Will Aequitas succeed against the TSX by restricting high-frequency trading?

A bold new challenger.

(Photo: Fernando Morales/The Globe and Mail/Canadian Press)

(Photo: Fernando Morales/The Globe and Mail/Canadian Press)

Whether high-frequency trading, estimated to comprise anywhere between 30% and 40% of stock market trades in Canada, helps or hinders the capital markets is still widely debated. But for many retail and institutional investors, certain trading strategies propelled by increasingly fast, smart algorithms cultivate an uneven playing field.

Aequitas Innovations Inc. wants to change all that. The upstart stock exchange, expected to launch in late 2014, is the brainchild of a handful of financial heavyweights, such as Royal Bank of Canada and IGM Financial (none of which were involved in Maple Group’s 2012 takeover of Toronto Stock Exchange operator TMX Group).

Not all high-frequency trading (HFT) is bad for market integrity; it can boost liquidity and tighten spreads between bid and ask prices. Aequitas plans to restrict only what it claims are “predatory” trading tactics. Some high-frequency traders exploit market quirks or try to profit by jumping ahead of large trades by institutional investors, says Jos Schmitt, CEO of Aequitas, who ran Alpha Group before it was taken over in the Maple acquisition. “We are going to put technology and trading models in place that will protect the long-term investors from predatory trading strategies,” he says. “We will create trading books that are really safe havens.”

Aequitas already has fans, who say HFT makes trading more costly and inefficient. “I think high-frequency trading is devastating for normal investors,” says Eric Sprott, chairman of investment manager Sprott Inc., which is not part of Aequitas. “Every day we lose value to high-frequency traders who serve no purpose in my mind.”

The new exchange would compete with TMX, which also operates the country’s main small-cap and derivatives exchanges. Schmitt says Aequitas aims to take some 20% of market share—largely from TMX’s current 80% slice of public markets in Canada—in the first few years of business. But exactly how it will do so is a mystery. Another big question mark is how the new venture, which will offer listings, market data and create a secondary market for shares of private companies, will make money as it clamps down on potentially revenue-generating HFT volume.

Andreas Park, an economics professor at the University of Toronto, says rebuilding confidence to bring back longer-term investors and true market-makers could go a long way in making up for any lost volume from restricting HFT: “If people feel they get disadvantaged persistently on public markets, what is the natural reaction? Stay away from public markets.”