That means we can now short a stock anytime we want. That's great news for shorters, but for companies trying to raise money at higher prices to hire more staff or move their projects forward, that rule can cripple them - especially under the liquidity constraints of the Canadian market.  


It doesn't take a lot of money to control a stock via short selling on the TSX Venture. As a matter of fact, institutions often hammer stocks via short selling and back up their shorts with warrants they obtained in a previous financing.They often force the price of a stock down to finance the same companies they're shorting to get a better financing price; or to force a company into a financing arrangement.


Short selling isn't the only thing destroying the TSX Venture. Another rule change is hurting the market and its one you would never expect. 


Dark Pool Liquidity


Hate it or love it, dark pools represent a lot of available liquidity for many institutions - especially independent brokerage houses. Here is a quick video explaining dark pools:


click image to play

While retail investors rarely participate in this type of trading, there are often benefits to the use of these dark pools in Canada via volume of trade.


Dark Pools is trading volume or liquidity that is not openly available to the public. Dark liquidity pools offer institutional investors many of the efficiencies associated with trading on the exchanges' public limit order books but without showing their actions to others. Dark liquidity pools avoid this risk because neither the price nor the identity of the trading company is displayed.


There are many advantages to dark pools, especially on the Canadian market.


One of the main advantages for institutional investors in using dark pools is for buying or selling large blocks of securities without showing their hand to others and thus avoiding market impact as neither the size of the trade nor the identity are revealed until the trade is filled.  


During a market decline, dark pools can help facilitate big sell orders from fund redemption without having to smash the open market and cause stocks to crash.  


Dark pools can also be posted inside the existing limit order book alongside public liquidity, usually through the use of iceberg orders.   


Iceberg Orders 


Iceberg orders are orders that appear to be small but in reality are much bigger.  


The order is queued along with other orders but only the display quantity is printed to the market depth.  


When the order reaches the front of its price queue, only the display quantity is filled before the order is automatically put at the back of the queue and must wait for its next chance to get a fill. While not exactly dark, iceberg orders have an advantage of not showing the full sell size of an order to avoid scaring market participants. It can also do the same for buy orders for those that want to purchase more stock without running up the price.  


While it may seem unfair that trades exists outside of the public realm during trading hours, trades executed in dark pools are incorporated into a post-trade transparency which means investors do have access to them.


This can aid price discovery because institutional investors who are reluctant to tip their hands in lit market still have to trade and thus a dark pool with post-trade transparency improves price discovery by increasing the amount of trading taking place.


In other words, volume of trade increases. For the Canadian market, that's a much-needed thing.   


New Rules that Affect Dark Orders 


On October, the Investment Industry Regulatory Organization of Canada and the Canadian Securities Administrators introduced rules that give lit orders priority over dark orders in the same venue. 


Smaller dark orders will now have to offer significant price improvement. Orders under 5,000 shares or C$100,000 dollars in value must offer at least half a tick in price improvement for stocks that have a spread of one tick spread, and a full tick of price improvement for stocks with higher spreads.


While regulators are trying make the market more transparent, industry insiders say the rules will reduce passive liquidity in dark pools and cause routing issues, as dark orders can only execute after all lit market options have been exhausted.


Canadian dark pool Match Now's parent ITG expects inter-listed equities trading in Canada to drop by 5% as the dark pools route the flow of trade into the US as a result of the new rules:


"We'll definitely see inter-listed stocks trade more in the US than in Canada because of this rule. Dealers can automatically route inter-listed trades to both US and Canadian venues, so there's no technological barrier to instantly routing these trades." - Doug Clark, managing director of research for ITG.


Here is yet another situation where a rule, meant to make the market better, is actually making it worse. Having to hunt for liquidity across all displayed markets before sending an order to a dark pool causes unnecessary confusion:


"There will be many situations when a buyer and a seller can't interact because of the way routing works around this rule because they create technical issues regulators don't understand," Clark said, adding that smaller and mid-sized dealers will struggle to adjust trading strategies, while institutional traders may eventually find a technology work-around to the routing issues.


Again, the smaller guys fail and the bigger banks win.


The October Rules Plague


Dark trading in Canada hit a record high of 5.87% of total trading volume last August.  


Dan Kessous, CEO of Chi-X Canada, fears the regulation will limit the use of dark trading, adversely affecting the market:


"There will be less resting liquidity so there will be lower volumes overall, and it will probably get worse over time as people realise they have to change their trading strategies."


Were his fears warranted?


Here's the same TSX Venture chart from before, but this time highlighting the record high dark trading month, just before the dark pool rules announcement:


dark pools canada chart  

In August, the stock market was rising despite being in the summer doldrums that the TSX Venture is commonly known for. While there is no proven correlation between the Venture's rise in August and dark pool trading, there's no doubt that the TSX Venture was rising during a month when dark pool trading was at its highest. 


Since October, much of the volume in Canada has been routed to the US for inter-listed companies. Trading volume for inter-listed companies are now much higher on the US exchanges for the majority of the inter-listed companies based in Canada.  


The TSX Venture volume is down more than 25% year-over year as of April, and transactions down nearly 45%.


Are the new rules making investing better for us?