Sunday, December 5, 2010

Box Office Futures Make Debut

A recent trivia item on the Internet Movie Database noted that the movie Takers was the first film to have its box office as the underlying interest of futures contracts. Intrigued, I decided to dig a little deeper.

Trading of Takers futures was approved by the Commodity Futures Trading Commission after a public meeting held to consider the issues arising from this unique product.

In March of this year, Trend Exchange (formerly Media Derivatives Inc.) requested CFTC approval to trade Opening Weekend Motion Picture Revenue collard futures and binary option contracts on Takers. Section 5c(c)(3) of the Commodity Exchange Act requires the CFTC to accept a contract unless the commission finds that the contract violates the Act. In its order approving the contracts, the CFTC found:

  1. Box office receipts are "commodities" for the purpose of futures trading, which for this purpose includes non-price-based measures of an economic activity, commercial activity or environmental event. The order lists many pages of contracts with similar economic underlying interests.
  2. The cash settlement price is derived from revenue numbers collected by Rentrak Corporation, a third-party data aggregator that has no direct monetary interest in any motion picture, and is disseminated throughout the industry. The underlying interest is therefore not subject to manipulation.
  3. The Commission made the exchange to adopt a rule requiring those who control a film’s marketing budget, release date or opening screen numbers and who hold at least 1,000 contracts to provide information to the exchange regarding decisions in these areas. The intention is to ensure they do not take actions such as delaying a release date or increasing the number of opening screens to benefit their futures holdings.
  4. The contracts provide a reasonable means for managing the risks associated with box office returns.

Thursday, November 25, 2010

Big Changes Proposed to Ontario Securities Act

You wouldn't know it from the title, but Schedule 18 of the Helping Ontario Families and Managing Responsibly Act, 2010 (Bill 135) contains some far reaching amendments to Ontario securities law. Most notably, it contains a legislative framework for regulating derivatives that is missing from both the Securities Act and the Commodity Futures Act.

In addition to numerous clean-up amendments, Bill 135
  • allows the OSC to designate credit rating agencies for the purposes of Ontario securities law but not to regulate the content of ratings or the agency's methodologies;

  • allows the OSC to designate trade repositories, which are entities that collect and maintain reports of completed trades by other entities;

  • provides a legislative framework for trading derivatives; and

  • extends the insider trading prohibition and related civil liabilities to TSX Venture Exchange listed companies with a "real and substantial connection" to Ontario.
Credit Rating Agencies

In an earlier post, I described the CSA initiative to create a framework for regulation of credit agencies. Bill 135 allows the OSC to require the agencies to have a code of conduct applicable to directors, officers and employees and to have policies and procedures to manage conflicts of interest between the agency and client companies.

Trade Repositories

The OSC would be able to designate trade repositories in what appears to be a similar process to that of recognition of exchanges, quotation and trade reporting systems and SROs.


Before the bill was even tabled, the proposed derivative regulation was a matter of speculation, at least in the Globe and Mail. The actual contents of the bill are not as bold as perhaps what was anticipated.

"Derivative" is defined as an option, swap, futures contract, forward contract or other financial or commodity contract or instrument whose market price, value, delivery obligations, payment obligations or settlement obligations are derived from, referenced to or based on an underlying interest (including a value, price, rate, variable, index, event, probability or thing), excluding
  • a commodity futures contract as defined in subsection 1 (1) of the Commodity Futures Act,
  • a commodity futures option as defined in subsection 1 (1) of the Commodity Futures Act, and
  • a contract or instrument that, by the regulations or Commission order is not a derivative.
The bill makes a number of linguistic changes to the Act to accommodate derivatives, such as changing references to "stock exchanges" to "exchanges" and replacing the term "security" (for the most part, but not in all cases) to "security or derivative." To the extent that a particular instrument fits the current definition of "security," there won't be any practical change. However, there are some contracts that might be exempt from the definition before that could now be caught. For example, it is arguable that forward contracts are not "securities" under the current definition unless they could be characterized as "investment contracts."

One problem with the bill is that the definition of "security" in the act has not been amended, which means that many contracts will be both "securities" and "derivatives." It would be preferable for the definitions to be exclusive, that is "security" does not include a "derivative." The bill in fact, gives the OSC the authority to rule that certain classes of derivatives are securities.

It would have been even better if the derivatives provisions were incorporated into the Commodity Futures Act, making it a comprehensive body of rules governing exchange-traded and over-the-counter derivatives, similar to what Quebec has done.

In terms of substantive changes, there isn't much in the bill. It allows for registration to trade derivatives. While this is unlikely to affect investment dealers (who are currently permitted to trade them), it would allow for a tailored registration regime for derivative-only firms.

Derivatives are exempt from the prospectus requirements if a disclosure document is prepared and accepted by the Commission. While the content of the disclosure document is not specified, this appears to be a codification of the current prospectus exemption for exchange-traded derivatives provided a risk disclosure statement is first given to the client. This also reflects the reality that each trade in a derivative results in the issuance of a new security because the clearing house becomes a counterparty to each side of the trade.

Insider Trading

The prohibition on trading on the basis of undisclosed material information (and the resulting civil liability for violations) has been extended to TSX Venture Exchange listed issuers that have a real and substantial connection to Ontario. Currently, the prohibition only extends to Ontario reporting issuers.

It isn't clear why this provision is needed, given that section 18 of TSX VE Policy 3.1 requires issuers with a "substantial connection" to Ontario to make a bona fide application to the OSC to become a reporting issuer within six months of it becoming aware that it has a significant connection. The concern might be that these issuers are traded on alternative trading systems in Ontario; previously the trading would have been done on the Venture Exchange and the BCSC and ASC would have jurisdiction. The Ontario government might be concerned that the very people who are responsible for having the company apply to be an Ontario reporting issuer might improperly delay the application to trade with knowledge of inside information. Even so, it is difficult to see why the provisions weren't extended to all TSX VE listed companies (as the gap continues to exist for those that do not have a real and substantial connection to Ontario) or, like section 57.2 of the British Columbia Securities Act, extended to all public companies regardless of reporting issuer status.

“Real and substantial connection” is not defined, and it could prove unworkable if the OSC adopts a different definition from that in the TSX VE’s rules.

There are a number of more minor problems with the bill. It continues the Ontario government’s insistence on putting provisions in the legislation that in other provinces are left to commission rules. In this case, some provision of National Instrument 21-101 Marketplace Operation are brought into the Act. In addition, the current power given to the OSC to suspend trading on a stock exchange in the event of a market disruption is unclear as to whether it extends to quotation and trade reporting systems and alternative trading systems. Although the provision will be amended to allow suspension of trading in securities and derivatives, the ambiguity remains.

This is legislation, not a commission rule, so there is no notice and comment period. However, it is hoped that some of the concerns with the act (which in my case go more to form than substance) can be remedied by the Legislature's deliberations.

Friday, November 19, 2010

CSA/IIROC Position Paper on Dark Markets Released

Following on the heels of studies by the SEC, IOSCO, and the Australian Securities and Investments Commission, the Canadian Securities Administrators and the Investment Industry Regulatory Organization of Canada have released a joint position paper on dark liquidity in Canadian markets.

The paper lists those issues the regulator feeds need to be addressed immediately, and it contemplates amendments to National Instrument 21-101 and the Universal Market Integrity Rules.

The paper defines "dark order" as an order that is entered on a marketplace without being visible to other market participants, and "dark pool" as a marketplace with no pre-trade transparency for any orders. Partially undisclosed orders, such as iceberg orders, are not considered dark orders as they contribute to price discovery.

The main risks dark orders and dark pools pose to capital markets are making price discovery less efficient and reducing liquidity available to all market participants by diverting order flow that otherwise would have gone to visible, public markets. On the other hand, orders are dark because full disclosure of trading intentions may have an impact on the market price, leading to a worse fill. Dark pools offer an alternative to the upstairs market where institutional block orders were traditionally traded. Dark orders also offer potential liquidity to smaller orders that are sent to a dark pool first in search of a better price than that available on visible markets.

The paper sets out the regulators' positions on three issues:
  1. Orders under a certain size should be required to be publicly displayed. The rationale for allowing dark orders not to be shown weakens if the order could be displayed with no market impact. Once entered, the order's size could not be reduced below the threshold (unless the reduction is due to a partial execution). The report suggests that the current threshold of 50 board lots in UMIR is an acceptable threshold, and invites specific feedback.
  2. Two dark orders of at least the minimum size should be allowed to execute at or between the national best bid and offer (at or between (i) the highest price for a buy order on any market and (ii) the lowest price for a sell order on any market). All other trades involving a dark order should provide meaningful price improvement over the NBBO (at least a penny for all stocks trading over 50 cents, or a half-penny if the NBBO spread is one cent).
  3. Within a market, visible orders at a price should have priority of execution over dark orders unless two dark orders exceeding the minimum size can execute. The regulators believe that this will enhance liquidity for larger orders, while requiring immediate post-trade dissemination of the trade details assists in price discovery.

The paper does not address other concerns. One is that the dark pool may try to attract order flow by offering a smart order router using data that is not available to other marketplace participants. This will be addressed in proposed amendments to NI 21-101 that are expected to be published in early 2011. The second issue is the practice of broker preferencing, which allows offsetting orders from the same firm to execute ahead of other orders at the price, even if those orders have established time priority. A request for information to allow the brokers to better evaluate the impact of preferencing will be published in the near future.

The deadline for comments is January 10, 2011.

Wednesday, November 3, 2010

Share Structure Concerns in IPOs

The Canadian Securities Administrators recently issued Staff Notice 41-305 concerning share structure issues in initial public offerings.

The purpose of the notice is to put issuers and insiders on notice of the issues that the various commissions will consider when deciding whether issuing a receipt for a prospectus is in the public interest. The primary concern is companies that have issued large amounts of shares for nominal cash consideration (or as payment for assets or services where the value cannot be easily or objectively determined). This is particularly true if the issuer has a limited history of operations and thus is difficult to value and the number of cheap shares issued is large compared to the number of shares to be issued in the IPO.

These issues persist despite the fact that both the TSX Venture Exchange and the Canadian National Stock Exchange have policies that address some of these issues and the CSA itself has an escrow policy that acts to lock up cheap shares issued prior to an IPO.

The notice states that the commissions will consider a number of factors when determining whether a share structure is objectionable. The main consideration is whether public shareholders are getting a disproportionately small ownership stake in the company relative to the amount of money raised in the IPO. On the other hand, staff recognize that management and insiders may have spent considerable time and resources in building the business, and they will consider factors such as whether the value of the shares issued to the insiders can be corroborated by factors such as arm's length pre-IPO financings.

The takeaway is that persons acting for companies that have a lot of cheap or free stock outstanding should have a discussion with commission as well as exchange staff early on in the IPO process.

Wednesday, September 22, 2010

IIROC reports on new product due diligence, principal protected notes

IIROC has issued two notices on their new product due diligence regulatory review and their principal protected notes compliance review.

New products
With respect to new products, IIROC notes that it is part of a Dealer Member's gatekeeper responsibilities to review and monitor new products before they are offered to clients. Otherwise, the dealer cannot determine suitability.

IIROC's examined 14 dealers. Two did not have written new product due diligence policies and many of the others were materially deficient. Some of the common deficiencies identified were:
  • No clear definition of "new product" that would trigger a review to determine retail and institutional suitability.
  • No appropriate level of internal review. At a minimum, the review should include the Chief Compliance Officer and the firm's relevant "subject matter experts" who have knowledge of the product.
  • Lack of a framework to ensure that the subject matter experts ask the right questions about the product and receive satisfactory answers.
  • Lack of consideration of conflicts of interest (such as a non-arm's length product) and how they should be addressed.
  • No analysis of proficiency issues arising that must be addressed to ensure advisors and their supervisors fully understand the product.
  • No process to monitor and follow up on customer complaints concerning the product.
  • No controls to ensure that all new products are reviewed. The notice states that this should include new products that come into the firm by a transfer or client deposit in addition to products identified by advisors

Principal protected notes

IIROC's review of PPN sales practices was a result of the freezing of the market for asset backed commercial paper in 2008. The review found the following:

  • Distribution of the required disclosure to clients was inconsistent. Although dealers stated this was the PPN issuer's responsibility, many dealers did not have a due diligence procedure to ensure that the issuer in fact sent the disclosure.
  • Dealers were unable to produce evidence that their clients received notice of monetization (i.e. that a protection event had been triggered affecting the product) as they did not have an agreement with the issuer whereby the issuer would send the notice.
  • Key information about products was missing from marketing material.
  • There was evidence that the many registered representatives did not understand the risks inherent in the products, particularly for elderly investors holding an investment that might be locked in for as long as ten years. There was no uniformity of training of RRs.
  • Client statements did not contain enough information to allow clients to identify their security holdings and monitor their investment.

Thursday, August 26, 2010

Securities Regulation in Federal States - Help Needed!

I am currently doing some research into the constitutionality of the proposed Canadian federal securities act, and would like to compare our situation with other federal states. I have covered off (I think) Brazil, Germany, Switzerland and the U.S., but would appreciate it if anyone could provide me with information about other countries, In particular, I would like to know if the constitutional basis for regulation at the federal (or state, or both) level. Any assistance will be appreciated and acknowledged.

Thursday, August 19, 2010

IOSCO's Principles for Direct Electronic Access to Markets

IOSCO published its final report on direct electronic access to markets in August. A consultation report on the subject was released in February, 2009. The report may be used by Canadian securities commissions in any examination of issues arising out of direct access.

The report identifies three forms of direct access:

  • Automated order routing through an intermediary's infrastructure, where the direct access customer's order is passed on automatically to a market for booking or execution using the intermediary's member identifier;
  • Sponsored access, where the customer can send orders directly to a marketplace without using the intermediary's infrastructure but using the intermediary's member identifier; and
  • Direct access, where a customer enters orders on a marketplace directly using its own (or the market's) infrastructure using an identifier for that customer. These market participants must enter into a clearing agreement with a member of the market's clearing agency.

The report notes that direct access arrangements pose potentially substantial risk to clearing firms and the market. It states that many markets are concerned that they do not have enforcement jurisdiction over their members' clients, but the report points out that the statutory regulator will have jurisdictions over all participants in its capital markets.

Intermediaries tend to mitigate their direct access risk in three ways:

  • Knowing their customer (e.g. examining regulatory history, creditworthiness);
  • Pre-execution risk controls (identifying problems or anomalies before an order hits the market's trading system or before it is executed); and
  • Post-execution controls.

Pre-execution controls are not as effective or non-existent for sponsored access clients.

The report sets out 8 principles applicable to direct access trading arrangements, grouped in three main categories: pre-conditions for direct access, information flow and adequate systems and controls. These principles are:

  • Minimum Customer Standards: establishing the customer's creditworthiness, knowledge of applicable market rules and ability to comply and ability to correctly use the order entry system.
  • Agreement: The intermediary should have a binding agreement with each customer, tailored to the services to be performed. Marketplaces should consider whether they should have agreements with direct access customers.
  • Rules should clearly spell out that the intermediary is responsible for trades by its direct access customers.
  • Intermediaries should identify direct access customers to markets to assist in surveillance.
  • Markets should provide intermediaries with adequate real time information to enable the intermediaries to institutes effective monitoring and risk assessment controls.
  • Markets should have systems and controls designed to minimize market integrity concerns (e.g. disorderly trading) arising from direct access customers' activities.
  • Intermediaries should have appropriate controls, particularly on a pre-trade bases, to prevent direct access customers from exceeding position or credit limits.
  • Intermediaries and clearing firms should have operations and technical capabilities to manage risks arising from direct access.

Wednesday, July 28, 2010

CSA Releases Proposal to Regulate Credit Rating Agencies

The Canadian Securities Administrators have released a draft of National Instrument 25-101 a proposal to regulate credit rating agencies whose ratings are used in places where credit ratings are referred to in securities legislation.

NI 25-101 is dependent on the enactment of legislation to give the various commissions jurisdiction to regulate the agencies. Legislation is already in place in British Columbia, Alberta and Quebec and is expected to come in to force concurrent with NI 25-101.

NI 25-101 is a voluntary framework for credit rating agencies that wish to become "designated credit rating organizations." An agency does not have to apply for designation, but if it does not, its ratings cannot be used to support, for example, an exemption from the prospectus requirements for a distribution of securities that have a minimum credit rating. NI 25-101 would replace the current regime of "approved" credit rating agencies in securities legislation.

An applicant to become a designated credit rating organization must file Form 25-101F1 with the applicable commissions. The disclosure in the form includes
  • whether the applicant makes its ratings generally accessible for free or for a fee,
  • the procedures and methodologies used by the applicant to determine credit ratings, including unsolicited ratings,
  • the applicant's code of conduct,
  • the applicant's policies and procedures for containment of non-public information and for identifying and managing conflicts of interest,
  • the number of credit analysts and supervisors and their qualifications,
  • the name of the compliance officer,
  • information concerning revenues from credit ratings, subscribers and licences to publish ratings, and
  • a list of the largest users of the rating service.
A designated credit rating organization must ensure compliance with the revised IOSCO Code of Conduct Fundamentals for Credit Rating Agencies. An agency will be allowed to deviate from the Code provided it explains the reasons for the deviation and how it meets the objectives of the Code notwithstanding the deviation.

In addition, designated credit rating organizations must have policies and procedures to identify and manage conflicts of interest and to prevent the inappropriate use of non-public material information, including pending rating changes. The firm will not be permitted to issue a credit rating if a conflict of interest exists and must designate an officer as responsible for compliance with NI 25-101. The agency must also make prescribed filings with the commissions.

While it is expected that the enabling legislation would prohibit commissions from regulating the content of credit ratings or the methodologies used, this may not be the case in all jurisdictions. In addition, the proposal does not address whether the current exclusion of credit rating agencies from the provisions imposing civil liability for misrepresentations should be maintained.

The deadline for comments is October 25.

Monday, June 21, 2010

CSA consults on venture issuer regulation

The Alberta, B.C., Manitoba, New Brunswick, Nova Scotia and Saskatchewan securities commissions have released a consultation paper on venture issuer regulation. The Ontario and Quebec commissions, while not fully participating in the consultation process, have urged their market participants to comment on the proposals. The comment period closes September 17.

The consultation paper contains the text of proposed rules, but these are for "conceptual purposes" only. Any rule changes resulting from the consultation process will be issued for comment in the normal course.

The paper notes that venture issuers (that is, issuers listed on the TSX Venture Exchange and the Canadian National Stock Exchange, or that trade over the counter in Canada or on international junior markets such as AIM on the London Stock Exchange) face particular compliance challenges given the complexity and breadth of modern securities regulation. It concludes that one size does not fit all and that a tailored approach to regulation of venture issuers is appropriate. Of course, whether this threshold assumption is valid is one of the questions asked.

The paper proposes that current exemptions for venture issuers and special rules tailored for venture issuers be contained in stand alone rules. To make the rules easier to understand, explanatory text will not be in a separate companion policy, but will be in short guidance notes contained within the body of the instrument.

Continuous Disclosure

The proposal will streamline disclosure obligations for venture issuers. The requirement to file first and third quarter financial statements will be removed. Instead, issuers will file an annual report that contains aspects of the current disclosure requirements for an annual information form (AIF), management's discussion and analysis (MD&A), and annual financials. It would be a mandatory document - today a venture issuer is not required to file an AIF unless it wants to use a short form prospectus or take advantage of a prospectus exemption that requires an up-to-date AIF. The MD&A will discuss objectives, targets and milestones, and progress against those targets, rather than annual information disclosure and a two-year summary of financial results.

Issuers would also be required to file a mid-year report including MD&A and financial statements for the six-month period, as well as updating any information in the annual report that has changed in the interim.

Venture issuers would not be required to file business acquisition reports but would file a report similar to a material change report. Confidential filings would not be permitted as they are today. The paper gives no explanation why, but perhaps the regulators are concerned about misuse of confidential filings to delay releasing bad news.

Information circulars would only be required to contain disclosure strictly necessary to allow a shareholder to understand the matters to be voted upon at the meeting. Other information, such as executive compensation and corporate governance disclosure, would be contained in the annual report and would not have to be included in the information circular unless the annual report had not been filed at the time the circular is filed.

Issuers will be able to use "notice and access" to electronically distribute material to shareholders rather than mail them.


The proposal contains several governance measures:

  • Directors and officers would have to act honestly and in good faith and to act with the care, diligence and skill of a prudent person acting for a venture issuer will be imposed. Although this is largely duplicative of corporate law, the proposal notes that some issuers are incorporated under legislation that does not contain these obligations and some venture issuers, such as trusts and partnerships, are not incorporated at all.
  • Boards of directors would have to have procedures to ensure they are made aware of, and have an opportunity to discuss, conflicts of interest between the board and management and any proposed related party transactions.
  • Companies would have to have procedures to deter illegal insider trading.
  • The CEO, CFO and two directors would have to sign a certificate filed with the annual and mid-year reports that the reports contain no misrepresentations and fairly disclose the information. They would also confirm that all of the directors and officers had confirmed their compliance with the proposed duty to act honestly and with the care and skill of a prudent person.
  • Audit committees would be required to have a majority of members who are not officers or employees of the issuer or its affiliates.

The provisions regarding the rights and responsibilities of directors and officers fall squarely under corporate law rather than securities law, and it is hard to see how the commissions have the authority to implement them. However, that is a matter for another post, another time.


The main proposal with respect to prospectuses is to reduce the requirement for three years' prior financial statements to two.

Wednesday, May 26, 2010

Draft Federal Securities Act Released

The proposed federal securities act is available at It has been tabled in Parliament for information only as it will be referred immediately to the Supreme Court for a ruling on its constitutional validity.

I'll be commenting on it after I've had an opportunity to digest it.

Monday, May 3, 2010

British Columbia Introduces Framework for Regulating Credit Rating Agencies

The B.C. Finance Statutes Amendment Act, 2010 contains provisions to amend the Securities Act to provide a framework to regulate credit rating agencies (CRAs). The Act has received Royal Assent, but the new provisions have not yet been proclaimed in force. The Act is as interesting for what is missing as for what it contains.

The Act provides the building blocks for a regulatory regime but does not require or even permit CRAs to be recognized. It contains provisions

  • preventing any person from representing that the Commission approves or endorses a CRA (amending s. 55 of the Act);
  • allowing the Commission to order a CRA to produce records (amending s. 141(2)), submit to a review of its practices and procedures or to change its practices and procedures (amending s. 161(7);
  • empowering the executive director to conduct a compliance review of a CRA (amending s. 141.1(1)) and the Commission to conduct an examination of a CRA's financial affairs (amending s. 153(1);
  • allowing the Commission to collect information from and share information with a CRA (amending s. 169(1)); and
  • allowing the Cabinet to enact regulations concerning CRAs (amending s. 183 - the Commission has a plenary power to enact rules regulating the securities industry other than certain categories reserved to the Cabinet under s. 184(4). That section is not being amended to preclude the Commission from enacting rules for CRAs.).

A more comprehensive regime for regulating CRAs is expected when new National Instrument 25-101 Designated Rating Agencies is released for comment, expected later this month.

The legislation does not contain an express prohibition on the Commission the substance of credit ratings or the procedures and methodologies by which credit ratings are determined, similar to the provisions of s.15E(c)(2) of the Securities Exchange Act of 1934. Perhaps the legislature was influenced by developments in the United States to require the SEC to do just that. The following is the provision from the House bill (H.R. 4173), the (1706 page!) Wall Street Reform and Consumer Protection Act of 2009:


(A) IN GENERAL.—The Commission shall examine credit ratings issued by, and the policies, procedures, and methodologies employed by, each nationally recognized statistical rating organization to review whether—

(i) the nationally recognized statistical rating organization has established and documented a system of internal controls, due diligence and implementation of methodologies for determining credit ratings, taking into consideration such factors as the Commission may prescribe by rule;

(ii) the nationally recognized statistical rating organization adheres to such system; and

(iii) the public disclosures of the nationally recognized statistical rating organization required under this section about its credit ratings, methodologies, and procedures are consistent with such system.

Thursday, April 1, 2010

Moody's Less Than Stellar Governance

This is an interesting article on Moody's cororpate governance (or lack thereof) during the financial crisis:

Saturday, March 27, 2010

IIROC issues draft guidance on locked and crossed markets

IIROC has issued a request for comments on proposed guidance on locked and crossed markets. A market is "locked" when a bid is entered on one marketplace at the same price as an offer on another marketplace, or an offer is entered at the same price as a bid. A market is "crossed" when a bid is entered at a higher price than an offer on another market, or an offer at a lower price than a bid.

Markets may be locked or crossed for any number of reasons, including different latencies in various order entry and market data systems (such that the person entering the order doesn't see the order in another market entered a split second earlier). However, one incentive to lock or cross a market is rebate arbitrage, where a trader will enter a passive order hoping to entice the order on the other side of the lock or cross to trade with it. The strategy is used to take advantage of the practice of many markets to pay a fee to liquidity providers (passive orders).

Intentionally locking or crossing a market is a violation of section 6.2 of National Instrument 23-101.

The draft guidance provides examples of situations IIROC considers acceptable and unacceptable. IIROC does not view a lock or crossed market to be intentional if
  • race conditions existed where orders are entered on different markets at essentially the same time,
  • the lock or cross is due to the latency of the system(s) used,
  • there was a malfunction or material delay in the system(s) used, or
  • a "bypass" order (an order to take out the visible orders at better prices on other markets when entering a cross outside the national best bid and offer) bypasses undisclosed liquidity at better prices that is exposed immediately after the entry of the order.
A market may be locked (but not crossed) if the person entering the order is required to enter it on a particular market. For example, if a security is subject to resale restrictions under the SEC's Regulation S, it can only be resold in a "designated offshore securities market" under that rule. Currently only the TSX, the TSX Venture, CNSX and Pure Trading are designated, which means that an order could be entered on one of those markets that locks with a non-designated markets. Although the notice is silent on the point, presumably an order could not be entered on Pure Trading that locks with the TSX.

The notice also clarifies that a person who has properly entered an order on a market that subsequently becomes locked because of an order entered on another market is not obliged to remove the order and enter it on the other market. It further clarifies that locking or crossing a market for the purpose of rebate arbitrage is not permitted.

The guidance is open for comment until May 25, 2010. Comments should be directed to James Twiss, Vice President, Market Regulation Policy.

IIROC publishes first installment of plain language rule rewrite for comment

IIROC has issued a request for comments on proposed new rules 3100 - Business Conduct and 3200 - Client Accounts. The rules are part of an overall project to rewrite all IIROC rules, by-laws and policies in plain language and to reorder and reorganize them in a more coherent manner (full disclosure: I was retained to work on parts of this project).

The project also had the following goals:

  • to eliminate unnecessary or obsolete provisions
  • to clarify IIROC's expectation of its members
  • to conform the rules to actual practice
  • to ensure consistency with other rules and securities legislation, and
  • to clarify those provisions that are mandatory (which are drafted as rules) from those that are suggestive (which are drafted as guidance notes).
In addition to the dealer rules, the universal market integrity rules will be included in this project.

As part of the rule rewrite project, a number of rules were identified which require substantive changes.

The rules are being released in 8 tranches with a longer than normal comment period (90 days versus the usual 30), in order to ensure opportunity for review and comment. Any proposed substantive changes are noted in the request for comment. In the case of rules 3100 and 3200, there are a number of substantive changes that are outlined in the request for comments.

The comment period is open until June 27, 2010. Comments should be directed to Sherry Tabesh-Ndreka, Policy Counsel, Member Regulation Policy.