Restrictions on Recorded Prices

Rule 7.5 of UMIR provides that the price of trade attributed to a client by the Participant acting as principal may vary from the price which is recorded on the marketplace provided that the recorded price is:

• in the case of a sale to a client, not higher than the net cost1 to a client, or not lower than the net cost to the client by more than the usual agency commission that would be charged by that Participant to that client for an order of the same size; and
• in the case of a purchase from a client, not lower than the net proceeds2 to the client, or not higher than the net proceeds to the client by more than the usual agency commission that would be charged by that Participant to that client for an order of the same size.

Participants are prohibited from providing a “negative commission” to a client.  A negative commission would occur if:

• in the case of a client buy order, the recorded price is higher than the net cost to the client; and
• in the case of a sell order, the recorded price is lower than the net proceeds to the client.

A “negative commission” would allow a client to complete the transaction at a price that could not otherwise be achieved in the open market.  The “negative commission” would permit the transaction effectively to trade-through better-priced orders displayed on one or more marketplaces.

Guaranteeing the Price of a Trade

A Participant may be asked by a client to accept as principal an order to be executed later in the trading day at a guaranteed price that will be determined by an event which will occur later in that trading day.  The Participant may be asked to guarantee a trade at:

• the closing price of a security on a particular marketplace;
• a volume weighted average price (“VWAP”) calculated during a specific period during a trading day; or
• any other benchmark price which has been approved by the Investment Industry Regulatory Organization of Canada (“IIROC”).

A Participant who agrees to, as principal, take on a guaranteed trade referenced to a future benchmark event, would in the normal course hedge their principal exposure during the trading day.  Later in the trading day, after the benchmark price is available and the guaranteed price has been established, the Participant would print the trade on a marketplace at the agreed upon guaranteed price. 

Any price guaranteed to a client that would vary from the price recorded on the marketplace by more than the amount permitted by Rule 7.5 of UMIR would require a Participant to “move the market” to a price that would comply with Rule 7.5.

Profit Sharing

If a Participant agrees to guarantee a trade price to a client based on a benchmark price not yet established, the Participant would, in the normal course, hedge its principal position.  Through these hedging activities, a Participant may achieve a better price than the price guaranteed to the client.  IIROC is of the view that the Participant may, under those circumstances, agree to share any resulting profit to the extent that the average price of the Participant’s:

• purchases to hedge its position are less than the price guaranteed to the client on the client’s purchase from the Participant; and
• sales to hedge its position are more than the price guaranteed to the client on the client’s sale to the Participant.

IIROC would consider a Participant sharing up to 50% of the profits it earned through its hedging activities, related directly to the guaranteed price trade to the client, as reasonable and would not consider this to be an attempt to provide a “negative commission” to the client or otherwise avoid the application of Rule 7.5.  The profit sharing agreement between the Participant and its client cannot be designed as an attempt to provide a trade price that would not otherwise be permitted by Rule 7.5.

Guaranteed Outperformance

On occasion, a Participant may wish to guarantee a trade, as principal, at a trade price that “outperforms” a benchmark price prior to the Participant undertaking any hedging activities specific to that client order and prior to the benchmark price being established.  Similar to profit sharing, IIROC is of the view that guaranteeing outperformance, based on “reasonably determinable” criteria or for a minor amount, is not an attempt to provide a client a “negative commission” or otherwise avoid the application of Rule 7.5.  IIROC is prepared to accept that a Participant may guarantee outperformance up to a maximum of the greater of:

• 50% of the Participant’s historical realized outperformance of the same benchmark over the prior calendar quarter; and

• 25 basis points.

To establish what is “reasonably determinable” a Participant is expected to refer to its historical hedging activities over the preceding calendar quarter relating to the same or substantially similar securities relating to the same benchmark as that referenced in the client order.  The demonstrated level of outperformance against the benchmark that the Participant historically achieved would be considered “reasonably determinable” for the purposes of this guidance.3

IIROC would expect that a Participant that intends to offer guaranteed outperformance trades would have policies and procedures in place to ensure compliance with the criteria described in this guidance. 

Notification Requirement

Immediately upon a Participant agreeing to guarantee the price of a trade to a client, the Participant must provide written notice to IIROC.  If a VWAP is to be guaranteed, the calculation period may not commence earlier than the time at which the order was received from the client.  If any types of trades are to be excluded from the calculation of the VWAP, those trade types must be identified in the notice provided to IIROC.

The written notice must indicate:

• the security;
• whether the trade will be a purchase or sale by the Participant;
• the volume of the trade;
• the method of determining the price which the Participant will be guaranteeing.  For example:
  • the closing price of a security on a particular marketplace,
  • a VWAP calculated for a specific period during a trading day on one or more identified marketplaces and excluding specific types of trades, or
  • any other benchmark price which has been approved by IIROC;
• the details of any profit sharing agreement entered into between the Participant and the client with respect to the trade;
• the details of any guaranteed outperformance, including the amount of outperformance being guaranteed; and
• the time and the marketplace on which the trade will be executed.

The written notice should be sent to IIROC at:

• Market Regulation, Eastern Region by e-mail addressed to surveillance@iiroc.ca or by fax to 416-646-7261; or
• Market Regulation, Western Region by e-mail address to surveillancewest@iiroc.ca or by fax to 604-602-6986.

Prior Approval of IIROC 

The Participant must obtain IIROC approval PRIOR to the Participant and the client agreeing to the trade, if the Participant and the client intend to:

• use a benchmark other than the closing price or a VWAP; or
• enter into a profit sharing agreement under which more than 50% of any profit will be shared with a client; or
• guarantee outperformance which exceeds the greater of:
  • 50% of the Participant’s historical realized outperformance of the same benchmark over the prior calendar quarter, and
  • 25 basis points.

Questions and Answers

The following is a list of the “most frequently asked” questions regarding the use of certain order types in achieving “best execution” in the context of recent developments in Canadian market structure and the response of IIROC to each question:

1. Can I guarantee a price that references a benchmark other than Closing Price or VWAP?  
   
   The guaranteeing of a trade price referenced to a benchmark other than VWAP or closing price requires IIROC approval.  Approval must be obtained PRIOR to the Participant and the client agreeing to the trade. 
2. Can I guarantee outperformance when I have not historically outperformed the benchmark while undertaking hedging activities?
   
   Every Participant will be able to guarantee outperformance of 25 basis points.  Guaranteed outperformance in excess of that amount can only be provided by a Participant who has demonstrated an historical ability to outperform the same benchmark, as contemplated in the client order, through hedging a principal position of substantially similar securities.  IIROC would expect that historical performance would be demonstrated by reference to the preceding calendar quarter.
3. In order to provide “guaranteed outperformance” what policies and procedures am I expected to have?
   
   A Participant who intends to offer guaranteed outperformance of a benchmark when taking on a client trade as principal would be expected to have reasonable policies and procedures in place to monitor the amounts of “outperformance” being guaranteed and to ensure that these amounts are consistent with historical hedging performance if the guarantee is for more than 25 basis points.  A Participant who provides “guaranteed outperformance” would also be expected to include this activity in its “supervision of trading” policies and procedures as required under Rule 7.1 of UMIR.  These policies and procedures are subject to review by IIROC during a Trade Desk Review. 
4. Can I guarantee outperformance of 50 basis points if this is consistent with my historical outperformance?
   
   Yes.  The maximum amount of outperformance a Participant may offer is limited to the greater of 50% of historical outperformance achieved through its hedging activities and 25 basis points.  A Participant wishing to guarantee more than that amount would be required to obtain IIROC approval prior to agreeing to the trade with the client. 
5. When I “print” the trade on a marketplace, do I use the trade price of the actual benchmark, or do I adjust the trade price to reflect any profit sharing or “outperformance”?
   
   If marketplace functionality exists, the “print” on the marketplace would be done at the actual net price to the client, including any amount of outperformance provided.  The net trade price contracted to the client would match the printed price on a marketplace.  If marketplace functionality does not support the printing at the net price to the client, a Participant would be permitted to print the trade at the actual benchmark price.  In all cases, the resulting trade to the client must be printed on a marketplace in accordance with Rule 6.4 of UMIR.
6. Can I offer both a guarantee of outperformance AND a profit sharing arrangement on the same transaction?
   
   Yes.  A Participant is always able to guarantee price improvement of a minimum of 25 basis points.  However, the maximum price improvement that can be provided to a client is limited to the greater of:

• 50% of the Participant’s historical realized outperformance of the same benchmark over the prior calendar quarter; and
• 50% of the profits earned through hedging activities on the particular transaction.

• 1“Net Cost” means the amount by which the sum of the total cost of the trade on the purchase of securities based on the purchase price on the marketplace and any commission charged to the client by the Participant exceed the amount of any allowance, discount, rebate and any other benefit with a monetary value that is allowed to the client on the trade by the Participant or any other person.
• 2“Net Proceeds” means the amount by which the sum of the total proceeds of the trade on the sale of securities based on the sale price on the marketplace and the amount of any allowance, discount, rebate and other benefit with a monetary value that is allowed to the client on the trade by the Participant or any other person exceeds any commission charged to the client by the Participant.
• 3Subsection (2) of section 38 of the Securities Act (Ontario) prohibits, with the intention of affecting a trade, any undertaking related to the future value or price of a security. The concept of “guaranteed outperformance” does not provide any guarantee relating to the future value or price of a particular security. “Outperformance”, for the purpose of this Guidance Note, refers to a Participant’s execution ability based on “reasonably determinable” (i.e. a historic “look-back”) criteria or the guarantee of a minor amount which is acceptable to IIROC (25 basis points better than the benchmark).