Since the international fi-nancial crisis and stock market crash of 2008, markets have staged a

series of rallies and retreats, and observers could be for-given for thinking that the system has more or less re-turned to normal. That air of normalcy, however, masks a concern about today’s mar-kets: Investor confidence that was shaken by the financial crisis and has yet to return to pre-crisis levels.

The loss of investor confi-dence has been highlighted in a number of recent investor surveys that question the fair-ness of the current system, even during “strong” markets. Trust in current markets has been eroded by market dy-namics that appear to favour sophisticated computer-based high-frequency trading (HFT) system operators (famously featured in the business best-seller Flash Boys) and their role in inexplicable market failures such as the 2010 “flash crash”.

The erosion of investor confidence means that some will sit on the sidelines while others will risk less of their assets in equity markets than

they would otherwise. That is not just a potential lost opportunity for investors; that timidity will affect the entire Canadian economy as public companies will find it more difficult or expensive to raise capital to fund or expand their operations. As well, it will negatively affect employment and wealth creation.

“The average person should care because, for the most part, a lot of them are indirect-

ly participating in the market through their RRSPs, pension plans, their own investment counselling services,” says Eric Sprott, chief executive and CIO, Sprott Asset Man-agement of Toronto. “They [will] realize that they are dis-advantaged [compared with] the HFT — because each day we all lose pennies, and those pennies add up at the end

of the year when you are los-ing that kind of money in this kind of trading.”

Sprott adds that high-fre-quency trading “totally dis-torts what is really going on in the financial world” with some estimates attributing as much as 30% to 50% of a mar-ket’s volume to high-frequency trading, in which sophisticat-ed investors skim small prof-its by quickly dipping in and out of markets at the expense of other investors.

“Why couldn’t we just get a market where we can see there are real buyers and sell-ers and what the real volume is,” says Sprott, “instead of having these in-between guys clipping pennies all the time and making it look like it is so much more robust than it really is.”

One logical response to the emergence of high-frequency trading and its effects would be to try to curb related preda-tory strategies.

That is one of the key oper-ating principles of Aequitas Innovations Inc., which will in mid-March begin operat-ing the new Aequitas NEO Exchange to rival the Toronto Stock Exchange.

See MARKETS on Page SC7

How to raise investor confidence

helping issuers regain momentumInvestment industry experts such as Perry Dellelce see a need to tackle avariety of issues that have posed problems for companies trying to acquirethe cash they need for growth and stability. One of those issues: red tape. SC7

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B y t h e h o n o u r a B l e M i c h a e l M. W i l s o n

The first stock exchange, when it launched in Canada more than 160 years ago, had a sim-ple purpose: to bring together investors looking to build wealth with companies look-ing to raise money for growth. This focus offered endless promise, allowing companies to grow and prosper.

It was the engine that drove the Canadian economy, creat-ing new wealth, prosperity and jobs for all Canadians. More importantly, it laid the foundation for our country’s entrepreneurial spirit, fos-tering innovation that drove growth.

Companies prospered, Can-adians prospered, Canada prospered.

But over the years, exchan-ges in Canada and abroad began to lose sight of their core purpose in a quest to boost short-term profits. Un-fortunately, this ultimately led to them putting the needs of a few before the needs of many, creating an imbalance in the governance of exchanges. The impact this had on investor confidence was significant, particularly when things such as the economic crisis also came to bear on the market. Even substantial improve-ments in the markets since the financial crisis have not been enough to restore investor confidence.

See CONFIDENCE on Page SC3

Why restoring investor

confidence is vital to us all

Canada finds itself at the fore-front of a new wave of stock exchanges and a push for in-creased focus on fairness and transparency for investors, fol-lowing the recent regulatory approval of Canada’s newest stock exchange, the Aequitas NEO Exchange.

Aequitas, which will com-pete with the country’s estab-lished stock platforms and whose goal is to curb the im-pact of harmful industry prac-tices associated with high- frequency trading, was grant-ed approval to begin oper-ations in March by the Ontario Securities Commission.

The impending launch of Aequitas will see Canada join the United States and Eur-ope as jurisdictions that have welcomed new markets that promise to change the way that securities are bought and sold.

“If you look at the indus-try and equity marketplaces overall, I think there is a clear acknowledgement by many market stakeholders that we have issues,” says Jos Schmitt, president and chief executive officer of the Aequitas NEO Exchange.

“They relate to the fairness of the market, they relate to the liquidity of the market, they relate to the transparency of the market — and all of that is impacting not only investor confidence but also the appe-tite of capital-raising compan-ies to go public.”

In the United States, the investor-led struggle against high-frequency trading has resulted in the creation of IEX Inc., billed as a “fair-access” equity trading venue owned by a group of large buy-side investors such as mutual funds and hedge funds, as well as, very recently, the Luminex initiative. Meanwhile, Europe has witnessed new initiatives, similar in nature, such as Plato Partnership Ltd .

“We see the emergence of a new type of marketplace and Aequitas, of course, is one of them — IEX in the U.S. is an-other one, along with Project Plato in Europe — that seek to create an environment that places the investor and issuer first again,” says Schmitt.

The Aequitas chief says a key difference between his exchange and existing trading platforms is how it views its role as intermediary between investors and securities issu-ers. “We have to remember why we’re here, the critical role we play in helping com-panies to find capital and in helping investors to create and generate wealth, and bring those two together in the most efficient way.”

Given the trading volume that high-frequency traders are credited with generating, traditional exchanges might view them as market makers that could support new, smaller issuers.

See EXCHANGES on Page SC6

Canada sets pace for new exchanges

SC2 nationalpost.com NATIONAL POST, ThurSdAy, JANuAry 29, 2015SC2 nationalpost.com NATIONAL POST, ThurSdAy, JANuAry 29, 2015

This secTion was produced by posTmedia works on behalf of aequiTas neo exchange inc. for commercial purposes. posTmedia’s ediTorial deparTmenTs had no involvemenT in The creaTion of This conTenT.

it’s only reasonable for investors to know if they are dealing with an advisor or if they’re dealing

with an exchange, when they execute your transaction how much that exchange is being paid and

by whom, and does somebody have access to that information before other people do

— john o’connell, chief executive officer, davis rea ltd..

There isn’t enough transpar-ency around the fees investors pay to participate in equity markets, and that lack of clar-ity is creating a level of hesita-tion that’s difficult to shake, says John O’Connell, chief executive of davis rea Ltd.

despite a big rebound in markets since the 2008 fi-nancial crisis, too many re-tail investors remain on the sidelines because “they don’t know who to believe,” says O’Connell, whose firm focuses on managing the portfolios of individual, long-term clients.

“They’re getting conflict-ing messages and informa-tion all the time and they just decided they can’t afford to take the kinds of hits that they’ve taken.”

dark pools and high-fre-quency traders have further muddled a landscape already struggling to come to terms with the Toronto Stock Ex-change’s focus on creating value for shareholders as a public entity, which can run counter to the needs of indi-vidual investors looking to buy and sell stock in the easi-est, most cost-effective way.

And while firms such as davis rea are regulated by the Ontario Securities Commis-

sion and must adhere to the highest fiduciary standards, there can be discrepancies in the regulation of different investment firms and a lack of information around who is actually profiting from invest-or fees in different situations.

“The Toronto Stock Ex-change, the way it’s operating right now, is kind of saying — ‘hey, give me your money so I can make fees and oh, by the way, we’ll buy and sell stocks for you.’ It’s backwards,” O’Connell says.

“It’s only reasonable for investors to know if they’re dealing with an advisor or if they’re dealing with an exchange, when they exe-cute your transaction how much that exchange is being paid and by whom, and does somebody have access to that information before other people do.”

Some progress is being made with the roll-out of the second phase of Client rela-tionship Model (CrM II), he adds, noting it will help reduce the current level “of regulatory arbitrage that exists out there and the amount that the large financial institutions want to control that regulatory environment for their benefit.”

New exchanges such as the Aequitas NEO Exchange, which received regulatory ap-proval in November and is set to launch in March of this

year, will also add an element of competition to equity mar-kets and prompt the TSX to make some changes, he says.

In response to the arrival of the Aequitas NEO Exchange, TMX Group, which runs the Toronto market, has already announced plans to introduce “speed bumps” as well as a market for privately held com-panies, two ideas Aequitas had previously proposed. however, upon closer inspec-tion the facts are showing that the TMX solutions are again driven by the interests of a select few and themselves.

The changes the Aequitas NEO Exchange proposes to level the playing field are cru-cial for investor confidence, O’Connell says, but they have positive impacts beyond Bay Street as well.

“It’s a burden on Canada to think that we have a lot of people who are not investing their money; they’re earn-ing low, low deposit rates by having the money sitting in a bank [and] not saving for retirement.”

fee structure needs transparency

Investors are increasingly interested in understanding how their assets are man-aged, and their trust in cap-ital markets is expected to grow as efforts to standardize reporting and improve com-munication ramp up, says Katie Walmsley, president of the Portfolio Management Association of Canada.

“If you look at reasons for lack of confidence or lack of trust [in the markets among investors] and causes of that, you could, in many cases, at-tribute it to a lack of under-standing of how their in-vestments are doing or not understanding the material that’s being presented to them,” she says.

“Given some of the mar-ket volatility that’s happened since [the downturn of ] ’08, they’re realizing they need to be clear on what their goals are.”

Portfolio managers who deal with the assets of clients, pensions and endowments, as well as individual and insti-tutional investors, generally start off from a high level of trust and confidence in their money managers.

This occurs because in these relationships clients hand over much of the deci-

sion-making and do not get involved with the day-to-day management of assets.

There’s actually been in-creased interest in profession-al help among investors who have grown tired of trying to stay current with the ups and downs of volatile markets, says Walmsley, but overall in-vestor sentiment is still not as high as it could be.

PMAC remains positive, however. A commitment to greater transparency from regulators in Canada and the united States, as well as the advent of new trading venues, such as the Aequitas NEO Exchange, are expected to help keep markets open and create good liquidity.

The Aequitas NEO Ex-change is structured differ-ently from the Toronto Stock Exchange, which handles most of the country’s trading volume, because it includes safeguards to discourage pred-atory high-frequency trading while allowing more investor input and lower fees.

Also important is the rollout of the second phase of the Client relationship Model (CrM II). CrM II is designed to help investors figure out how well they’re moving toward their invest-ment goals and to make sure they get genuinely trans-parent reporting, no mat-ter what type of investment manager or broker they are

dealing with — or who the manager or broker is regu-lated by.

CrM II came into effect last year and is being phased in over a three-year period with new requirements for reporting to clients about the costs and performance of their investments, as well as the content of their accounts.

“It’s a very positive de-velopment that I think is go-ing to go a long way to ensur-ing communication between investment advisors and their clients is going to be better,” says Walmsley.

Those changes should also help overall confidence, she adds, and address the needs of investors at all levels.

“They’re recognizing there is risk in the equity markets, and they need to understand what that risk is and what their investments are in,” she says.

“They want to be clear that their investment manager is managing that portfolio in line with their comfort level.”

Equity markets need to create more direct ways to list and trade securities in order to increase the amount of liquid-ity available to investors, ac-cording to John Ing, president and chief executive of Maison Placements Canada.

“Markets need two things: One is liquidity and the second is trust, and if you can’t trust what you are doing on the screens it behooves you to look at how you can gain that liquidity and that trust,” Ing says.

But as the order types, fee structures and technological solutions developed by the TMX Group, which owns the Toronto Stock Exchange, be-come increasingly geared toward the needs of high-fre-quency traders, the average, long-term investors are being driven away.

And while high-frequency traders may inject temporary liquidity into the markets, that algorithmic trading that moves hFTs frequently in and out of short-term pos-itions in fractions of a second doesn’ t ac tua l ly create any real, long-term capital investment.

It can, instead, prevent nat-ural, longer-term purchases from taking place.

“The retail client [has been] the worst casualty because their small orders would be very much canni-balized, and notwithstanding what the Ontario Securities Commission and the rest of the regulators were trying to do, they were easy prey for a lot of these high-frequency and algorithmic trading,” Ing says.

Some institutional invest-ors and brokers responded to frustration over volatility and “fictitious” trades by set-ting up their own electronic networks, or dark pools, he notes, and while the move was understandably done in self-defence it ended up adding to the multitude of platforms institutions can now trade in.

That level of fragmenta-tion has made markets too complex for many investors, and it has also taken away the sense that natural buyers and sellers can gather in one marketplace to create actual liquidity instead of trying to compete with hFT firms that give a false impression of it, Ing says.

“Our capi ta l marke ts [now] have more and more layers of rules, regulations,

pay for play — all in the hope of encouraging trading, but it’s been an inhibitor of trad-ing.”

Those regulations also make it more difficult for small companies to raise money or get listed on ex-changes such as the TSX Ven-ture Exchange, even though providing listing services and allowing start-ups to raise capital are the what capital markets were set up to facili-tate, Ing says.

Equity markets won’t work, he adds, unless they are built around a model that makes room for all the players — no matter how big, rich or slow they are.

“The small dealers, the boutiques, have always been the backbone of the industry. They are the ones in which you get the formation of strat-egies to innovative financing,” Ing says.

“In an environment of indi-vidual investors, not all things fit all people.”

A more efficient system for trading would help investors feel more secure about stay-ing in the markets and help defuse the battle for liquidity between long-term investors and high-frequency traders, says the chief executive of ITG Canada.

The current structure that gives traders with the fast-est connectivity the ability to capture trades first, making orders unavailable to long-er-term investors or forcing them to pay more for the same product, has created a layer of unnecessary intermediation that’s making investors feel like the markets are trying to “pull a fast one” on them, says ITG’s Nick Thadaney, whose brokerage trades on behalf of large institutional clients.

“When intermediation makes up 50%-plus of the market, that’s a problem.”

Investors rattled by a ser-ies of events, from the 2008 downturn to the flash crash of May 2010, aren’t finding enough comfort in the recent measures announced by ma-jor players such as the Toronto Stock Exchange to try to ad-dress market issues.

That’s causing tighter li-

quidity because retail invest-ors — and even some institu-tional ones — are staying away from the markets, and that kind of hesitation isn’t only hurting the financial sector but entities across the econ-omy as well.

“If it’s harder [for small companies] to raise money and pursue innovation, then you don’t have as many jobs, you don’t have the free flow of capital. It’s a vicious circle,” Thadaney says.

And while current markets are still funding that kind of innovation, the system “is not as efficient as it could be.”

Thadaney, who supports Aequitas Innovations Inc.’s proposal to create the new Aequitas NEO Exchange and sits on the company’s board, says the new exchange’s focus on long-term investor rep-resentation and its focus on open and efficient markets would go a long way toward restoring confidence.

The Aequitas NEO Ex-change is looking to bring issuers and investors together in the most cost-effective way, shifting incentives away from the volume of trading, in a structure that is designed to address some of the problems critics see with the TSX, which they say is more focused on in-creasing fees and profits than on meeting the needs of their

stakeholders (corporate issu-ers, investors and brokers).

Supporters of the new ex-change also hope it will cre-ate an ongoing conversation around what the markets need to function well into the future, and even drive some changes.

Earlier this year, the TMX Group, owner of the TSX, set up TSX Private Markets to help small private companies raise money as they seek to become public companies — an idea Aequitas had previ-ously put forth.

“Part of this is about being a positive agent of change, and we strongly feel that with the right intentions and the right stakeholders around the table, we’re going to have the right level of engagement and, ergo, the right outcomes for the investor and the broader marketplace as a whole,” says Thadaney. “And if you have the right outcomes for the in-vestor, all the other things will fall into place.”

Experts from various sectors were asked for their perspective on the current state of investor confidence — what the confidence level is like today; the implications of that confidence level; what needs to be done to achieve the optimum confidence level.

gauging investor confidencev o i c e s a t t h e t a b l e

retail buy-side

John O’Connell, Davis Rea Ltd.

Katie Walmsley, Portfolio Management Association of

Canada

smart investors want the details

buy-side association

more direct route would aid activitysmall dealer

John Ing, Maison Placements Canada

trading system needs efficiencieslarge dealer

Nick Thadaney, ITG Canada

NATIONAL POST, ThurSdAy, JANuAry 29, 2015 nationalpost.com SC3NATIONAL POST, ThurSdAy, JANuAry 29, 2015 nationalpost.com SC3

everybody’s playing to the intermediary crowd, they’re creating new order types, they’re adding in some

technology that allows the fastest players to have an advantage. these guys who are laser-focused on the

minutiae of market structures gain an advantage and ... profit off it, even though some of them take very

limited risk and are not really adding a lot of service to the marketplace — doug clark, itg canada

canadian equity markets have become so complex and fragmented that they no longer fulfill their ori-

ginal purpose of serving in-vestors, and experts say that’s making too many players un-easy about buying and selling securities.

“Everybody’s playing to the intermediary crowd, they’re creating new order types, they’re adding in some tech-nology that allows the fastest players to have an advantage,” says doug Clark, managing director of research at ITG Canada, a brokerage that trades on behalf of large insti-tutional clients.

“These guys who are laser-focused on the minutiae of market structure gain an ad-vantage and are allowed to profit off it, even though some of them are taking very limit-ed risk and are not really add-ing a whole lot of service to the marketplace.”

The big change for the stock market came when the TSX, which hosts the majority of Canada’s activity, went public in the early 2000s.

The change was part of a global trend that saw most major markets go public, but it meant that instead of work-ing as member-owned util-

ities ensuring fair and orderly trade between natural buyers and sellers, stock exchanges became for-profit entities interested in creating value for their own shareholders.

“you started seeing a dif-ferent approach to how they ran their businesses,” Clark says. “No longer were they interested in making sure natural buyers and sellers matched quickly; there was an interest in how to create extra mediation.”

Order types and data feeds began being traded on mul-tiple marketplaces, as the TSX itself went from one venue to three — the TSX, Alpha and TMX Select — after it was pur-chased in 2012 by the Maple Group, a consortium made up of Canada’s largest banks and pension funds.

The merger allowed the TMX Group to offer trading and listing as well as clearing and settlement, and created extra fragmentation without competition.

“you end up creating more trading even though the actual end-of-day trading between long-term buyers and sellers hasn’t fluctuated all that much, but it gives them more volume, gives them greater revenue, gives them, at the end of day, greater profits,” Clark says.

Since 2008, markets have additionally had to contend with a proliferation of high-frequency traders who per-formed high-volume trades and who, at times, prevented trades by long-term investors from happening.

The impact of hFTs was lar-ger in the united States than in Canada, partly because of this country’s fair-access rules, its level of transparency of pricing and rules around how dark pools can operate.

But rob Peters, chairman of Black diamond Land & Cattle Company Ltd., a private

investment company with in-terests in real estate develop-ment, ranching and energy investments, says many of the conflicts that arose out of the u.S. market structure are still a problem for Canada.

“you have some high-fre-quency traders who are clip-ping the thing for something like an eighth of a cent be-cause they have more infor-mation, and instant informa-tion, on bids and offers and

they can play against that,” he says.

“People with more know-ledge in one area are taking advantage of the normal, day-to-day movements of the stock market.”

When much of the hFT community was ramping up in Canada in 2008, the TSX got rid of its user advisory panel, where buy-side and sell-side traders used to come together once a quarter to dis-cuss the issues in the market — another move that did little to help investors feel like their interests were top of mind.

“The honesty is really so important in our business — people are relying on their brokers or their banks to be fair, and we have seen that there’s been a lot of regula-tory criticism of what is going on within some of these oper-ations,” Peters says.

In the united States, trad-ing-venue IEX was established to counter some of the frustra-tions that resulted from the increase in high-frequency

trading and to address issues around predatory hFTs.

But as Clark points out, de-spite the creation of alternate trading venues such as Chi-X Canada, Pure Trading and Omega to compete with the TSX in Canada, the main ex-change hasn’t faced any real competition.

The latest player set to join this landscape is Aequitas Innovations Inc.’s Aequitas NEO Exchange, set to go live in March of this year. That ex-change, which received regu-latory approval in November, is promising to cater to long-term investors and to give them board representation.

It’s an exchange Peters is supportive of because, he says, it is “simple and clean.”

“I think the reason people would go [to Aequitas] is that they feel that it would be handled a little better than the TSX — these people are offering up a very classic, old model that worked very, very well for years, with no conflict of interest,” says Peters.

“Going back to what stock-brokers were, it was all very clear-cut. you put in an order and you get a fair and straight commission on it.”

Exchanges such as the one Aequitas is proposing are also significant for the market

landscape because a differ-ent business model will get people’s attention, says Clark.

“you can see the TSX is already doing things in prep-aration for Aequitas, even though they don’t react at all when Chi-X makes any sort of announcement,” he says, noting that the TMX Group recently announced plans to introduce a “speed bump” and launched a private- market trading platform.

“Chi-X has roughly 20% market share, [yet] when they do a pricing announce-ment or new order types, the TSX rarely reacts to it because they don’t see Chi-X as actually having the oppor-tunity to steal much more of the market share; there’s nothing different or unique about them.”

Similarly, he notes, IEX has less than 1% market share in the united States, but it is changing the way that market-places are talking about their facilities and how they’re engaging with their clients.

“If you are unique, you may not be very big but you offer the optionality of being explosive, because you truly are disrupting in a significant fashion as opposed to just try-ing to copy somebody’s busi-ness model.”

We need to bring them back. We need to restore confidence in our markets. It is fundamen-tal to what we do. It lies at the heart of this business. how do we restore confidence? We re-focus once again on the origin-al purpose of an exchange. We put the needs of many before the needs of a few.

To restore confidence and

re-engage investors, we need to leverage technology and market structure innovation with trading platforms that level the playing field and bring demonstrable fairness back to trading.

To make the market more appealing for investors, and issuers, we need to facilitate meaningful liquidity and, as a result, provide more investment opportunities by both discour-aging predatory hFT strategies and by re-invigorating formal

market makers with the tools they need to be successful.

To encourage more invest-ment we need to respond to the lack of transparency in the markets today by offer-ing information on a timely and comprehensive basis to all participants — particularly retail investors and their ad-visors — by promoting trans-parency in order handling and by providing a low-cost, high-quality market data solution to tackle the current anti-com-

petitive market data offering.By addressing these press-

ing market issues of fairness, liquidity and transparency affecting investor confidence, the financial industry can and will regain the trust of investors.

At this pivotal time in our industry’s evolution, I am hon-oured to be a member of the Aequitas board of directors. All of the founding sharehold-ers of Aequitas are committed to ensuring that these issues

are addressed by maintaining an equal balance in our board and shareholder base between buy-side investors and issuers on the one hand, and sell-side firms on the other.

Creating this balance is fun-damental to the success of the Aequitas NEO Exchange, and key to helping restore investor confidence.

Michael M. Wilson is chair-man, Barclays Capital Canada Inc., a member of the board of directors of Aequitas Innova-tions Inc., and former federal finance minister with the Pro-gressive Conservative govern-ment of Brian Mulroney.

investor confidence must be restoredconf id en c e

continued from page sc1

Michael M. Wilson

fresh approach will help ease uncertainties that have arisen over canadian equity markets

evolving to better serve investorsThe Canadian marketplace has faced a variety of upheavals that have caused uncertainty among investors and created a landscape that is in need of remedy, experts say.

the honesty is really so important in our business

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CHICAGO NEW YORK

2014 (AUGUST)

TORONTO

TMX ACQUIRES MICROWAVE NETWORK LINKING MARKETS IN TORONTO, NEW YORK,

AND CHICAGO.

The 2014 numbers are only getting worse, with 11% of all observable orders lasting less than 1 millisecond.

The 2014 numbers are only getting worse, with 11% of all observable orders lasting less than 1 millisecond.

Between 2010 and 2014, hundreds of millions of dollars have been invested to reduce the time for a message to go back and forward between Chicago and New York by 6 milliseconds… the time it takes to blink your eyes is about 400 milliseconds.

Between 2010 and 2014, hundreds of millions of dollars have been invested to reduce the time for a message to go back and forward between Chicago and New York by 6 milliseconds… the time it takes to blink your eyes is about 400 milliseconds.

The average holding period for a security today is calculated in seconds, not days, months or years.

In 2013, 90% of all observable orders in the Canadian marketplace lasted for less than one minute, 50% for less than 1 second and 20% for less than 10 milliseconds.

The average holding period for a security today is calculated in seconds, not days, months or years.

In 2013, 90% of all observable orders in the Canadian marketplace lasted for less than one minute, 50% for less than 1 second and 20% for less than 10 milliseconds.

NEW YORK AND CHICAGO, AMERICA’S TWO GREAT TRADING CENTRES, ARE 720 MILES APART AS THE PHOTON FLIES — ABOUT 3.9 MILLISECONDS AT THE SPEED OF LIGHT. BUT VARIATIONS IN TRANSMISSION TECHNOLOGY OR HOW LONG THE ROUTE IS CAN MAKE MILLIONS OF DOLLARS’ WORTH OF DIFFERENCE TO

HIGH-FREQUENCY TRADERS. — Katie M. Palmer

THE TECHNOLOGICAL ARMS RACECERTAIN MARKET PARTICIPANTS LEVERAGE A TECHNOLOGICAL ADVANTAGE TO DEPLOY PREDATORY

STRATEGIES THAT CAN IMPACT INVESTOR CONFIDENCE

2010 (AUGUST)13.1 MILLISECONDS

2012 (JULY)9 MILLISECONDS

2012 (DECEMBER)8.5 MILLISECONDS

200014.5 MILLISECONDS

THE EVOLUTION OF THE ARMS RACE — THE LENGTH OF TIME FOR INFORMATION TO FLOW BETWEEN CHICAGO AND NEW YORK

720 MILES / 3.9 MILLISECONDS @THE SPEED OF LIGHT

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The human brain has always been obsessed with tech-nology, because advances in technology create ad-

vances in culture, civilization and personal longevity.

When our ancestors first learned how to create and control fire they could stay warm, protect themselves from predators and enemies, and carry out their work in what were previously cold and dark hours.

The advent of the print-ing press in the 15th century helped spread knowledge throughout the world, quickly and affordably.

And nuc lear f i s s ion , achieved last century, brought the promise of clean, abun-dant energy.

however, for every positive or constructive use we find for new technology, we usu-ally find a negative or destruc-tive one, too. The use of fire as a weapon, printing presses as disseminators of hate litera-ture and highly lethal nuclear bombs all demonstrate the negative side of major techno-logical advances.

The same applies to technol-ogy in the world of financial markets, where advances are

happening with greater speed than it has ever before.

“Technology has changed dramatically over the last 25 years,” says Karl Ottywill, chief operating officer of Aequitas NEO Exchange Inc. “And the rate of change today is far great-er than it ever was before.”

Mack Gill, CEO at Millen-niumIT, which supplies soft-ware and infrastructure for the soon-to-launch Aequitas NEO Exchange, agreed that technological changes have been dramatic over the past two decades.

“We’ve gone from main-frames to client server tech-nology in the 1990s, which was a massive step forward in terms of lowering costs and speed of development,” says Gill, a Canadian based in Sri Lanka, where Millen-nium, owned by the London Stock Exchange Group, is headquartered. “For the past 10 years we’ve been entering a new phase: widespread use of the cloud and a whole new range of infrastructure to support IT.”

For Gill, the best word to describe technology today is “agile.”

“It used to be that people were locked into very large,

very expensive, very long-cycle technology products,” Gill says. “What we have today is the ability to have much faster turnarounds and more cus-tomization. Basically, we’ve become more agile.”

One of the most-talked-about technological advances in the financial world is the speed at which trades can now be made. The technology that once levelled the playing field and allowed individuals on home computers and retail traders to compete with insti-tutional traders tilted in the past few years to benefit the big players.

Those entities with access to the most sophisticated technology were able to beat the others to a trade by only a few milliseconds, locking in at better prices than those who were slower to complete their trades. And, just like the nuclear arms race between na-tions, high-frequency traders and their technology suppli-ers began racing to decrease trade times to gain advantages over each other and smaller players, often using speed to anticipate and get ahead of another trader’s order, in what some call predatory high- frequency trading.

But just as many people concluded that the nuclear arms race was a no-win situa-tion, many financial industry insiders recognize that the quest for ever-faster trades — or lower latency speeds be-tween starting and finishing a trade — is not a productive way forward.

“I refer to it as a race to zero,” says Ottywill. “It is a bit futile: how far do you go and how close to zero do you want to get? It gets to the point where it’s ridiculous, where everybody is trying to gain that extra micro-second to get out ahead of everybody else.”

Instead of pursuing that unwinnable race, which makes no sense in terms of our market structure ap-proach, Ottywill and Aequitas are using the latest technol-ogy in other ways: to level the playing field and protect the long-term investor.

“A lot of folks started saying, ‘Instead of trying to get this race to zero, let’s just try to sta-bilize performance and make it deterministic,’ ” Ottywill says. “We’d rather offer consistent behaviour that prioritizes the long-term investor.”

Millennium’s Gill predicted that latency will continue to

decrease, but agreed that’s no longer the major draw for traders evaluating different exchanges.

“you want to have a market that is taking good care of its ultimate clients —institutional investors and retail investors — by being fair and transpar-ent,” Gill says.

To that end, some of the most advanced technology today is being used to equal-ize trade opportunities. The Aequitas NEO Exchange, for instance, will prioritize long-term investors and incorpor-ate a “speed bump” that will slow down high-frequency traders.

We know from experience that as long as humans exist, technology will continue to evolve. And the current state of technology in the financial markets offers some clues about what we can expect in the future.

Ottywill predicts technology will evolve to further equalize trading opportunities, build-ing on what Aequitas and some others in the industry are already doing.

he also sees technology be-ing used more widely across the industry to enable private markets, which is another

project his company is already working on.

“In the next five to 10 years you’ll start to see more and more private securities trading, or companies that are using centralized private facilities to raise capital and to allow for secondary trading between their investors,” Ottywill says.

Gill also predicts that future advancements in technology will aim to promote transpar-ency and fairness.

“There are different ap-proaches and different mod-els,” he says. “you’ll see a lot of trial balloons over different exchanges over time.”

But he also predicts an in-crease in the use of technology focusing on compliance and risk management.

“That’s another angle to market fairness: making sure you have a strong compliance framework in place,” Gill contends.

“you need to be tracking massive data sets and looking at correlations and being able to have alerts on certain types of market behaviour, because you want to make sure certain things aren’t happening in your marketplace. I think that will be a big focus for the next few years.”

“The view of many exchan-ges was, ‘do we really need market makers when hFTs are filling the role?’ But they are not, because their focus is mainly on active larger-cap securities, of which we don’t have many in Canada.”

The Aequitas chief notes that in the discussions and meetings he had prior to the formation of the rival stock exchange, he was told by both private and publicly listed businesses that they saw less

and less reason to go or stay public. “The most common re-action that we picked up was, ‘the cost/benefit ratio of go-ing public is no longer justify-ing it, we see the costs and the impact on our organization but we don’t see the liquidity benefit anymore.’”

The consequence of fewer Canadian companies willing or able to tap public mar-kets for capital shows up in slower economic growth and employment, lost tax revenue and, potentially, the failure of those businesses if they are unable to tap other sources of investment.

The lack of reliable sources of capital for the country’s small and medium-sized businesses is a major con-cern of david Allan, a for-mer governor of the Toronto Stock Exchange and current executive chairman of bio-technology development company AvidBiologics Inc. “As an issuer I have found the Toronto Stock Exchange to be a very poor portal for access to capital in terms of how it conducts itself.”

Allan, an investment in-dustry veteran, was also the founding and sunset chair-man of the Toronto Stock Ex-

change’s market access imple-mentation committee that cre-ated improved access to public capital for small and medium-sized companies.

“Since that time, the TSX has regressed in terms of its interest in fostering and promoting capital forma-tion. It doesn’t talk about it, it doesn’t get out there, it doesn’t enthuse on behalf of SMEs, which are driving growth of the economy.”

“They don’t advocate any-thing other than ‘how do we run a profitable stock ex-change,’ ” adds Allan. “Ever since the demutualization of

the TSX, it has become strict-ly another business. There’s a dramatically different at-titude inside the TSX than there was before, and I think that everything I have seen and heard firsthand from Aequitas is that their consti-tution of shareholders really re-mutualizes, if you like, the concept of the exchange.”

Andreas Park, an associ-ate professor of economics and finance with the univer-sity of Toronto and a visit-ing professor at Copenhagen Business School, believes Aequitas’s approach, which seeks support from market participants, benefits Can-adian companies looking to go public in ensuring the smooth functioning of the secondary market. “I think

what Aequitas has in mind as a model … is broadly sup-ported by institutional in-vestors, so you have OMErS on board with it and also major brokerages like rBC on board with it.”

Park believes that the launch of the Aequitas ex-change in March may also not be a bad thing for the TMX Group Inc., which cur-rently has about a 74% share of trading across its exchan-ges that include the Toronto Stock Exchange, the TSX Venture Exchange and the Alpha Exchange.

“It may actually benefit the TSX,” notes Park. “Aequitas adds an interesting option and may attract additional trading activity and listings to the Canadian market.”

Businesses felt abandoned by system

Progress across the board: The speed and agility that advancing technology has brought to everyday life is equally felt in the financial investment world.

despiTe The ineviTaBle seTBacks along The way, Technology BenefiTs The financial markeTs

accentuating the techno-positives

eXchange s continued from page sc1

Aequitas NEO Exchange Inc. successfully completed its first industry test weekend on Jan. 24-25. “We are very thankful to all those who participated,” said Jos Schmitt, president/CEO, Aequitas NEO Exchange Inc. “It allowed us to assess the state of readiness and robustness of our various technol-ogy systems and operational procedures, and I am pleased to report the results were positive. This is a testament to the

quality of the MillenniumIT trading platform our Exchange will be using, and to the diligent work of the entire NEO Ex-change team and its partners.” Activ Financial, Integrated Transaction Systems (ITS), IrESS, Thomson reuters and ITG Canada were among the test participants. “This first industry test went smoothly,” added Nick Thadaney, CEO of ITG Canada. “This is not surprising, as we have been very

impressed by the timeliness and quality of work produced by the Aequitas team so far. ITG is excited to be one of the first dealers to participate in a test weekend and we are eager to get going.” The Aequitas NEO Exchange remains on track to launch its trading platform in latter March. It will conduct additional industry test weekends in the production environment leading up to the launch.

aequitas neo exchange completes successful industry test weekend ahead of its march 2015 trading launch

NATIONAL POST, ThurSdAy, JANuAry 29, 2015 nationalpost.com SC7NATIONAL POST, ThurSdAy, JANuAry 29, 2015 nationalpost.com SC7

Market watchers know that despite the rebound over the past six years, many investors are behaving as though they are still in crisis mode: in-vesting with caution or keeping their money on the sidelines altogether.

But there’s another, less-talked-about crisis of confi-dence in the investing world, and it’s among the issuers.

Peter Schwartz, chairman of private equity and merchant banking firm Laurence Cap-ital Corp., says many small and medium-sized companies lack confidence in their ability to raise capital in today’s markets.

“If you were to compare the number of growth-company CEOs in Canada today com-pared to 15 years ago who would say, ‘I’m clearly planning a public offering, and here’s my path,’ I think there would be a dramatic difference,” says Schwartz, who is also chairman and founder of demure Oper-ating Company, a business-to-business platform for the travel market. “I think there’s a level of comprehension there about what some of the key limit-ing issues are, and it’s not just market cycle, as we might have all thought in the past.”

Our stOck exchanges tOday

One of those limiting issues, according to Schwartz, is the recognition that the existing stock exchanges in Canada — especially the TSXV — are not the right places to raise money to fund growth right now.

“The exchange isn’t the kind of exchange that it needs to be,” says Schwartz, citing high-frequency trading as just one of the major deterrents. “There are a lot of late-stage private-growth company entrepre-neurs out there who just don’t see this as something they wake up in the morning wanting to deal with.”

david Allan, executive chair-man at well-known biotech companies yM BioSciences and Stem Cell Therapeutics, agrees, adding that Toronto’s venture exchange is simply not hospit-able to new issuers.

“The TSXV is antagonistic, in my opinion, to issuers,” says Allan, who worked with former

Ontario Premier Bill davis to overhaul the Toronto Stock Exchange about 40 years ago, when it was, he says, “an old boys club” concentrating on blue-chip stocks.

“My take on it is that the weakness in the stock ex-change, after becoming a pub-lic company, is that it does not think about its mandate and its importance in the economic cycle,” Allan says.

“The stock exchange does not embrace the small and medium-sized market.”

On top of that, he says, when it comes to “encouraging access to capital, encouraging investment, getting out there and proselytizing, describing to the community why capital markets are important,” the Toronto exchange is “thunder-ingly silent.”

Perry dellelce, managing partner at corporate finance law firm Wildeboer dellelce, adds that overly strict regula-tions serve to compound the problems.

“There’s a lack of confidence in the ability of a company to raise financing and to com-plete a transaction in the small to mid-cap space, for sure,” he says, pointing to the large num-ber of failed deals as evidence. “They call it a venture exchange … but the bureaucracy and the necessary corporate govern-ance and the requirements to be a public company are simply too burdensome for the type of company that may be contem-plating a public offering on the current exchange.”

Private caPital

But it’s not only the stock exchanges that are letting down Canadian growth-seeking com-panies. If those companies choose to avoid public markets and seek out the support of pri-vate capital instead, the outlook isn’t much better.

“The investment banks generally don’t want to raise money for private companies that stay private, and investors want to see a pathway to liquid-ity that is relatively short,” says dellelce, who has been in the industry for 22 years.

“And the few VCs or private equity companies or investors that are sophisticated enough and prepared to invest are

generally looking for mid- to late-stage companies, not the smaller companies.”

Part of the responsibility for a lack of access to funds for small and mid-sized companies lies with the companies or com-munities of companies them-selves, dellelce says.

“In the case of technology, for example, leaders in the community, myself included, have spent an inordinate amount of time working with incubators and start-up hubs and universities to bring people together,” he says. “But no one has really spent the time to attract the capital.”

a sOlutiOn in sight

What is it going to take to get

small and mid-sized companies back on track, attracting invest-ors and growing? According to Allan, an exchange that’s going to “invigorate capital markets” is what Canadian investors and issuers need.

“Currently, the stock ex-change has lost all of the verve of the radical changes that were made some 30 or 40 years ago,” says Allan.

According to Schwartz, we need to change the mindset of investors. We need to “drag the needle back,” so that investors become interested in compan-ies before they hit the big time. It took eight years, for example, for Facebook to go from incep-tion in 2004 to initial pub-lic offering in 2012. It wasn’t an overnight success story,

but it had backers early on.“Let’s give ourselves some

credit here in Canada and rec-ognize that we’ve identified some issues,” Schwartz says. “And if somebody is going to take the lead role in trying to

bring issuers and investors together in one place, and we’re going to look at these issues over a longer period of time, not tie everything to market cycles, then maybe we can get somewhere.”

if you were to compare the number of growth-company ceos in canada today compared to 15 years ago

who would say, ‘i’m planning a public offering, and here’s my path,’ i would think there would be a dramatic

difference ... there’s a level of comprehension there around what some of the key limiting issues are, and it’s

not just market cycle, as we might have thought in the past — peter schwartz, laurence capital corp..

With the backing of a group of market investors and the country’s largest bank, the Aequitas NEO Exchange will utilize measures to disrupt the practices of predatory high-frequency trading and create a fairer marketplace for all participants.

“People are not as confident in the markets because you are not sure about the pricing you are getting, you are not sure who you are trading with on the other side, whether they are actually trading as traders or whether they are trading to make money from strategies around the trading,” says Brent robertson, director of trading, beta portfolio management, with OMErS Capital Markets.

OMErS (the Ontario Muni-cipal Employees retirement System), is one of the found-

ing shareholders of the new Aequitas NEO Exchange.

robertson adds that not all high-frequency trading strat-egies are necessarily harmful, but he zeroes in on so-called “predatory” trading. “They trade against me and then they trade against you, and we both suffer a little bit for that. That is where the confidence in the market drops.”

It is a sobering thought to learn that high-frequency trad-ing is a concern even for multi-billion-dollar pension plans such as OMErS. “That is one of the things that we really notice on our trading side,” says rob-ertson. “With the size of what we are trying to trade at times, we are trying to look for what the real liquidity is, not just the volumes that show up.”

The need for a new stock exchange such as Aequitas NEO Exchange was echoed by Greg Pollock, president/CEO of Advocis, an associa-

tion that represents Canadian financial advisors and plan-ners. “I think what they are positioning is an alternative in the system for small invest-ors in particular. We want to make sure that we continue to innovate in the markets and create various types of prod-ucts and tools and platforms, but on the other hand we have

to ensure that there is fairness and transparency for every-one. I see this as an innovation and I see this as a good thing.”

Pollock adds that it was nearly 40 years ago that Can-ada first introduced electronic trading in the western world with CATS (computer-assisted trading system) and has em-

braced innovations such as derivatives — of which mutual funds are a popular form. “We need innovation in the system so I applaud Aequitas for cre-ating this alternative platform, and I think it is going to create a little bit better level play-ing field for the Main Street investors that our members deal with.”

Earlier this year, the head of the Ontario Securities Commission, which regulates securities trading in the prov-ince, said that it was looking into high-frequency trading. At that time it was waiting for the results of a study from the Investment Industry regula-tory Organization of Canada

investigating the impact of high-frequency trading practi-ces in Canadian markets.

rather than put new rules in place to try to eliminate high-frequency trading play-ers, however, financial indus-try veteran Scott Penman be-lieves that the preferred strat-egy of regulators is to create more competition rather than more rules.

“They are very thought-ful about the whole situa-tion; they are very reluctant to apply new rules because typically, rules-based regula-tion leads to loopholes,” he says. “They were very much more interested in — and I think welcomed — a competi-tive solution to deal with what they thought was an issue,” adds Penman, who is a mem-ber of the board of directors of Aequitas, representing the interests of IGM Financial.

recent investor surveys show that regulators and stock market participants have some way to go to restore confidence in the investment system. A 2013 CFA Institute study found that only 52% of

investors trust the financial services industry “to do what is right,” and just 19% “strong-ly agree” that they have a fair opportunity to profit by in-vesting in capital markets. A 2013 survey conducted by Aequitas found that invest-ment advisors rate market confidence at 44 out of 100, blaming hFT strategies and flash crashes, and only give markets a 40 out of 100 score for fairness.

“People’s v iew of the marketplaces has deterior-ated,” says Penman. “yes, hFT may be one cause of that and that has come to the forefront in the last couple of years and particularly, with the book, Flash Boys, but secondly, just the volatility of markets. People are still smarting from what happened in 2008.

It takes a long time to re-store confidence and I think the introduction of this platform has the potential to further restore [confidence] and bring people back to the focus of what markets are all about — and that is long-term investing.”

price stabilization can boost investor confidencemarke t s

continued from page sc1

we want to make sure that we continue to innovate in the markets

restoring faith among issuers key to growth

Canada’s small and medium-sized companies lack confidence that they can raise funds for growth and stability.

Perry Dellelce of Wildeboer Dellelce says business confidence is also eroded by onerous regulations.

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Why? It’s a result of predatory high-frequency trading (HFT), an investment strategy

that leverages technology to gain an unfair speed advantage the average investor

can’t see coming, can’t compete with and could never afford themselves.

WE’RE HERE TO HELP LEVEL THE PLAYING FIELD.WELCOME TO THE AEQUITAS NEO EXCHANGE.

aequitasneoexchange.com