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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. 1 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 2 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. 3 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 4 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. 5 DISCLAIMERS The opinions expressed herein are those of the writer and do not necessarily reflect the opinions of ITG Canada Corp. This report has been prepared solely for informational purposes only and is not intended to provide financial, legal, accounting or tax advice and should not be relied upon in that regard. Information provided in this report is believed to be accurate and reliable, but we cannot guarantee it is accurate or complete or current at all times and no representation is made in this regard. Conclusions and opinions do not guarantee any future event or performance. ITG Canada Corp. is not liable for any errors or omissions in the information or for any loss or damage suffered. Although the information contained in this report has been obtained from sources that ITG Canada Corp. believes to be reliable, we do not guarantee its accuracy, and as such, the information may be incomplete or condensed. All opinions, estimates and other information included in this report constitute our judgment as of the date hereof and are subject to change without notice. ITG Canada Corp. will furnish upon request publicly available information on which this report is based. ITG Canada Corp. is a member of Investment Industry Regulatory Organization of Canada (IIROC) and the Canadian Investment Protection Fund (CIPF). The information herein is believed to be accurate at the time of publication, but the information is subject to change without notice. ITG Canada Corp. is SM SM also affiliated with the Canadian equity marketplace MATCH Now . MATCH Now is a product offering of TriAct Canada Marketplace LP (“TriAct”), member CIPF and IIROC. These materials are not intended to be used for trading or investment purposes or as an offer to sell or the solicitation of an offer to buy any security or financial product. No guarantee or warranty is made as to the reasonableness of the assumptions or the accuracy of the models or market data used by ITG Canada Corp. or the actual results that may be achieved. ITG Canada Corp. is not a registered investment adviser and does not provide investment advice or recommendations to buy or sell securities, to hire any investment adviser or to pursue any investment or trading strategy. All information, terms, and pricing set forth herein is indicative and based on, inter alia, market conditions at the time of this writing and are subject to change without notice. © 2016 Investment Technology Group, Inc. All rights reserved. Not to be reproduced or retransmitted without permission. # 40516-9924 SM ITG Canada Corp. wholly owns Triact, which runs a Canadian Dark ATS called MATCH Now . ITG Canada Corp. has a minority ownership in, and a Board Seat on, Aequitas Innovations Inc., which operates Canadian marketplaces which may be discussed in this article. Broker-dealer products and services are offered by: in the U.S., ITG Inc., member FINRA, SIPC; in Canada, ITG Canada Corp., member Canadian Investor Protection Fund (“CIPF”) and Investment Industry Regulatory Organization of Canada (“IIROC”); in Europe, Investment Technology Group Limited, registered in Ireland No. 283940 (“ITGL”) and/or Investment Technology Group Europe Limited, registered in Ireland No. 283939 (“ITGEL”) (the registered office of ITGL and ITGEL is Block A, Georges Quay, Dublin 2, Ireland). ITGL and ITGEL are authorised and regulated by the Central Bank of Ireland; in Asia, ITG Hong Kong Limited (SFC License No. AHD810), ITG Singapore Pte Limited (CMS Licence No. 100138-1), and ITG Australia Limited (AFS License No. 219582). All of the above entities are subsidiaries of Investment Technology Group, Inc. MATCH NowSM is a product offering of TriAct Canada Marketplace LP (“TriAct”), member CIPF and IIROC. TriAct is a wholly owned subsidiary of ITG Canada Corp. 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