Background

The implementation of Single-Stock Circuit Breakers is intended to address rapid, significant and unexplained price movement in a particular security that calls into question whether there is a “fair and orderly market” for that security.  In the view of IIROC, market forces should generally drive trading activity without interference by IIROC.  Ordinarily, IIROC will only intervene to vary or cancel a trade in those exceptional circumstances when, in the opinion of a Market Integrity Official, the trade has an impact on a fair and orderly market or otherwise represents a risk to market integrity in accordance with the internal policies and procedures of IIROC respecting “erroneous and unreasonable orders and trades”.3

In order to provide greater public transparency, IIROC has issued proposed guidance on certain of the circumstances in which IIROC may undertake discretionary regulatory intervention under Rule 10.9 of UMIR in order to vary or cancel a trade.  See IIROC Notice 10-0331 – Rules Notice – Request for Comments – UMIR – Proposed Guidance on Regulatory Intervention for the Variation or Cancellation of Trades (December 15, 2010).  IIROC expects to publish in the near future the summary of comments and responses together with a request for comments on the revised draft guidance.

Single-Stock Circuit Breakers are intended to operate as part of a multi-tiered approach to controlling short term, unexplained price volatility.  Each set of controls will ultimately play an important role in the overall framework designed to mitigate the risks associated with “unexplained short term price movement” and promote “fair and orderly” markets.  The report on the market events of May 6, 2010 undertaken by IIROC (“May 6 Report”) recommended that steps be taken to review or enhance each level of control together with IIROC’s policy for regulatory intervention for the cancellation or variation of trades.4

The four identified levels of control are described briefly below:

• The first set of controls is currently at the Participant level with Participants required, under Policy 7.1 of UMIR, to have in place policies and procedures reasonably designed to ensure that trading is carried out in compliance with the applicable requirements, which include provisions of securities legislation, UMIR, the Trading Rules and the Marketplace Rules.5  As a result of the findings in the May 6 Report, IIROC issued additional guidance on best execution and management or orders and on the use of certain order types (particularly “Stop Loss Orders” that are entered as market orders when triggered and which played a role in the price declines on May 6, 2010).6  The Canadian Securities Administrators have proposed to augment these requirements in a new national instrument governing electronic trading by marketplace participants and their clients that would introduce specific obligations for direct electronic access (“DEA”).7
• The second set of controls would be at the marketplace level with each of the marketplaces expected to have effective volatility parameters in place that would detect “erroneous orders” prior to execution.8
• The third level of controls is Single-Stock Circuit Breakers. 
• The fourth set of controls are market-wide circuit breakers which would trigger and halt trading on all marketplaces when there are declines in prices which affect the market generally.9

Given the “tiered” nature of these controls, the content of the requirements at each level must be co-ordinated to ensure that there are no readily identifiable gaps and that each set of controls is capable of “working” effectively in conjunction with the other levels.  Market integrity requires that there be a “fair and orderly market” in the trading of all listed securities.  Notwithstanding the introduction of Single-Stock Circuit Breakers, IIROC retains the discretionary power to intervene, if required, to ensure a “fair and orderly market” in the trading of a listed security when:

• the security is not subject to Single-Stock Circuit Breakers; and
• the security is subject to Single-Stock Circuit Breakers but the breaker has not been triggered.

Summary of Single-Stock Circuit Breakers

Until changed with the issuance of a future Rules Notice, Single-Stock Circuit Breakers:

• apply to:
  • each security that is a constituent of the S&P/TSX Composite Index,10 and
  • each Exempt Exchange-traded Fund the assets of which is comprised principally of listed securities; 11
• provide for a trigger level such that there would be a halt in the event of a price increase or decline of at least 10% in a 5 minute period;
• apply from 9:50 a.m. to 3:30 p.m.;
• provide an initial halt of 5 minutes that may be extended for a further 5 minute period;
• exclude from the trigger calculation prices of trades that may execute outside the “best bid – best ask” spread; and
• would result in the cancellation of any trade that executes at more than 5% beyond the trigger price.

Operation of Single-Stock Circuit Breakers

Securities Covered

Single-Stock Circuit Breakers applied to securities in a broad-based index12 dampens extreme volatility in those securities and, by extension, the volatility of the level of the index in which they are included.  In turn, this lessens the possibility that a malfunction or trading error in a few securities is interpreted as a broad-based market decline by index observers.  For this reason, until changed with the issuance of a future Rules Notice, Single-Stock Circuit Breakers will apply to:

• each security that is a constituent of the S&P/TSX Composite Index; and
• each Exempt Exchange-traded Fund the assets of which is comprised principally of listed securities.

Circuit Breaker Trigger Points

A Single-Stock Circuit Breaker would be triggered for a particular security in the event of a price increase or decline, in a five-minute period, of at least 10%.  For the purposes of determining price increase or decrease, IIROC will compare each trade price of a security on a Canadian marketplace (the potential “triggering” trade) to a reference price.  For the purposes of this calculation, the “reference price” will be any transaction in that security in the five-minute period immediately preceding the potential “triggering” trade.  Generally speaking, IIROC will look to transactions that establish either a “high” or “low” price during the relevant five-minute period in determining the “reference price”. 13  If the last sale was more than five minutes earlier, no reference price will be calculated and the Single-Stock Circuit Breaker would not trigger. 

The price of any trade which is permitted by UMIR or by the Order Protection Rule in National Instrument 21-101 to be executed outside of the “best bid” – “best ask” spread will not trigger a Single-Stock Circuit Breaker nor will it be used in calculating price movement for the purpose of establishing a “trigger” point.14  Prices of trades (other than the execution of the types of orders described) that execute on dark marketplaces are included in the calculation of the triggering price in the same way that these trades are currently included in the calculation of the “last sale price” under UMIR.

Length of Trading Halt

The security would be halted for a period of five minutes following the triggering of a Single-Stock Circuit Breaker, subject to the ability of a Market Integrity Official to extend the halt by a further five minutes, if a significant imbalance of buy and sell order remains.   

If during the five- or ten-minute (as applicable) halt, IIROC determines that a further halt is required, for instance to facilitate the dissemination of material news that may have leaked into the market, IIROC would send an electronic notice to market participants and replace the Single-Stock Circuit Breaker halt with a traditional “regulatory halt”. 

Unless such an electronic notice is released by a Market Integrity Official, each marketplace is able to resume trading at the expiry of the five- or ten-minute period.  Immediately following the imposition of the halt following the triggering of the Single-Stock Circuit Breaker, marketplaces would prepare for the resumption of trading by either:

• entering a “pre-open” state to allow for order entry and the dissemination of an indicated “calculated opening price”; or
• permitting order entry and using a “shotgun” opening at the resumption of trading.15

Trading Hours during which Circuit Breakers may be Triggered

Single-Stock Circuit Breakers will be active between the hours of 9:50 a.m. and 3:30 p.m.  Trading in the first twenty minutes following the regular opening and for the last thirty minutes before the close of regular trading would not be subject to a halt under a Single-Stock Circuit Breaker as IIROC is of the view that these periods of natural volatility should be excluded from the application of circuit breakers.  Excluding this period will avoid the unnecessary triggering of a Single Stock Circuit Breaker due to overnight developments that should not give rise to a trading halt, including foreign market movements, issuer news releases, geo-political developments, anticipated spikes in demand and/or supply or index events.

During these periods when the Single-Stock Circuit Breaker is not active, existing measures designed to facilitate orderly openings and closings - including the ability of a Market Integrity Official to impose a regulatory halt - will continue to apply. 

Handling Trades Executed after the Trigger of a Single-Stock Circuit Breaker

IIROC expects, given the volume and speed of trading in the current market, that some trades will occur after the triggering of the circuit breaker but prior to the invocation of the trading halt across all Canadian marketplaces.16  A Market Integrity Official would use their authority granted under Rule 10.9 (d) of UMIR to cancel any trade that is more than 5% beyond the calculated trigger price, as these trades are clearly in a zone where a person would not have had a reasonable expectation of execution at that time.

For greater clarity, the chart illustrates the treatment of trades occurring immediately following the triggering of a Single-Stock Circuit Breaker and prior to the invocation of the trading halt based on a 10% price movement to trigger the Single-Stock Circuit Breaker and a further price movement of 5% before the cancellation of a trade.

Special Circumstances

There are certain circumstances when a Single-Stock Circuit Breaker should not be triggered even though there may be the requisite movement in market prices over the specified period of time.  In particular, a Single-Stock Circuit Breaker will not be invoked for a particular security under any of the following circumstances that may take place during the trading day:

• after the “general” circuit breakers have been triggered (as the invocation of the general circuit breaker indicates that there is a prevailing market sentiment which is not related to liquidity issues for that particular security);
• after a Single-Stock Circuit Breaker has been invoked for that security (as the previous invocation of the circuit breaker should have acted as a warning to the market that there may be liquidity issues with that particular security and that market participants should be monitoring trading developments in the security); and
• after the imposition of a “regulatory halt” in the trading of that security, particularly when the halt has been imposed to permit the dissemination of “material news” (as the market should be allowed to react to the news provided that the news has been properly disseminated in accordance with applicable securities legislation and marketplace requirements).

• 3In  order  to  provide  greater  public  transparency,  IIROC has  issued  proposed  guidance  on certain  of  the  circumstances  in  which  IIROC  may undertake discretionary regulatory intervention under Rule 10.9 of UMIR in order to vary or cancel a trade. See IIROC Notice  10-0331 – Rules Notice – Request for Comments – UMIR – Proposed Guidance on Regulatory Intervention for the Variation or Cancellation of Trades (December  15,  2010). IIROC  expects  to  publish  in  the near  future  the  summary  of  comments  and  responses  together  with  a  request for comments on the revised draft guidance.
• 4See IIROC News Release – IIROC announces results of regulatory review of May 6 trading in Canadian equity marketplaces (September 9, 2010). 
• 5Market Integrity Notice 2005-011 – Notice of Amendment Approval - Provisions Respecting Manipulative and Deceptive Activities (April 1, 2005), made effective a number of amendments to UMIR, including an amendment to Policy 7.1 to clarify that Participants have supervisory and compliance responsibility for all client orders irrespective of the source of the order or the means by which the order is transmitted to a marketplace.  For guidance on the current compliance requirements under UMIR for a Participant that provides a client with “Dealer-Sponsored Access”, commonly known as “direct market access”, see Market Integrity Notice 2007-010 – Guidance - Compliance Requirements for Dealer-Sponsored Access Trading, (April 20, 2007).
• 6IIROC Notice 11-0113 – Rules Notice – Guidance Note – UMIR –Guidance on Best Execution and Management of Orders (March 30, 2011) and IIROC Notice 11-0114 – Rules Notice – Guidance Note – UMIR – Guidance Respecting the Use of Certain Order Types (March 30, 2011).
• 7Notice of Proposed National Instrument 23-103 – Electronic Trading and Direct Electronic Access to Marketplaces, (2011) 34 OSCB 4133 (April 8, 2011).  Under the proposed National Instrument, marketplace participants would have to have appropriate policies, procedures and controls in place that ensure that the risks associated with electronic trading and DEA are prevented or managed.  The requirements would apply to all electronic trading whether performed by the marketplace participant or by a client that has been granted DEA.
• 8Canadian marketplaces currently employ a variety of mechanisms to limit risks associated with “erroneous” or “fat finger” orders impacting the price of a particular security at the marketplace level.  See “Canadian Marketplaces Volatility Controls – Freeze Parameters, Reject Parameters and Collars” in IIROC Notice 10-0298 – Rules Notice – Request for Comments – UMIR – Proposed Guidance Respecting the Implementation of Single-Stock Circuit Breakers(November 18, 2010).  Under section 15 of the proposed National Instrument 23-103, marketplaces would be required to prevent the execution of orders exceeding price and volume thresholds set by a regulation services provider.  Prior to the approval of the proposed National Instrument, IIROC expects to issue a request for comments soliciting input on the appropriate approach for marketplace volatility parameters.
• 9Market-wide circuit breakers are currently co-ordinated with the triggering of market-wide circuit breakers in the United States.  In light of proposed changes to the market-wide circuit breakers in the United States, IIROC has issued a request for comments soliciting input on the appropriate parameter for triggering market-wide circuit breakers in Canada.  See IIROC Notice 11-0359 – Rules Notice – Request for Comments – UMIR – Request for Comments on Market-wide Circuit Breakers for the Canadian Marketplace (December 13, 2011).
• 10A description of the S&P/TSX Composite Index is available at http://www.tmx.com/en/pdf/0000Description.pdf
• 11In UMIR, an “Exempt Exchange-traded Fund” means a mutual fund for the purposes of applicable securities legislation, the units of which:
  (a) are a  listed security or a quoted security; and
  (b) are in continuous distribution in accordance with applicable securities legislation but does not include a mutual fund that has been designated by the Market Regulator to be excluded from the definition. 
  To date, no security has been designated to be excluded from the definition. Until such time as all Exempt Exchange-traded Funds are included in the Single-Stock Circuit Breaker program, IIROC would propose to publish on its website a list of those Exempt Exchange-traded Funds that are subject to being halted by the triggering of a Single-Stock Circuit Breaker.
• 12Based on trading statistics for 2010, approximately 80% of the value of securities traded on Canadian equity marketplaces is in securities included in the S&P/TSX Composite Index.
• 13Price movements will be calculated by comparing each trade price of a security on a Canadian marketplace (the potential “triggering trade”) to a reference price.  For purposes of this calculation, the “reference price” will be any transaction in that security that takes place in the five-minute period immediately preceding the potential “triggering trade”.  Generally speaking, IIROC will look to transactions that establish a low or a high price during the relevant five-minute period in determining the “reference price”.   Where the price of the triggering trade differs from the reference price by more than 10% (or 20%, as applicable), IIROC will propose that the price of the triggering trade be varied to the “calculated trigger price”, which, in all cases, would be either 10% or 20% away from the reference price.
• 14This exclusion would cover executions resulting from an Opening Order, Market-on-Close Order, Closing Price Order, Call Market Order, Volume-Weighted Average Price Order, a Basis Order and a Special Terms Order (unless the Special Terms Order has executed against an order or orders that are not Special Terms Orders).
• 15In either case, the first execution on each marketplace would qualify as an execution from an Opening Order.
• 16Until the Single-Stock Circuit Breaker is fully-automated, trading will continue on each marketplace until the trading halt has been coordinated and imposed.  It is difficult to estimate the period of time required to actually halt trading in circumstances when circuit breakers are triggering in succession for a series of securities.