Download Blockchange A look at the evolving nature of Canadian trading

ITG Canada
Blockchange
A look at the evolving nature of
Canadian trading
The Canadian market has long been compared to a game of Lego played by a
group of nine-year-old boys. It’s all about the blocks, and the big guys dominate.
But the last few years have seen a continued decline in the relative market share
of block trading, and recent structure changes have greatly altered the nature of
downstairs markets. In the pages that follow we want to take an updated look at
the evolving nature of Canadian equity trading.
The single most significant catalyst for change, over the past year, has been the
marked increase in volatility since late summer 2015. The chart below clearly
demonstrates the uptick in implied volatility in both the U.S. and Canada since
that time.
U.S. VIX index, Canadian VIXC Index
Source: Bloomberg
This increase in volatility has resulted in increased trading volume in both
markets, with volume in both Canada and the U.S. hitting recent highs in Q1.
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Total Market Volume in the U.S. – Tape A+B+C – And Canada
Source: Bloomberg
While Canada and the U.S. have had very similar movements in market volatility
and volume, the one area where we have seen a divergence is in block levels. In
the U.S. the share of market volume attributed to the Trade Reporting Facility
has been in a reasonably steady state for several years.
TRF Share of US Market Volume
0.35
0.3
0.25
0.2
0.15
0.1
0.05
0
TRF Share
Source: ITG Canada
The TRF encapsulates a number of activities, most notably block activity and
trades done on various dark ATS facilities. The portion of the TRF volume
attributable to dark pools has only recently become transparent. According to
FINRA data, since mid Q2 2014, when such data was reported, dark pool trading
has – on a quarterly basis – accounted from between 14.2 and 15.7% of total
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volume, with the most recent report showing dark pool trading accounting for
15.19% of total volume in Q4 2015. If both TRF market share and dark market
share have been relatively flat for the last several quarters, it follows logically that
broker block activity has likely been relatively flat as well.
In Canada, where blocks are printed on exchange, we have a somewhat clearer
picture of block activity. During the past few years blocks have been on a steady
decline. Even more notable is the decline in block share, ex swap basket
related activity.
Blocks as a percentage of Canadian Market Share
Source: ITG Canada
Overall block activity in Canada has declined from historic levels of 20+%, to just
under 15% of total volume. Block activity, ex the swap basket trades, is now
hovering around 11% – far below the historic levels that left many foreign traders
viewing Canada as a cowboy market, driven solely by upstairs block desks.
Add to this the observation that ETFs are accounting for a growing percentage of
block activity, and we come to the quick realization that actual trading of
corporate equities is being handled far more on the “downstairs market” than
ever before.
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ETF Share of Blocks and Total Market
Source: ITG Canada
Some of the decrease in block market share is almost certainly a result of
increased levels of HFT intermediation, and the resulting growth of the
denominator that is total volume. The shift of several venues to so-called
“inverted” pricing models has resulted in growing opportunity for prop strategies
to stitch together fragmented flows, using structural inefficiencies. The Alpha
speed bump has created a separate, unique opportunity for high frequency
players to intermediate retail flows at greater levels without increasing risk. The
good news for native Canadian capital market players has been the return of
interlisted market share to Canadian venues.
3-1-2016
2-1-2016
1-1-2016
12-1-2015
% CAN Volume
11-1-2015
10-1-2015
9-1-2015
8-1-2015
7-1-2015
6-1-2015
5-1-2015
4-1-2015
3-1-2015
2-1-2015
56%
53%
50%
47%
44%
41%
38%
35%
1-1-2015
Canadian Share of Interlisted Volume
Source: ITG Canada
This chart – perhaps more than any of the others presented here – tells the real
story of the evolving Canadian market. In late fall 2015, as oil prices fell, dealers
pulled back capital, and the inverted venues took hold, Canada’s share of
interlisted volumes witnessed a near step function increase. As internal risk
policies and external regulation forced a pull-back in dealer capital, more orders
were traded electronically on exchange. These electronic orders were then
subject to the gaming introduced by certain prop elements – leading to an
increase in overall market volumes. This would explain why Canadian volumes
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have witnessed a slightly better increase than U.S. volumes, despite our market
generally being viewed as out of favour.
Another way to look at this evolution is to view average block size and average
trade size.
Average Block Size / Average Trade Size
Source: ITG Canada
While the average block size has remained incredibly static for several years,
the average trade size continues its state of decline.
While block share has fallen, the client demand for low impact block trades has
not. As such, it does not come as a surprise that the share of blocks accounted
for by electronic block markets has risen over the past six months. Our analysis
suggests that such venues accounted for roughly 2.6% of non-swap blocks in
June 2015 – and 4% of upstairs blocks that month. In March 2016 we believe
such blocks accounted for 3.6% of non-swap blocks, and 5.3% of upstairs
block volume.
In summary, the continued trends of decreasing capital commitment and growing
dependency on electronic trading have shifted the Canadian markets away from
the nine-year-old Lego pit of yesteryear, to markets that are more heavily
intermediated and reward tech savvy firms versed in the minutiae of market
structure and informational control. No longer should foreign participants feel like
outsiders, trading at a distinct advantage to those locals “in the club,” but rather
can view their global experience as an advantage in navigating the Canadian
markets. The more trading in Canada evolves, the more we must all realize that
trading matters.
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