The Canadian Cherry-picking “Anti-HFT” Payment for Order Flow Kaleidoscope


Canada’s TMX Group has just announced some changes to how it intends to operate its stock exchanges, and you should be aware of these changes whether or not you trade in Canada. The fact is, Global markets are connected, national regulatory structures are unique and disparate, and capital flows to environments and countries with the “friendliest structures.” To start with, here is a Reuters article on TMX’s latest change, and here is the official TMX announcement.



In recent years the TMX Group was bought out by a consortium of investors (Maple) that include Canadian banks, pension funds, and investment firms (TD, CIBC, Ontario Teachers, Manulife, etc.).

Also, in recent years, our regulator friends north of the border have made some serious market structure changes that have included a trade-at rule and the elimination of payment for order flow. While this has resulted in a reduction in dark liquidity, it also has had other consequences. In the US, large retail brokers sell their clients orders to internalizer divisions at firms like Citigroup, Citadel, UBS, and KCG. It is a huge revenue source. Since this practice has been banned in Canada, these large retail brokers have recently started routing orders to the US, where they get a free fill from these same firms (to our knowledge), and this has resulted in declining volumes for TMX. The undesired result of declining volumes, partially due to the disparate regulatory structures in the US and Canada, has led TMX to make some changes.


 What Are These TMX Changes?

For starters TMX recently made a huge technology upgrade that has sped up its engine from milliseconds to microseconds (30 microseconds to be exact – faster even than BATS). This speed upgrade certainly was made with the intent of appeasing a high-speed algorithmic customer base. Second, TMX is planning a speed bump, minimum order sizes, and a rebate taker-maker structure on its slower exchange – ALPHA. Finally, they are also are planning to institute what they call a “long life” order type. This order type has priority to trade over more fleeting orders.

The changes announced yesterday have been billed as “anti-HFT”. On the surface, the changes look very investor friendly, especially in the wake of Michael Lewis’ Flash Boys, and the success of the US’s IEX Group. Slowing down trading, priority for orders that rest over orders that flicker… that sounds great, right?

Of course, the devil always ends up being in the details. Let us try to explain.


What’s Really Going on Here?

 Upon first glance it was easy for us to view TMX’s proposed changes as being a preemptive response to Aequitas’s planned launch in Canada. A more detailed look under the hood reveals that these changes have some other bite to them as well.

Facts as we understand them:

 1)      TMX has a faster engine, and a slower engine – (Alpha)

2)      Alpha will be Taker-Maker (you get a rebate if you hit the bid or take the offer, but you pay if you post bids and offers).

3)      Resting orders on Alpha can have priority over fleeting orders.

4)      Alpha will have a speed bump of 5-25 milliseconds.

5)      You can Post-Only on Alpha, and those orders do not have the speed bump.


What are likely behavior outcomes?


1)      Large retail brokers, like a TD, will have an incentive to route their market and marketable limit orders to Alpha. There, they will get a rebate for doing so, instead of just getting a free fill by routing that retail flow to internalizers across the border in the US.

2)      High Speed market makers will post on Alpha because they will have advantages. Their post-only orders will not have a speed bump, while orders trying to hit or take those orders will have the speed bump.

3)      Institutions who are routing to hit a bid or take an offer on Alpha may find that the liquidity they see posted disappears and fades as they try to access it. There will likely be lower institutional router fill rates.


The third item above is the Flash Boys story.

Think of it like this: A large institutional manager trading in Canada sees large displayed bids of 50,000 shares each on several TMX venues – say TSX and Alpha. They route to try to sell 100,000 shares at that price. They get some fills first on TSX (the fast exchange), but encounter a speed bump in trying to hit the 50,000 share bid on Alpha. Within that 5-25 millisecond speed bump, they may very well find that the Alpha bid fades. It is likely that the same high speed market makers who are posting on TSX are also posting on Alpha, so as they start getting hit on TSX, they use the speed bump time to fade their bid on Alpha – their post-only order on Alpha are not subject to the speed bump.

Institutional attempts to interact with displayed liquidity will be thwarted!


So Who Will Be Accessing the Displayed Liquidity on Alpha Then?


The retail orders routed from large banks will be the ones who get to trade with the displayed liquidity on Alpha. Actually, we should say that another way. The high speed market makers posting on Alpha have a mechanism now for them to only interact with “dumb” retail flow. They will pay a rebate for that privilege, as there is short term alpha-performance that can be extracted from being on the other side of Uncle Fred and Aunt Ethel’s orders. Heck the short term alpha guys do that in the US already!



 In the United States we have been on a path of faster and faster markets, that are catered more and more towards helping faster players extract short term alpha. Every high speed market maker wants to trade with dumb orders on the other side, and avoid the adverse selection of large institutional orders that are not “scheduled and managed.” This is why Citadel, Citigroup, UBS, KCG, and others pay large retail broker for their retail market orders. It is also why these same ELPs pay rebates in institutional broker routers to be on the other side of VWAP trades. In Canada, these practices are not allowed in that form.

While payment for order flow is not allowed in Canada, the maker-taker & taker-maker mechanisms are. It looks like TMX figured out a way to use the exchange pricing mechanisms, combined with special order types, and even speed bumps, to allow high speed short term alpha extractors to cherry pick customers and do essentially the same thing in Canada  that they do in the United States.

This demonstrates to all of us that we need to look at the details to see what really is going on when big changes are announced, and not just the headlines in news articles and press releases.

This also demonstrates that when different nations have disparate regulatory environments, there are high barriers that can prevent one regulatory body from doing what they feel is the right thing, if neighboring regulatory environments differ (Canada and the United States).

This finally demonstrates that the more things change, the more they stay the same.


Important Disclosure

 Themis does not trade in the Canadian markets. We do not have an axe to grind here, except to note that it is likely we are now bearing witness to the types of mechanisms and order types we may see in the US down the road; market structure changes, practices, and mechanisms have a funny way of being shared across markets over time.

We did have a great deal of help delving into this issue from two sources that we want to acknowledge. One source is “The Twitter”, where we were involved in an educational and lively debate. The other source is ITG’s Doug Clark. He has forgotten more about Canadian and global market structure than we will ever know. He is a great man, a good friend, and always generous in sharing his views and knowledge. If you have questions and really want to delve deep into how these changes may affect your trading in Canada, he is the man to call, and ITG is lucky to have him.