After Adjustments, Aequitas Still Set for 2015 Launch

"When you look at the [HFT] debate and the Michael Lewis book, do I agree with everything that's written? No, at the end of the day it's a book and it's someone seeking to sell a book," says Jos Schmitt, CEO at Aequitas. "But one thing that I would say about it is that many of the examples that are in there are ones that I've seen in the market."

Announced last year as a new Canadian securities exchange, Aequitas initially came out of the gate swinging. It proposed that it would restrict access to HFT strategies that it didn't feel added proper liquidity to its hybrid book, give full execution priority to market-making firms with liquidity provision obligations, and allow participants trading through a member's access to become market-makers subject to certain criteria. However, the Ontario Securities Commission raised concerns that some of Aequitas' plans would contravene existing regulations as they stood.

"Last year, we were discussing our market-structure solutions with the regulators, and we even went through a unique and valuable step with the regulators in the sense that they went for public comment on some of our key features," Schmitt recalls. "Based on all of the feedback that they and we received, we made a number of adjustments late last year, and came up with a solution that we believe is actually better than what we had before."

Institutional Fairness
Some of those adjustments, published in January, include replacing the restriction mechanism on the hybrid book for liquidity-taking HFT strategies with a system of speed bumps and trading fees. Clients engaging with Aequitas through direct access on another's membership will no longer be allowed to become market-makers, and Aequitas will not be operating a maker-taker system of rebates, with no payments made for providing liquidity on the exchange. In a slight shift in approach, market-makers will also no longer get 100-percent execution priority on the books, so as to avoid crowding out the quote.

"In our initial proposal, we said that we'd put them at the top of the queue, but what we're saying now is that we'll put them in a position where they can always participate on a certain percentage of the volume, so everyone is treated fairly," he explains. "The market-maker can really trade a lot, because of course, if you have obligations to provide liquidity then it's also important for you to be able to trade out, but at the same time we're ensuring that other participants aren't disadvantaged by the market-maker always being ahead of them."

Out of all of the orders that hit Canadian marketplaces today, 90 percent of them disappear within a minute, and not many of them are traded. You might think, okay, a minute isn't too bad. 50 percent disappear within a second. 20 percent disappear within 10 milliseconds. I wouldn't call that the behavior of a long-term investor. - Jos Schmitt, Aequitas.

Indeed, a properly functioning market-making system is at the heart of Aequitas' objective, which Schmitt describes as returning confidence in the market to the real participants, whom he sees as long-term investors, and not necessarily short-term HFT arbitrageurs.

"I'll give you a few statistics that we see in Canada that should put this in perspective," he says. "Out of all of the orders that hit Canadian marketplaces today, 90 percent of them disappear within a minute, and not many of them are traded. You might think, okay, a minute isn't too bad; 50 percent disappear within a second, and 20 percent disappear within 10 milliseconds. I wouldn't call that the behavior of a long-term investor, and I wouldn't call it the behavior of a market-maker either. I think it's a sign of something that's going wrong with the market, and activity or volume is not equal to liquidity."

Schmitt is keen to stress that while Aequitas will weed out predatory HFT strategies ─ those that seek to detect orders and trade ahead of them to the originator's disadvantage, or ones that don't add proper liquidity to the market ─ it's not anti-HFT in principle. The practice does add value when utilized properly, he says, and they are only looking to obviate the effects of the more abusive strategies.

Hybrid Approach
Schmitt says that they are "absolutely" still on target for a 2015 roll-out, and now that the amendments to the original business plan have mollified regulatory concerns and been accepted by the firm's backers, the work is beginning on the actual nuts and bolts.

"Since the second half of January, once the funding came in, we've been working on the implementation of the exchange and the private securities markets. Our target dates are the first half of next year, rolling out first the trading platform, then the listings platform, and the final piece will be the private listings platform," he says.

In terms of technology, the exchange is taking a hybrid approach between outsourced provision, and in-house building. That, he says, is determined on a case-by-case basis.

"I've always been of the opinion that, as a marketplace, you should be good at what your business is, but we shouldn't try to be an expert in everything," he says. "So we will outsource a number of components of our solutions, our data centers and our software solution, and leverage expertise around us where it's available. Where it's not available, or where it's an area of key differentiation for us, we'll do it ourselves."

The Bottom Line

• Aequitas is set for a 2015 launch, starting with the trading platform and then sequentially moving through its listings markets. It will use a mix of home-grown technology and outsourced facilities.
• The exchange plans to limit the ability of some HFT firms to engage in what Schmitt describes as technological front-running, or detecting order signals in the market and picking off long-term investors before they can trade. It will do this through a number of mechanisms, including trading fees and speed bumps.
• While it will give advantages to market-making firms, such as execution priority on a percentage of the order flow, there are conditions for this. Market-makers will have an obligation to continuously provide liquidity, even in times of stress, and there will not be payments for liquidity provision, in the form of maker-taker rebates or anything else.