desk reviews for Dealer Members headquartered in British Columbia. Increased message traffic is a tangible driver of IIROC s IT costs insofar as it leads to a need to increase the capacity of IIROC s surveillance systems capacity. Marketplaces are forecasting further increases in message volumes which will eventually exceed the present ability of IIROC s surveillance system to perform real-time surveillance. IIROC is therefore investing in its surveillance system to increase its processing capacity from 400 million messages daily to 1 billion messages daily. The guiding principle of Fairness suggests that a Dealer Member s Market Regulation fee should be based on its usage or consumption of regulatory resources. IIROC Notice Administrative Notice Request for Comment Republication of Market Regulation Fee Model 11