Canada: Canada Proposes New Rules For Electronic Trading And Direct Market Access

Copyright 2011, Blake, Cassels & Graydon LLP

Originally published in Blakes Bulletin on Securities Regulation, April 2011


  • New obligations for marketplace participants for all electronic trading
  • New controls when providing direct electronic access for clients
  • Exempt market dealers ineligible for direct electronic access

The Canadian Securities Administrators (CSA) have published for comment proposed National Instrument 23-103 Electronic Trading and Direct Electronic Access to Marketplaces (NI 23-103). The new rules introduce a Canada-wide regulatory system for electronic trading. To date, such trading has been regulated by some exchange rules governing when participants are allowed to grant direct access to their clients, and some guidance for dealers about the enhanced compliance requirements for dealing with direct access by clients.

Direct client access to trading on marketplaces has been known as direct market access (DMA) or dealer sponsored access. In Canada, the terminology will now be "direct electronic access" (DEA). The new rules do not apply to retail trading where clients access accounts via the Internet, such as discount brokerage.

The Notice introducing the new rules discusses the background, reflecting both the proliferation of trading technology, increased use of direct and high-volume trading and a reaction to the "flash crash" of May 2010, which highlighted systemic risks. Because of the increased risks to the Canadian market, the CSA have decided to establish a consistent regulatory framework, with a particular focus on managing risk.

Obligations of Marketplace Participants

NI 23-103 applies to all marketplace participants which are members of an exchange, users of a quotation and trade reporting system or subscribers of an ATS. The other term used in NI 23-103 is a "participant dealer" which means a marketplace participant that is an investment dealer.

Under NI 23-103, all marketplace participants will be required to "establish, maintain and ensure compliance with appropriate risk management and supervisory controls, policies and procedures that are reasonably designed, in accordance with prudent business practices, to manage the financial, regulatory and other risks associated with marketplace access or providing clients with DEA".

The rules don't specify any particular appropriate controls, policies and procedures, but do list some broad requirements for controls, such as systematically limiting the financial exposure of the marketplace participant, ensuring compliance with marketplace requirements, and ensuring that the entry of orders does not interfere with fair and orderly markets.

All order flow must be monitored, including automated pre-trade controls designed to systematically limit financial exposure and ensure compliance with market-place and regulatory requirements. The marketplace participant must have direct and exclusive control over the controls, policies and procedures. The services of third parties may be used to provide risk management or supervisory controls. A participant dealer could allocate some of these controls to another investment dealer that is directing trading to the participant dealer.

These requirements will apply to all electronic trading, not just DEA. NI 23-103 imposes a number of specific controls that a marketplace participant must have. These are similar to the controls required by the TSX rules for eligible direct access clients, but the new rules would be broader in scope.

If a marketplace participant or a DEA client uses an automated order system (black box), NI 23-103 imposes on the marketplace participant the obligation to ensure it has the necessary knowledge and understanding of that system, whether used by itself or its client. The marketplace participant must have controls that allow it to immediately prevent erroneous orders from automated order systems from reaching a marketplace.

Only investment dealers that are participant dealers can provide DEA services to their clients.

NI 23-103 places squarely upon the participant dealer the full responsibility for all orders entered onto a marketplace using their identifier, so it has the responsibility to ensure that the risks associated with providing that number are adequately managed.

Eligible DEA Clients

Rather than specifying an eligible client list, the new rules would require participant dealers to set their own appropriate standards, and conduct due diligence to assess whether each client meets those standards, such as the client having appropriate financial resources, knowledge, ability and monitoring systems.

DEA clients must be trading only for their own account, unless the DEA client is itself an investment dealer, a portfolio manager or a similar foreign entity under specified IOSCO jurisdictions.

However, a client that is a registrant in Canada is not allowed to be a DEA client unless it is an investment dealer or a portfolio manager. This means, in particular, that exempt market dealers (EMDs) can't be DEA clients nor can they provide DEA services to their clients. The stated rationale for this is that EMDs should not be able to opt out of the Universal Market Integrity Rules. Instead, orders from EMDs or their clients would have to be sent to executing investment dealers, but not using DEA. The CSA have requested specific feedback on this issue in the comment period.

NI 23-103 does not address foreign brokers registered in Canada as EMDs to permit them to engage in expanded trading with Canadian clients, while other lines of the business may provide trading services for foreign clients, typically through a DEA arrangement with a Canadian investment dealer. Such arrangements would no longer be allowed if such EMDs were prohibited from being DEA clients.

As with the current TSX requirements for eligible clients, NI 23-103 would require participant dealers to enter into written agreements with each DEA client providing certain specific terms, although NI 23-103 requirements would be broader than the TSX form of agreement. The proposed DEA client agreement would require the DEA client to co-operate with regulatory authorities. If the DEA client is trading for the accounts of its own clients, those client orders must flow through the systems of the DEA client before they reach the participant dealer's system. Those clients would also be required to enter into a written agreement with the DEA client in which they agree to meet the standards set by the participant dealer.

With respect to training of DEA clients, the CSA would leave it up to the participant dealer to satisfy itself that the client has adequate knowledge. If the dealer concludes that a DEA client does not have adequate knowledge, the dealer must ensure the necessary training is provided to the client prior to granting DEA to the client. The new rules do not specify any particular course or training proficiency. The participant dealer is responsible for ensuring the DEA client receives any relevant changes and updates to applicable marketplace and regulatory requirements.

Each DEA client will be required to be assigned a unique identifier which would be attached to each order entered on a marketplace. The client identifiers will need to be provided to IIROC as the regulation services provider, to facilitate monitoring of trading by DEA clients.

Obligations on Marketplaces

NI 23-103 also imposes new requirements on marketplaces relating to electronic trading. The new requirements include that marketplaces must provide a marketplace participant with reasonable access to its own order and trade information on an immediate basis (to facilitate monitoring), support the use of DEA client identifiers, and have the ability to immediately terminate access by a marketplace participant or a DEA client (such as when dealing with rogue algorithms). The marketplaces will be required to prevent the execution of orders outside the thresholds set by IIROC or the marketplace. Marketplaces will also be required to regularly assess risk management and supervisory controls at the marketplace level to ensure fair and orderly trading and also to assess the effectiveness of what they implement.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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