The executive charged with launching Canada's newest stock exchange says he sees the task as a labour of love.
Aequitas Innovations CEO Jos Schmitt says he was involved in starting a derivatives exchange at the age of 28 when he was living in Brussels.
That was well before he got involved in the Canadian stock market business, most recently as CEO Alpha Group, an alternative trading system that was swallowed last year in a $3.8 billion takeover of Toronto Stock Exchange by a consortium known as Maple Group.
Rather than resting on his laurels, Schmitt recently accepted an offer to spearhead the launch of a new exchange that aims thwart unfair competition from high frequency traders.
“When you love something you can’t stop it,’’ explained the 51-year-old Dutchman, during a telephone interview from his office in the Royal Bank Plaza in downtown Toronto.
SH What is keeping you busy this week?
J.S. The Ontario Securities Commission agreed to publish a notice about some key features of Aequitas from a market structure perspective. The notice will seek comments from all stakeholders to help guide the OSC in taking a final view of some of the very innovative and differentiating features that we hope to put in place. We hope to get a conclusion somewhere towards the end of October.
We hope to be able to file our formal application as an exchange somewhere towards the end of the year. If that goes well, then we hope to be operational somewhere towards the end of next year or early 2015.
We are arranging meetings and holding one-on-one presentations with issuers, institutional investors, dealers, all types of stakeholders, financial advisors. We are trying to reach out to as many people as possible to seek feedback.
SH: What will this exchange look like, where will it be located, and how many employees will it have?
J.S. We already have 10 15 people, and that will rise to 50 or 60 people when we fully operational. The head office will be located in Toronto, but the exchange would consider having a presence in other communities outside of Toronto.
The objective of Aequitas is to focus on the core market place stakeholders that are investors and issuers. We identified a number of major issues in the market place and we are looking to solutions to tackle those issues.
One issue we see is that long term investors today, whether they are retail or institutional, trade in a sub optimal fashion, usually to the benefit of high frequency trading firms, who are leveraging technology to apply what I would call technological front running.
We want to stop that.
Another item we identified is the disappearance of the market maker.
SH: What is a market maker?
J.S. A market maker is a market participant, someone who trades on the market and assumes the obligation to provide the spread between bid and ask prices. That is a very critical role in any market place because the market maker is the safety net for liquidity in periods of stress or when securities are less liquid.
But they are starting to disappear because their business model is no longer sustainable. That is not because of improper behavior on the part of high frequency traders. It’s because high frequency traders are taking away liquid trades, leaving only the opportunity to trade in periods of stress or in illiquid securities.
SH: Who would trade on this exchange?
J.S. All Canadian issuers could trade on this exchange. We would allow anyone listed on another exchange to be traded on ours.
We will provide our own listing facilities for those who would like to list directly on our exchange.
SH: Who are Aquinas’s main shareholders?
J.S. Royal Bank of Canada (TSX: T.RY, Stock Forum), IGM Financial Inc., CI Financial Corp., Canadian Pension Fund PSP Investments, OMERS Capital Markets, BCE Inc. (TSX: T.BCE, Stock Forum) and brokerages ITG and Barclays.
We are a totally autonomous organization with a number of shareholders. No one shareholder has more than 15% of the ownership. We are not, contrary to what some people believe, a Royal Bank exchange or anything of that nature.
SH: Will the success of Aequitas depend on the level of dissatisfaction with high frequency trading in Canada?
J.S I think it goes a bit larger than that. A lot of attention is put on that
When we talk about HFT, we have to be cautious. Because what we want to tackle is bad behaviour. We also believe that high frequency traders can add value to the market. But we say that if you want to do that, you have to live according to our rules. Our rules say long term investors and issuers have to be treated in the right way.
Aequitas is really coming with a new paradigm for trading, but also and a new paradigm for listing, one that goes beyond public companies, because we are also setting up a market for private companies, because we think there is a need to create more efficiency and more liquidity in the private equity space. This is very important for small and mid-sized companies seeking funding.
SH: Can you give us your definition for high frequency trading?
J.S. If I would summarize it as technological front running, taking advantage of technology, taking advantage of services provided by market places such as co-location, or low speed data feed and so on to trade ahead of long term investors.
That is really what we want to eliminate because we believe that has a negative impact on investor confidence. We believe it also has an impact on market makers.
SH: Who are these high frequency traders?
J.S.These are organizations that work for their own accounts, using sophisticated technology, and who take advantage of technological differences between market places. The organizations are owned by private people, usually with a trading background. They team up with people with a strong technology background.
SH: In a recent interview, you were asked to discuss some high frequency trading strategies and you used latency arbitrage as an example. What is that exactly?
J.S. This is where a large order is entered. That order is going to be executed on three different markets. When the order gets sent out, it hits one market before it hits the other two. Because of networking, because of technology, or whatever it is, latency arbitrage is looking out for those kinds of orders, seeing the first leg coming in, and then adjusting the market prices on the other exchanges, usually to the detriment of the investor, who is behind that big order.
SH: How prevalent is high frequency trading in Canada?
J.S. I think if we look at some figures came out from IIROC (Investment Industry Regulatory Organization of Canada) they estimate it to be in the range of 30% to 40%.
SH: What solutions might be used to curb high frequency trading?
J.S When someone sends an order to our smart order router, we will make sure that it hits every market at the same time. It suddenly becomes very difficult if you want to take advantage of the signal, because we generate the signal on the three markets simultaneously. That is one way of doing it.
SH: Can you help to revitalize trading in smaller stocks?
J.S. Absolutely! That is where the market maker kicks in. If market makers disappear, they disappear from the small stocks. We are trying to put solutions in place to re-incentivize market makers so that they can be successful and so that they will be providing the liquidity and safety net that is needed for small and mid-sized securities.
But at the same time, you have to be careful as an issuer not to go public too quickly because if you are not ready for a public listing, you can have the best market maker in the world and you will not get interest.
SH: In addition to high frequency trading curbs, what else will the exchange will offer?
J.S. We will come with a separate market place, a private equity market, were people can find funding and trade securities with the help of accredited investors.
This is large project and we decided to come out early to allow for a good debate to take place and to allow people to come in with a lot of input. We want regulators to comment at an early stage of the process to deal with complaints and issues or concern.
With a project of this size, you don’t want to hear down the road that the regulators have some concerns about features that are critical to your value proposition.
SH: Will the Aequitas exchange try to compete with the TSX?
J.S. What we are doing here in Canada with Aquetis is we are coming with a true new concept that doesn’t exist anywhere else, and I wouldn’t be surprised to see more of it developing outside of Canada also.
I Hope that we grow the market, make issuers confident again and help small and mid-sized companies find opportunities in a successful way and that will grow the pie as well.