Canada Rising: CNSX Markets Holds Its Own

Amid all the talk of acquisition, fragmentation and regulation, the Canadian National Stock Exchange is carving out its own piece of the pie as it tries to become more than a simple small-cap player.  By Anthony Malakian

[NOTE: Late in the day on June 27 it was announced that Ian Bandeen would be stepping down as CEO of CNSX Markets. Taking on the role of interim CEO would be Richard Carleton, who had previously held the title of vice president of corporate development for Pure Trading. Click here to read a Q&A with Carleton, who spoke with Anthony Malakian immediately after the announcement, and to watch a video of Anthony giving his take on the change at the top, click here.]

The Canadian marketplace is a dichotomy. Its two most noteworthy stories are those of fragmentation and consolidation: The Toronto Stock Exchange (TSX) is no longer the lone exchange in the nation, and, as a result, is the target of a takeover bid by the imperial power that is the London Stock Exchange (LSE).

It is foolhardy to think of Canada as an emerging market—Canadians bristle at the suggestion­—and the LSE’s dogged pursuit of the TSX’s parent, TMX Group, bears that out. Canadians are proud people who desire to be viewed as something different than solely America’s neighbor to the north. But they want cross-border listings, and understand the need to form partnerships with the Yanks.

Canada experienced a bit of schadenfreude after avoiding the storm that crippled Wall Street in 2008, crowing about the country’s principles-based approach to regulation as opposed to the rules-based approach favored by the US. But that doesn’t mean Canada isn’t taking market structure overhaul cues from the US.

As post-financial crisis regulations and the LSE’s battle for the TMX Group dominate the headlines, the Canadian National Stock Exchange (CNSX) carries on trading, accounting for less than 1 percent of the market’s traded volume, while its alternative trading system (ATS) Pure Trading makes up 2 percent, according to IIROC figures for the last four quarters, ending on March 31.

This share of the market is modest at best, but the CNSX plays an important role as the Canadian market has rapidly expanded from basically one exchange to multiple players.

This is its story.

The Insurgent
CNSX Markets was established in 2001, the year that the TSX acquired the Canadian Venture Exchange. As the name suggests, Venture focused on the small-cap portion of the marketplace. To some in the junior capital space, there was a concern that the merger would lead to pricing pains and more difficulty in getting listed and regulated.

Enter the CNSX, the first new Canadian stock exchange in more than 75 years. The Toronto-based startup would try to carve out a niche for itself among Canada’s junior capital space, comprising firms in the oil, gas, base and precious metals, bio-farm and bio-tech industries. The CNSX marketplace was launched in the summer of 2003 and a year later became a fully recognized stock exchange.

The early days were rough for the fledgling trading venue, as they usually are for any venture exchange around the globe. “Listed companies may like your business model, like your prices, and believe in the regulation model, but they tend to use you as a stick to beat the incumbent with,” says Richard Carleton, interim CEO of the exchange. “The idea is that the established exchange—if it has any business sense at all—responds competitively and hangs on to the lion’s share of the business.” That was the sentiment into which the CNSX was born.

After a couple of years of trying to build out the listed business, the CNSX held another round of consultations with the industry. What they established was that while the junior capital space was nice, it wasn’t moving any needles, as the majority of business that gets done from a volume-traded standpoint was conducted on the TSX.

It’s also important to note that there were—and still are—a significant number of Canadian stocks that are inter-listed in the US. American exchanges had superior algorithmic trading capabilities, which meant that most algorithmic trading flow was being executed in the US and was bypassing the Canadian dealer community and public markets.

According to Carleton, when the CNSX spoke with firms like Credit Suisse and Goldman Sachs, the feedback was that, while they’d love to interconnect and try to reach new liquidity pools, latency and capacity issues made this a no-go.

This was the motivation behind Pure Trading, the CNSX’s ATS. Carleton, who had served a stint at the TSX before going into consulting, was hired by the CNSX in late 2005 to build out the technology team for what would become Pure Trading.

Pure was a major change for the Canadian marketplace and represented a significant technology overhaul in the industry, as everything from order management systems (OMSs), data management systems and smart order routers had to be upgraded.

As Ian Bandeen, outgoing CEO of CNSX, puts it, the Canadian marketplace had grown stagnant and complacent in terms of the industry’s infrastructure. This left the door open for Pure to make an immediate dent, something that the CNSX exchange was having difficulty accomplishing.

“One of the biggest problems we faced as a community with the 2007 introduction of multiple markets was that the preceding decade had been characterized by a monopoly exchange provider servicing an oligopoly of bank-owned investment banks,” Bandeen says. “There had been no incentive or need to innovate. By comparison, the Americans had made significant leaps, both in technology and market structure, during that period.”

There were, famously, unsuccessful lawsuits filed by the TSX to prevent the launch of Pure, and soon thereafter, the Omega, Chi-X Canada and Alpha ATSs crashed the party, too. The Canadian marketplace would never be the same.

“Knowing what I now know—I would never recommend starting up a new listing exchange,” Bandeen says. “There are so many entrenched interests, perspectives and regulations to overcome. That said, having endured that and having now achieved acceptability within the community, CNSX has a huge competitive advantage.”

A Dark World
While all the talk in Canada surrounds the LSE–TMX merger, of perhaps more pressing importance is the long-term debate raging around market structure, dark pools and regulation.

Pure and the CNSX are lit markets, as are Omega, Alpha, Chi-X and the TSX Venture Exchange (TSX-V). Currently, the dark liquidity conversation is in its infancy, as only 3 percent of Canadian trade volumes are transacted in the dark. But in June alone, the country saw the addition of two new dark ATSs, and one lit ATS.

As for the CNSX, Carleton says the exchange is fighting against those firms that deal in small retail orders in the dark, as opposed to bulk, institutional orders.

“Our business philosophy is that we’re believers in the auction market process,” Carleton says. “We are trying to present a clean, simple, continuous auction market model that doesn’t have, or doesn’t imbed, dark order types in between the spread. These are the sorts of things that have become commonplace in the US and Ian and I would argue that the US equity structure is a mess, and that a bunch of severe errors were made in years past,” he says.

“In Canada, we have an opportunity to not go down the road where, for example, client flow is being worked over four or five times by an integrator like Knight, Citadel, Getco or ATD; internalized in your proprietary dark pool; or shown to another dark pool where you and other dealers have an opportunity to trade against it,” Carleton says. “Orders that make it out of these processes—the so-called ‘toxic sludge’—are unlikely to contribute to price discovery in any way.”

But in the same way that the CNSX/Pure was once the disrupter of the TSX/TSX-V monopoly, CNSX is now not only battling traditional rivals but also the dark pools themselves. And perhaps of even greater concern to the CNSX is Alpha being granted the right to list stocks, says Omega president and COO, Mike Bignell. “Long-term, if Alpha gets the right to list companies, the CNSX is going to be in for some tough competition because Alpha is able to cook up listings from soup to nuts in that they are affiliated with the banks and perform corporate-finance functions,” Bignell says.

Staying Ahead
To combat these challenges, the CNSX is in the closing stretch of a five-year overhaul of its trading platform, created in conjunction with provider Nasdaq OMX. CNSX is also working with Nasdaq OMX to identify bottlenecks in the system. According to Carleton, the system overhaul is now in production—with about four new releases per year—and is about ready to be delivered.

“We’re coming up to the five-year mark, which is pretty much as long as you want to run something in production in this day and age, so we’re working with Nasdaq OMX to work through the requirements and delivery schedule for the next-generation trading system,” he says.

Additionally, the CNSX is in the midst of deploying appliances from Solace Systems to manage its market data broadcasts. The Solace integration will allow CNSX to insulate the trading system better, Carleton says. While the Solace boxes are currently in production, no clients were connected at press time. Carleton says they are letting the system run for a couple of weeks for gateway testing.

The CNSX is also working on a full upgrade of its backbone network inside the trading system itself. It is looking at an InfiniBand migration for the network and has deployed a variety of Mellanox Technologies switches to provide it with Layer 3 capability, which will help the exchange to support the Solace integration and the migration to InfiniBand.

Last but not least, the CNSX is building out its optimization capabilities in order to relieve strain on its databases, Carleton says. “One of the things that we’re focusing on, away from the real-time capabilities that normally capture most of our attention, is the production databases,” he says. “They are also experiencing a lot of strain as a result of the increased volumes. So we’ve had to do a lot of optimization work—we’re an Informix user—both with the Informix application itself and the hardware platform supporting the database. The simple act of preparing end-of-day files for clearing and settlement, if it takes you 12 hours to do, means you’ve blown the cycle for everybody, which puts a lot of cost and extra manual handling into the system.”

The Future
There is a lot of support for the CNSX throughout the Canadian marketplace, if for no other reason than it helps firms go public, which is good for everybody.

“One thing that they do very well is that their process for going public is much easier with CNSX, which it needs to be with those micro-level companies that can’t afford to be putting out a lot of money with respect to going public,” says Renée Colyer, the CEO of Forefactor, a Toronto-based consultancy. Colyer adds that it helps that the CNSX team comprises former TSX employees. “So that they have experience, they know what they’re doing, and they’ve chosen a business model that bridges the gap in Canada,” she says.

Even Omega’s Bignell agrees with Colyer—with a caveat: “Their strength is that they’re able to get out to the smaller companies and get them on their board,” he says. “The CNSX provides a platform for smaller-cap companies to get into the public eye and raise money. That’s not a bad place to be in a booming economy, and it’s a little tougher when the economy isn’t as robust as it was. The economy is coming back but it’s certainly a tough place to compete for listings.”

For the CNSX and Pure to continue to compete with the likes of the TSX and TSX-V, they will have to make sure their bets on technology—and the listings business—pays off.

“One of our big advantages is that we are an exchange, not just an ATS,” Bandeen says. “This brings both benefits and obligations. Unlike an ATS, we must conduct our business with an eye to what is in the public interest. Luckily, our senior management is united in wanting to fulfill that obligation.”