For those who trade both the Canadian and U.S. equity markets, the sheer volume and volatility brought on by the pandemic highlighted some of the differences between the two marketplaces. TABB Group Research Analyst Colby Jenkins examines key aspects of the Canadian equities market structure and provides insights into recent developments with Canadian firms, from both a technology and competitive perspective, while providing a forward look at best execution.
As the dust settles and institutional investors begin to eye the prospect of trading in a post-pandemic world, some covid-driven trends may be here to stay. The equity markets have seen an explosion in trading (Exhibit 1), pronounced volatility, and the continued evolution of trading capabilities to service the institutional client base. Certain advancements in electronic trading may be a reaction to make working from home, work.
If nothing else, this past year has proven that human resiliency as well as technological resiliency are both crucial in running a successful trading franchise. This theme was particularly pronounced within the equities community as it dealt with a year of unprecedented, covid-driven volatility – which was somewhat of a litmus test for institutional technological aptitude. This challenge was shared across all borders, albeit to different extents depending on the region.
Taking the Canadian equities market for example, there are several key differentiating factors that separate it from its US counterpart. For instance, while the US operates under a market structure that often separates retail order flow from institutional order flow, the Canadian market does not. The Canadian market’s unique fair access structure ensures that retail and institutional orders both contribute to the price discovery process, maximizing interaction between these orders.
Operating as an integrated franchise, Canadian banks’ retail and institutional flows are comingled on exchange and have been for some time. Given the pronounced influence that retail flow has had on markets this past year, driven mainly by ease of access from retail trading apps like Robinhood in US markets or Wealthsimple in Canadian markets, it can be argued that the Canadian framework (in which retail order flow is already interacting with institutional order flow) is better positioned to absorb and benefit from a rising tide of retail flow.
Another key distinction between the US and Canadian markets is the more prominent Canadian ‘upstairs’ market. Unlike the US, in which the largest proportion of trading occurs via electronic channels, in Canada it is still essential to utilize desk relationships to access information, liquidity and capital, via cash desks, in the search for accessible liquidity. Exhibit 2 underscores this trend using block trading (defined as 10,000 shares or more and a value of $100,000 or more) as a proxy for ‘upstairs’ activity.
Exhibit 2: Canadian Block Market Share
The Canadian market also operates with a unique feature called broker preferencing. Broker preferencing allows an incoming order to match and trade with other orders from the same dealer ahead of orders from other dealers at the same price, and that may enjoy time priority. Clients of the largest trading franchises benefit from Canadian broker priority rules – which ultimately translate to improved performance and lower costs for these customers. In other words, in order to enjoy Canadian best execution, the best bet is going with the largest player.
All of these pieces fit together to create a unique, but nevertheless increasingly complex market ecosystem. Despite these numerous differences, there is one striking similarity between the approaches Canadian and US banks are taking with respect to their trading franchises: investments in trading technology.
Within the Canadian market, for instance, several banks have recently made high-profile acquisitions or launched new electronic platforms. In August 2020, the Bank of Montreal (BMO Financial Group) announced it had completed the acquisition of Clearpool Group, ‘a provider of holistic electronic trading solutions’ in a bid to expand its electronic offering. More recently, Royal Bank of Canada (RBC) launched Aiden, its artificial-intelligence based electronic trading solution, in what has been a doubling down on its automated and tech-focused approach to trading.
It is worth noting that much of this progress occurred against the backdrop of a pandemic that continues to rattle markets globally. If nothing else, this past year has proven that investments in technology and the reliability of trading infrastructure are essential in running a successful trading franchise.
Looking to the Canadian Imperial Bank of Commerce (CIBC), one of the dominant trading franchises in the Canadian equities market, steps had been taken well ahead of the curve to solidify the franchise’s electronic trading arm. Unlike some competitors that have only recently made large investments into their electronic capabilities, CIBC launched its electronic trading platform over a decade ago and has maintained its position as a market-leader for electronic trading ever since, representing close to a quarter of total Canadian trading activity (Exhibit 3).
Exhibit 3: Canadian Broker Rankings
Recently, CIBC has been quietly re-investing into this market-leading trading infrastructure. Throughout the covid pandemic, CIBC has been undertaking a rebuild of its execution platform. Several key technology solutions have been remodeled from the ground up. Looking closer, three major areas of focus stand out: investments in AI driven algorithmic trading capabilities, smart order routing (SOR) solutions leveraging the size and scale of the CIBC trading franchise, and a complete refresh of its low latency market access.
Ultimately, all banks, both Canadian and American, are being confronted with an evolving market that will only grow in complexity. This will in turn require a continued commitment to reinvestments into their technological capabilities. However, the other side of this equation is harder to quantify. Electronic trading and developments in artificial intelligence, may not be the be-all and end-all when it comes to navigating the market landscape. This is particularly true in the Canadian market, where liquidity conditions are quite different to those of the US markets.
The intelligence behind the technology, including investments in human capital, is essential to servicing clients in today’s markets, CIBC would argue. In speaking to CIBC’s Heather Killian (Executive Director, Prime Services Group) about the recent steps CIBC has taken to maintain its position as a market leader she remarked that, “technology is the baseline, the true value add comes from service and human expertise across the franchise. Technology can and should be upgraded constantly and it has been integral to our equities franchise well before the term AI began trending, and what will truly differentiate execution and best execution is the human capital behind it.”
Looking forward, as the complexity of the marketplace grows, it is true that clients will likely find themselves in a narrowing middle ground when thinking of best execution. A middle ground where high tech must meet high touch. With the evolution of the market, we have seen a revolution in the tools used to navigate it, so it comes with no surprise that technology keeps evolving with the market. Two questions then remain: should all trading franchises adopt a dual focus on technology and human capital to provide best execution in today’s complex environment? And is the Canadian integrated equity franchise model better suited to navigate the post-covid market landscape?