CONFIDENTIAL | CIBC Equity Capital Markets

Eye on ExecutionHeather Killian

Executive SummaryCanadian markets have experienced more than a typical summer slowdown over Q3. Equity market volumes have been some of the lowest we have experienced in years. After a moderate start to the year, volumes have continued to decline over Q3, with year-to-date ADV in senior listed names down just over 10%. On a quarter-over-quarter basis, average daily volumes are down almost 20%. We would anticipate this trend to reverse over Q4 with the customary pickup experienced post-summer seasonality, and September has shown marginal improvement over the previous two months. However, without the return of market volatility or a meaningful market event, it is difficult to imagine significant change.

Some noteworthy market trends/events from Q3, which we review in this note, include:

• Regulatory approval of the TSX market making program

• Official publication of the Nasdaq Canada exchange application which will facilitate product development in market making programs, exchange listings, derivatives trading, and other

• Marketplace developments including new order types, expansion of dark facilities, fee changes and general marketplace competition

• Our take on marketplace pricing models and access fee pilots

• Market trends including market share distribution by venue, interlisted statistics, block share

Canadian market structure dialogue has been focused on the revitalization of market making programs, with the approval of the TMX program. Off-shoots of this discourse include discussions on the importance of queue priority, and topics such as broker internalization and client segmentation. On a global basis, client dialogue continues to focus on the implementation of MiFID II. From a trading perspective, the ability to demonstrate and stand behind best execution will be crucial. In our opinion, access to liquidity will be key, as a client’s list of execution brokers continues to shrink.

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Market microstructure initiatives in the form of new order types, fee changes and general developments have increased this quarter. The TSX has introduced a handful of items/proposals including the expansion of long life order types to the full symbol set, changes to minimum posting sizes in Alpha, regulatory approval for dark trading functionality, limit-on-open order type for use in the opening auction, and approval of changes to their market making program. Nasdaq Canada continues to pursue their exchange medallion which we anticipate will launch early Q2 2018.

We also provide this quarter’s marketplace activity including block share, growth in auction volumes, interlisted and dark pool market share, and Canadian trading fees.

As always, we welcome your feedback.

Marketplace Summary – Q3 2017TSX Listed

Venue Volume % Volume Value % ValueAvg Trade Size (Daily)

Q3 2017 Vol vs. Q2 2017

Vol

Q3 2017 Vol vs. Q3 2016

Vol

2017 YTD ADV vs. 2016

YTD ADV

TSX 16,831,715,627 53.13% 307,736,296,806 54.40% 385 -21.47% -19.57% -15.22%

NASDAQ CXC 4,987,330,278 15.74% 87,641,184,073 15.49% 307 -22.24% -14.53% -4.10%

NASDAQ CX2 1,376,975,988 4.35% 24,034,177,908 4.25% 236 -13.20% 0.84% -6.94%

OMEGA 1,253,961,964 3.96% 25,411,777,331 4.49% 234 -33.22% -28.65% -9.90%

CSE/PURE 544,811,005 1.72% 9,505,948,208 1.68% 346 -18.50% -20.08% -18.12%

Total (PROTECTED) 24,994,794,862 78.90% 454,329,384,326 80.32% 344 -21.84% -18.23% -12.60%

OMEGA LYNX 50,821,400 0.16% 597,882,778 0.11% 312 -19.38% -50.18% -53.36%

AEQTAS LIT 1,917,823,581 6.05% 31,145,428,466 5.51% 1,126 7.41% 10.67% -7.27%

TMX ALPHA (SPEEDBUMP)

1,854,694,614 5.85% 31,680,966,933 5.60% 382 -25.34% -15.45% 2.64%

AEQTAS NEO (SPEEDBUMP)

645,199,400 2.04% 9,861,324,436 1.74% 212 10.64% 11.85% 7.73%

TRIACT MATCHNOW (DARK)

1,967,525,532 6.21% 33,854,409,812 5.99% 359 -14.31% -6.48% 5.91%

NASDAQ CXD (DARK)

161,548,800 0.51% 2,490,549,168 0.44% 501 6.28% N/A N/A

INSTINET ICX (DARK)

12,899,600 0.04% 228,241,592 0.04% 402 -19.62% 73.13% 179.38%

LIQUIDNET (DARK) 72,962,900 0.23% 1,451,967,133 0.26% 58,794 -10.49% -4.05% -0.82%

Total (UNPROTECTED)

6,683,475,827 21.10% 111,310,770,316 19.68% 428 -10.43% -1.61% 1.78%

TOTAL 31,678,270,689 100.00% 565,640,154,642 100.00% 359 -19.68% -15.21% -10.15%

ETFs 3,992,106,475 12.60% 67,858,593,072 12.00%

Non ETFs 27,686,164,214 87.40% 497,781,561,570 88.00%

Source: IRESS, CIBC

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TSX ListedQ3 ADV Q2 ADV Q1 ADV Annual YTD ADV

Q3 2017 ADV = 510,939,850 Q2 2017 ADV = 625,708,862 Q1 2017 ADV = 677,767,088 2017 YTD ADV = 605,422,098

Q3 2016 ADV = 593,013,152 Q2 2016 ADV = 694,963,218 Q1 2016 ADV = 734,111,142 2016 YTD ADV = 673,822,039

Q3 2015 ADV = 527,573,514 Q2 2015 ADV = 517,720,970 Q1 2015 ADV = 628,486,282 2015 YTD ADV = 557,551,607

Q3 2014 ADV = 474,757,618 Q2 2014 ADV = 482,159,227 Q1 2014 ADV = 573,623,704 2014 YTD ADV = 509,842,718

Q3 2013 ADV = 475,723,487 Q2 2013 ADV = 516,194,966 Q1 2013 ADV = 529,047,142 2013 YTD ADV = 506,802,836

Source: IRESS, CIBC

An update on Market Making ProgramsAt the end of August, amendments to the TSX Market Making Program received official approval from the Canadian regulators, and become effective at the end of November. An updated market making guide is expected shortly and ought to include market maker pricing which is still to be determined. It is our understanding that the official launch of the program will apply a phased in approach, beginning with approximately 100-200 securities mid-Q1, 2018. The full roll out of all securities will follow in early summer.

Highlights of this effort to modernize the market maker program include the introduction of a dual market maker on each security assignment, enhancements to the MGF facility, and strict performance obligations on behalf of the market makers. Recall that these programs are heavily geared towards providing incentives to market makers through increased trading benefits which include higher queue priority, participation rights and (retail) client segmentation.

The final proposal included only minor changes from the original publication – specifically for MGF fills to only be executed at the TSX BBO rather than at the Canadian NBBO. In other words, the DMM must be quoting at the best available price (across all marketplaces) in order to receive a fill.

It is our expectation that the next two years will be an interesting time as competition heats up in market making programs amongst bank-owned dealers who are active in this space, electronic providers who pursue local registration, and existing manual market makers who make investments in their technology and capabilities.

Marketplace Pricing ModelsMarketplace pricing models remain one of the more debated aspects of current market structure, and in particular, their impact on order routing behaviours. Marketplace pricing is not a new topic but worthy of mention, in particular with the US (SEC) focus on lowering access fees.

An access fee pilot was officially recommended by the EMSAC (Equity Market Structure Advisory Committee) in early July, and further reinforced later that month through SEC Chairman Jay Clayton’s policy remarks. This pilot is intended to test how adjustments to the access fee cap under rule 610 would affect equities trading. It would provide the commission with data to assess the effects of access fees and rebates on liquidity provision, liquidity taking and order routing. The proposed pilot would lower the access fee cap of 30 cents per 100 shares, to 20, 10 and 2 cents per 100 shares depending on the different (test) buckets of securities. Rebates will not be banned – but they will lower commensurately, as a plan to lower limits on fees that exchanges charge, by extension, reduces how much they pay out in rebates.

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In Canada, the securities regulators pre-emptively addressed access fees and lowered trading fee caps for non-inter-listed securities from $0.0030 per share to $0.0017 per share in April of 2017. Inter-listed securities continue to be capped at $0.0030, though if levels change in US markets then it is expected Canada will follow suit so as not to disrupt the fragile ecosystem that has developed around north and south trading patterns. Canadian regulators did not directly ban rebates, nor did they infer there will be any pilot programs to do so, though they have indicated interest in participating in a US model should that occur.

Industry debate on the use of rebates lingers. Liquidity is not free, and liquidity provision comes at the cost of the risk / reward of contributing to the price discovery process. Overall we are agnostic on the use of rebates in marketplace pricing schedules, however we believe rebates are a transparent way of incenting order flow as all fees are disclosed publicly. The cost of liquidity provision as priced through an exchange pricing model is both transparent and quantifiable. Rebates allow for sub-penny pricing in a way that cannot be approached with current minimum tick sizes, and the supply and demand are a careful balance of what can be earned in the net spread. If rebates are removed, liquidity providers will simply reconstruct their models to capture more spread in place of the rebate.

Here are a handful of suggestions that we might propose in an effort to provide constructive options to the rebate debate:

• Remove / reduce the conflict of interest rebates create between brokers and customers through the use of cost-plus pricing

• Scale rebates such that they are higher for less liquid securities where liquidity provision is most needed and reduce rebates in highly liquid securities

• Introduce tick size variation and reconstruct rebates into intelligent tick sizes

We are curious to hear your thoughts!

Competition Across MarketplacesCanadian marketplaces have had an active quarter in the realm of product initiatives. We include a few of the more notable developments this quarter.

Dark order types on exchangeThe TSX received approval for enhancements to their dark trading functionality in early August. With an official launch of October 23rd. See full details here.

Other lit venues have also been assessing the addition of dark facilities to their marketplaces in order to grow market share. The CSE recently filed a proposal to introduce dark functionality, with the addition of a few more complex order types such as a ‘fade to dark’ order and a ‘step limit’ order. Similar functionality has historically been available via broker algorithms and is now being offered directly by the marketplace.

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In alignment with our previous comments on this topic, we anticipate that growth in competing dark facilities will be slow and will have varying levels of success. Participants need a reason to change current routing behaviour – be that through access to greater liquidity, better pricing, increased client demand, or simply a better mouse trap through improvements in efficiency or workflow. Marketplaces that are able to deliver on this may be able to succeed at growing market share, though MATCH Now continues to dominate this space despite the introduction of competition in recent years.

We note one area of potential review for dark trading may be the appropriate size requirements for at-the-touch trading, which is currently set at 50 standard trading units or have a value of more than $100,000. As market share continues to grow specifically in at-the-touch trading for orders that exceed Canadian dark rules size requirements, we question whether it may be time to review whether these are appropriate levels, or whether they ought to be raised.

Source: Marketplaces, CIBC

Nasdaq exchange medallionAlthough technically not a Q3 development, at the time of publication of this note, Nasdaq Canada has officially published their exchange application for public comment. One of the first developments we will expect from the new exchange will be a competitive market making program, similar to an area of focus we have seen for other Canadian marketplaces. It is also our expectation that Nasdaq Canada will introduce competition in listings and eventually expand trading in other asset classes including derivatives. The power and reach of the Nasdaq brand should assist to attract dual-listings, allowing Canadian companies to raise money and improve exposure in both markets. Completion of their exchange application is a significant step in this process. Based on the timing allowed for public comment, we would anticipate that Nasdaq Canada could be launching as an exchange as early as Q2 2018.

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TSX and TSXV reduction in Market-on-Close (MOC) feesThe MOC facility has historically been a premium priced product for the TMX. After much consultation, the TMX is succumbing to industry pressure and has reduced MOC trading fees, effective November 1st. This commercial gesture has been well received by the trading community.

Market on Close Fee Changes$1 and Over Under $1

Current November 1, 2017 Current November 1, 2017

TSX

fee per share per side $0.0030 $0.0025 $0.0030 $0.0020

maximum per trade per side $30 $25 $30 $25

TSXV

fee per share per side $0.0012 $0.0025 $0.0012 $0.0002

maximum per trade per side $60 $25 $60 $25

TSX and TSX Alpha changes to ETF trading fees In the first price hike we have seen in years, the TSX has proposed an increase in the rebate and take fees for ETFs, effective October 1st. This has pushed TSX ETF fees to the maximum allowable per Canadian regulations, though the spread between active costs and passive rebates remains the same.

By contrast, Alpha rebates have been reduced and the active fee has remained static, thereby reducing the spread between the fees.

TSX Fee ChangesCurrent Effective October 1st

Active Passive Active Passive

Displayed volume interaction – ETFs ($1 and over)

$0.0015 ($0.0011) $0.0017 ($0.0013)

TSX Alpha Fee ChangesEffective October 1st Effective October 1st

Active Passive Active Passive

Displayed volume interaction – ETFs ($1 and over)

($0.0010) Post Only – $0.0016 ($0.0010) Post Only – $0.0014

Non-Post Only – $0.0014 Non-Post Only – $0.0013

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Extension of Long Life to all securities As of October 23rd, long life order types will be available for all TSX and TSXV securities. One of the key benefits of the use of long life orders is improved priority allocation. This is provided in exchange for committing an order to the book for a full second, without being able to cancel or amend.

IIROC Expansion of Client IdentifiersWorking groups on the IIROC proposal for unique client identifiers on all orders to a marketplace have been diligently working behind the scenes. Recall that this initiative is consistent with global programs such as the consolidated audit trail (CAT) in US markets and MiFID II in European markets, where a Legal Entity Identifier (LEI) will be attributed to orders with the goal of enhancing market integrity, protecting investors and addressing electronic trading risks through improved surveillance.

The benefits will need to be weighed carefully against this (potentially) costly undertaking which will require changes to trading systems, workflows including onboarding processes and supervision, and back office systems to name a few impacted areas. Furthermore, with recent headlines on security breaches including the Equifax hack, issues of cybersecurity will need to be seriously considered should this proceed as proposed. The official comment process concludes on November 13, 2017.

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Execution IQ

Canadian Market ShareThe third quarter has been exceptionally quiet. Senior listed market volumes for Q3 are down near 20% quarter-over-quarter, and around 15% relative to Q3 2016. Block share as a percentage of marketplace activity spiked in September as a result of some derivative trading activities which brings the quarterly average up to around 19% of overall volumes. With the exclusion of some of these large derivative transactions, block volumes are closer to historic norms of around 17%.

Source: IRESS

Canadian Market Share by VenueDistribution across venues is gradually shifting. Over the same time period last year, TSX has lost just over 3% market share, which has migrated to a variety of marketplaces.

Per last quarter’s note, Omega had experienced technical issues as they migrated trading engines to a new datacenter. Their resulting loss in market share is visible this quarter, having been picked up primarily by other inverted venues – NEO and CX2.

In particular, the Aequitas venues have shown the largest growth quarter over quarter and this is seen primarily in the trading of one of the marketplace owners, RBC, who appears to have increased their order flow to these venues.

Source: IRESS

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TSX N-CXC MNOW AEQ LIT Alpha N-CX2 Omega AEQ NEO CSE N-CXD LYNXQ3 2016 Q1 2017 Q2 2017 Q3 2017

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Interlisted Market ShareInterlisted market volumes dipped throughout Q3, which is consistent with what was seen across the Canadian marketplace. Share of interlisted securities trading in Canada averaged at 45% over the quarter, with September ticking up as high as almost 49%.

Source: IRESS

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Contact

Heather KillianExecutive DirectorPrime Services – Equity Markets416 594-8149heather.killian@cibc.com