Impact of the Dark Rule Amendments Baiju Devani Director, Analytics IIROC
Agenda 1. Background 2. Objectives 3. Approach and metrics 4. Key findings 2
Background Recognize the value of dark orders/markets Reduces informational leakage Post-trade price discovery Balance against lit market benefits Pre trade price discovery and transparency Need for proactive action Fairness and level playing field Flow segmentation and non mid-point internalization 3
Study objectives Evaluate market-wide impacts of rule change Market quality: liquidity measures and price efficiency measures Evaluate impact on trading groups : wealth transfer Investigate behaviours Who was providing liquidity before/after Concentration of liquidity providers Market met internalization by brokers 4
Metrics Market quality Spreads (Effective, Realized, Time-weighted quoted) Market depth: dark + lit (5 trading increments) Mid-quote return autocorrelation (absolute value) 10 second, 30 second and 60 second Volatility standard deviation in mid-point return 1 minute, 5 minute and 30 minutes 5
Metrics continued Concentration Herfindahl index & ranking Market met internalization Flow originating from the same broker with one side marked CL and one side marked IN (client-principal trade) 6
Methodology Study window August 15th to December 15th Comparable to related work and appropriate Security segment: 241 securities from TSX Composite 44 highly liquid ETFs Covers 94% of dark trading (75% of lit) 7
Methodology: trader group segments Based on a machine learning classifier from earlier IIROC study A small human annotated labeled set used for training the classifier Trading characteristics codified in 200+ features Segments: HFT, Buy Side, Sell Side, Retail 8
Methodology: impact evaluation Pre/Post analysis on all measures 2-stage regression to establish a causal relationship for market quality measures Herfindahl index and ranking analysis for aggregate measure of concentration in liquidity provisioning 9
Methodology: impact evaluation,, Controls: Time: A variable to control for the trend over the study period Natural logarithm of dollar volume: Value of overall trading for each stock date combination Volatility: High minus low quoted price, divided by the timeweighted average mid-quote for each stock date combination Price: Time-weighted average mid-quote for each stock date combination 10
11 Key Findings: dark volume trend dark rule study period 0 3 6 9 12 2012-Jan-08 2012-Jan-08 2012-Jan-08 2012-Jan-08 2012-Jan-08 2012-Feb-05 2012-Feb-05 2012-Feb-05 2012-Feb-05 2012-Feb-05 2012-Mar-04 2012-Mar-04 2012-Mar-04 2012-Mar-04 2012-Mar-04 2012-Apr-01 2012-Apr-01 2012-Apr-01 2012-Apr-01 2012-Apr-01 2012-Apr-29 2012-Apr-29 2012-Apr-29 2012-Apr-29 2012-Apr-29 2012-May-27 2012-May-27 2012-May-27 2012-May-27 2012-May-27 2012-Jun-24 2012-Jun-24 2012-Jun-24 2012-Jun-24 2012-Jun-24 2012-Jul-22 2012-Jul-22 2012-Jul-22 2012-Jul-22 2012-Jul-22 2012-Aug-19 2012-Aug-19 2012-Aug-19 2012-Aug-19 2012-Aug-19 2012-Sep-16 2012-Sep-16 2012-Sep-16 2012-Sep-16 2012-Sep-16 2012-Oct-14 2012-Oct-14 2012-Oct-14 2012-Oct-14 2012-Oct-14 2012-Nov-11 2012-Nov-11 2012-Nov-11 2012-Nov-11 2012-Nov-11 2012-Dec-09 2012-Dec-09 2012-Dec-09 2012-Dec-09 2012-Dec-09 2013-Jan-06 2013-Jan-06 2013-Jan-06 2013-Jan-06 2013-Jan-06 2013-Feb-03 2013-Feb-03 2013-Feb-03 2013-Feb-03 2013-Feb-03 2013-Mar-03 2013-Mar-03 2013-Mar-03 2013-Mar-03 2013-Mar-03 2013-Mar-31 2013-Mar-31 2013-Mar-31 2013-Mar-31 2013-Mar-31 2013-Apr-28 2013-Apr-28 2013-Apr-28 2013-Apr-28 2013-Apr-28 2013-May-26 2013-May-26 2013-May-26 2013-May-26 2013-May-26 2013-Jun-23 2013-Jun-23 2013-Jun-23 2013-Jun-23 2013-Jun-23 2013-Jul-21 2013-Jul-21 2013-Jul-21 2013-Jul-21 2013-Jul-21 2013-Aug-18 2013-Aug-18 2013-Aug-18 2013-Aug-18 2013-Aug-18 2013-Sep-15 2013-Sep-15 2013-Sep-15 2013-Sep-15 2013-Sep-15 2013-Oct-13 2013-Oct-13 2013-Oct-13 2013-Oct-13 2013-Oct-13 2013-Nov-10 2013-Nov-10 2013-Nov-10 2013-Nov-10 2013-Nov-10 2013-Dec-08 2013-Dec-08 2013-Dec-08 2013-Dec-08 2013-Dec-08 dollar volume (%) ALF CHX TCM TSX Other
12 Dark volume by participants dark rule study period 0 3 6 9 12 2012-Jan-08 2012-Jan-08 2012-Jan-08 2012-Jan-08 2012-Jan-08 2012-Feb-05 2012-Feb-05 2012-Feb-05 2012-Feb-05 2012-Feb-05 2012-Mar-04 2012-Mar-04 2012-Mar-04 2012-Mar-04 2012-Mar-04 2012-Apr-01 2012-Apr-01 2012-Apr-01 2012-Apr-01 2012-Apr-01 2012-Apr-29 2012-Apr-29 2012-Apr-29 2012-Apr-29 2012-Apr-29 2012-May-27 2012-May-27 2012-May-27 2012-May-27 2012-May-27 2012-Jun-24 2012-Jun-24 2012-Jun-24 2012-Jun-24 2012-Jun-24 2012-Jul-22 2012-Jul-22 2012-Jul-22 2012-Jul-22 2012-Jul-22 2012-Aug-19 2012-Aug-19 2012-Aug-19 2012-Aug-19 2012-Aug-19 2012-Sep-16 2012-Sep-16 2012-Sep-16 2012-Sep-16 2012-Sep-16 2012-Oct-14 2012-Oct-14 2012-Oct-14 2012-Oct-14 2012-Oct-14 2012-Nov-11 2012-Nov-11 2012-Nov-11 2012-Nov-11 2012-Nov-11 2012-Dec-09 2012-Dec-09 2012-Dec-09 2012-Dec-09 2012-Dec-09 2013-Jan-06 2013-Jan-06 2013-Jan-06 2013-Jan-06 2013-Jan-06 2013-Feb-03 2013-Feb-03 2013-Feb-03 2013-Feb-03 2013-Feb-03 2013-Mar-03 2013-Mar-03 2013-Mar-03 2013-Mar-03 2013-Mar-03 2013-Mar-31 2013-Mar-31 2013-Mar-31 2013-Mar-31 2013-Mar-31 2013-Apr-28 2013-Apr-28 2013-Apr-28 2013-Apr-28 2013-Apr-28 2013-May-26 2013-May-26 2013-May-26 2013-May-26 2013-May-26 2013-Jun-23 2013-Jun-23 2013-Jun-23 2013-Jun-23 2013-Jul-21 2013-Jul-21 2013-Jul-21 2013-Jul-21 2013-Jul-21 2013-Aug-18 2013-Aug-18 2013-Aug-18 2013-Aug-18 2013-Aug-18 2013-Sep-15 2013-Sep-15 2013-Sep-15 2013-Sep-15 2013-Sep-15 2013-Oct-13 2013-Oct-13 2013-Oct-13 2013-Oct-13 2013-Oct-13 2013-Nov-10 2013-Nov-10 2013-Nov-10 2013-Nov-10 2013-Nov-10 2013-Dec-08 2013-Dec-08 2013-Dec-08 2013-Dec-08 2013-Dec-08 dollar volume (%) HFT RET Buyside Sellside Other
Market quality: overall no impact TSX Composite Measure Category Measure Segment Active/Passive Change Liquidity Time weighted quoted spread Market Market Retail active plus passive Effective spread active Deterioration HFT active plus passive Improvement passive Improvement Level 0 (Dark) Decreased depth Level 1 (NBB NBO) Market Depth (Overall) Level 2 Level 3 Level 4 Level 5 Level 1 (NBB NBO) Improvement Level 2 Market Depth (Lit) Level 3 Level 4 Level 5 Price efficiency Volatility Return Autocorrelation Deterioration 13
Market quality: overall no impact Highly Liquid ETF s Measure Category Measure Segment Active/Passive Change Liquidity Time weighted quoted spread Market Market Retail active plus passive Effective spread active Deterioration HFT active plus passive passive Level 0 (Dark) Decreased depth Level 1 (NBB NBO) Market Depth (Overall) Level 2 Level 3 Level 4 Level 5 Level 1 (NBB NBO) Improvement Level 2 Improvement Market Depth (Lit) Level 3 Level 4 Level 5 Price efficiency Volatility Return Autocorrelation 14
Diversity of liquidity providers Inverse Herfindahl index A higher number represents more diversity in liquidity provisioning Panel A: TSX Comp pre post t statistic Lit + Dark 35.96 31.00 ( 7.795)*** Lit 33.94 28.13 ( 10.193)*** Dark 10.82 32.53 (20.452)*** Dark ALF only 2.09 2.74 (2.440)** Dark CHX only 11.68 10.81 ( 2.264)** Dark TCM only 17.59 22.55 (4.09)*** Dark TSX only 16.39 18.98 (2.10)** Lit markets become more concentrated (as large liquidity providers simply shifted from provisioning liquidity in dark to lit) Dark markets became more diversified (as it reverted to less intermediation and more a venue for institutional trading) 15
Diversity of liquidity providers Top 20 LP s Ranked by Overall Liquidity Provisioning in TSX Comp Top 20 LP s Ranked by Dark Liquidity Provisioning in TSX Comp User 01 (HFT) User 02 (HFT) User 03 (HFT) User 04 (HFT) User 05 (non-hft) User 06 (HFT) User 07 (HFT) User 08 (HFT) User 09 (HFT) User 10 (HFT) User 11 (HFT) User 12 (non-hft) User 13 (non-hft) User 14 (non-hft) User 15 (HFT) User 16 (non-hft) User 17 (non-hft) User 18 (HFT) User 19 (non-hft) User 20 (non-hft) Dark Lit User 08 (HFT) User 01 (HFT) User 02 (HFT) User 17 (non-hft) User 21 (non-hft) User 12 (non-hft) User 19 (non-hft) User 10 (HFT) User 04 (HFT) pre User 22 (non-hft) post User 23 (non-hft) User 03 (HFT) User 24 (HFT) User 25 (non-hft) User 26 (non-hft) User 07 (HFT) User 27 (non-hft) User 28 (non-hft) User 29 (non-hft) User 30 (non-hft) Dark Lit pre post 90 60 30 value (million) 0 0 100 200 300 value (million) 90 60 30 value (million) 0 0 100 200 300 value (million) 16
Market met internalization (MMI) MMI for TSX Comp by broker and traded marketplace 60 value (million) 40 ALF_Dark TCM_Dark Other_Dark Lit 20 0 pre post pre post pre post pre post pre post pre post pre post pre post pre post pre post A B C D E F G H I Other MMI dropped significantly from 2.75% of all traded value to 1.81% (retail from 8.2% to 2.9% in TSX composite) Rule impact on brokers depended on business model 17
Conclusion On balance, the regulatory objective was met with minimal impact to market quality Liquidity, spread and volatility measures show no impact Return auto-correlation shows deterioration 18
Conclusion: trading group level There were winners and losers Active retail (representing 67% of retail flow) lost price improvement benefit (increased effective spreads) HFTs (dominant LP s) saw an increase in earned effective spread 19
Conclusion: diversity of LP s and MMI Most liquidity provisioning done by same participants Shift from dark to lit Overall reduction in internalization Impact was dependent on business model Alpha and business models that dependent on it impacted more 20
Final thoughts Pre-rule change, dark market structure offered: Segregation of retail flows LP s control over who they trade with Availability of a finer pricing grid on tick constrained securities How much of the negative impact that we saw a result of traditional benefits of trading in dark? Markets have since evolved Segregation of flows in form of speed-bumps South bound retail flows 21