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STRATEGIES
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technology to gather data.
For instance, a trader who knows that the price of gold has changed
in New York can take advantage of a temporary price inefficiency for an ETF tracking a gold index to generate profit.
NEO aims to restore a fair balance between these traders and long- term investors by imposing a delay between the receipt of an order and its execution, particularly for high-frequency traders. “Market makers are much more comfortable placing orders because they know they have time to protect themselves if there’s a market movement,” Schmitt says.
The Investment Industry Regulatory Organization of Canada (IIROC) notes that other trading platforms also offer some form of imposed delay.
Market makers play a vital role
Market makers, who often work at broker-dealers or brokerage firms, play a crucial role in the process of creating and redeeming ETF units and, more important, in determining unit pricing.
ETFs are made up of a basket of underlying securities. The value of this basket fluctuates, which influences the ETF’s price. For a market maker to provide continuous bid or ask quoting, pricing has to be based on the value of the underlying assets plus fees, such as costs related
to the purchase or sale of the basket of underlying securities, stock exchange fees and the cost of foreign currency transactions.
Prices posted on electronic platforms may come from retail orders, but not usually. “For nearly every ETF trade that happens, one side
is the investor and the other side is the market maker,” says Patrick McEntyre, managing director, electronic trading, with National Bank Financial Ltd.
The market maker relies on the exchanges to provide technology that can accept order messages quickly and process a lot of information and traffic, McEntyre says.
“The investor should not shy away from a product based on how fre- quently something trades,” says MacKenzie. “They should feel confident that a market maker is there to facilitate liquidity, and [that] this liquid- ity is based on the underlying investment of that product.”
Ensuring best execution
Advisors often are unaware of the market their ETF will trade in. This decision is up to their dealer, which is required to provide best execution.
Under IIROC Dealer Member Rule 3300, dealers must consider the price, the speed of execution, the certainty of execution and the cost of the transaction.
“For each of these factors, advisors have to know how the dealer exe- cuting the trade will handle their order to ensure best execution,” states an email from IIROC. “While advisors don’t necessarily need to know all the mechanics of the marketplace, they need sufficient understand- ing of the marketplace to be able to enter orders in an informed manner, give appropriate instructions regarding orders and understand how the
dealer will execute those instructions.”
MacKenzie says the advisor should have “the utmost confidence” in
the routing decision made by the broker-dealer.
“There are policies put in place, and those are constantly reviewed by
the broker-dealer to ensure that the best trading practices are in place so the client gets the best price and the ability to get orders completely filled,” MacKenzie says.
While the Canadian Securities Administrators, not IIROC, monitors the activities of exchanges and ATS, IIROC regulates their ETF and equities trading activity. In particular, IIROC administers the Universal Market Integrity Rules and monitors the procedures of trading desks and individuals with market access. Thus, IIROC reviews trades after execution to detect any violations of trading rules and may conduct pre- liminary investigations.
Name Lastname, presi-
Trading ETF options
dent at Company Name here tk
Some advisors and investors buy or sell options on certain ETFs through the Montreal Exchange, which specializes in derivatives.
In July, the number of ETFs and indexes comprising the underlying securities for call or put options was limited to approximately 50. During the first quarter of 2020, volume was concentrated in the following ETF manufacturers: BlackRock
Inc. (73.9%), BMO Global Asset Management (20.5%), Horizons ETFs Management (Canada) Inc. (5.6%) and Vanguard Group Inc. (0.03%).
During this period, iShares S&P/ TSX 60 Index ETF had the highest volume of options, followed by BMO Equal Weight Banks Index ETF, BMO S&P 500 Index ETF and Horizons Marijuana Life Sciences Index ETF.
“Some investment advisors invest in a security or ETF that
is optionable. They think it’s an extra layer of liquidity,” says Alain Desbiens, director, BMO ETFs, Quebec and Atlantic region, with BMO Global Asset Management.
ETFs with options listed to trade are more attractive to
some investors, says Catherine Kee, senior manager, corporate communications and media relations, with TMX Group Inc. The hedging activity of the option market maker should increase the trading, she says.
“It’s important to remember that the amount an ETF trades does not necessarily mean an ETF is more or less liquid,” Kee says. “The liquidity of an ETF is based on the liquidity of its underlying assets.”
ETFs traded on the NEO Exchange are not optionable under a Montreal Exchange-listed derivative, Kee adds.
Jos Schmitt, president and CEO of NEO Exchange Inc., says this hasn’t been a major issue to date.
If options eventually impact NEO’s ability to list an ETF, he says, he will push to allow for options trading on NEO-listed ETFs through Montreal Exchange-listed derivatives.
— Guillaume Poulin-Goyer
IE AD 1-4 page Feb2020.pdf
1 2020-02-27
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