How to Trade in Canada

Researched and written by:

How to Trade in Canada Prepared for NYSE TECHNOLOGIES by ITG CANADA CORP.

Sept. 30, 2011

An industry briefing prepared by ITG for:

Table of Contents: Introduction to Canadian Markets........................................................................ 2 Regulatory Structure...................................................................................................4 Securities Commissions...............................................................................................4 Member and Market Regulation.................................................................................5 Proposed National Securities Regulator.....................................................................6

Registration.....................................................................................................................8 IIROC PO Types & Capital Requirements:.................................................................8 Exempt Market Dealers (“EMD”)..............................................................................12

Canadian Marketplaces...........................................................................................13 Evolution of Canadian Exchanges.............................................................................13 Development of the ATS Rules.................................................................................14 The Current Trading Landscape in Canada.............................................................16

Trading Access............................................................................................................19 Trading Regulations..................................................................................................20 Proposed Rules...........................................................................................................23 Taxation..........................................................................................................................27 Indexes and ETFs......................................................................................................28 Derivatives.....................................................................................................................31 Clearing..........................................................................................................................33 Introducing NYSE Technologies’ Compute On Demand........................... 34 Customer Challenges.................................................................................................34 Solution Benefits........................................................................................................35

About NYSE Technologies..................................................................................... 36 About ITG..................................................................................................................... 37 Although prepared for NYSE Technologies by ITG, the views, concepts and information set forth in “How to Trade in Canada” are solely those of ITG and references to “we”, “our” and similar terms refer to ITG or its affiliates. Except for the description of NYSE Technologies’ Compute on Demandsm solution, and the “About NYSE Technologies” section neither NYSE Technologies nor its affiliates adopt, endorse or control the content contained in “How to Trade in Canada”, and do not recommend, or make any representation as to the risks or benefits from, any securities or investments, or third-party products or services. Investors should undertake their own due diligence regarding securities and investment practices.

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Introduction to Canadian Markets Canada currently has the 9th largest economy in the World – as measured by the G20. It is a member of the Group of Eight (G8) as well as the Organization for Economic Cooperation and Development (OECD).

Traditionally an economy built on mining, forestry and fishing, the Canadian economy has seen a shift towards energy and services (including both financial services and transport) over the past several years. (This is very much in line with shifts we have seen in many developed economies over the past decade or so). This bias towards financial services and energy is very evident in the makeup of Canadian listings and trading.

The Canadian economy and banking system have outperformed other G8 nations during and after the financial crisis of 2008, and have benefited from the perceived safety of their financial institutions and markets. That said, both employment growth and GDP were negative for several quarters during the crisis.

Figure 1: Canadian GDP and Employment Rates

annual percent change 5 4 3 2 1 0 -1 -2 -3 -4 -5

2006

2007 Employment

2008 GDP

2009 Leading indicator (monthly percent change) Source: Statistics Canada

In a recent study of G7 countries by IMF economists, Canada was lauded for its fiscal policies and described as a “beacon for what it takes to get out of a fiscal mess�1. In particular, the IMF cited two things which Canada was able to accomplish: first, they established public support for austerity and second, they developed an ambitious plan with specific changes to the way that government operated such as changes to unemployment insurance and a reduction in transfer payments to the provinces.

1 Chipping Away at Public Debt: Sources of Failure and Keys to Success in Fiscal Adjustment, edited by Paolo Mauro, 2011

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Canadian Listed Issuers The TMX Group has the second highest number of listed companies of any exchange group in the world, with over 3,600 listed issuers. As of December 2010, those issuers had a market capitalization in excess of C$2.3 trillion. TMX Group operates the Toronto Stock Exchange (TSX), Canada’s senior equity exchange which has 1,485 listed issues with a market capitalization of $1.9 trillion and the TSX Venture Exchange (TSXV), serving junior equities with 2143 listed issues and market capitalization of $48.5 billion.

Both the Energy and Finance sectors make up over 30% of the value of the listings, and value traded daily, while the number of listings is dominated by the mining sector which accounts for more than 45% of the issuers.

In 2010, the TSX’s volume traded was 104,555,199,337 shares for a value of $1,390,747,798,461 representing 189,117,628 trades. The TSXV traded 67,887,794,824 shares with a value of $34,358,151,228, representing 9,226,926 transactions 2.

Figure 2: Market Capitalization of Issuers by Sector

Oil & Gas 18%

Diversified Industries 14%

Communications & Media 6% Utilities & pipelines 5% ETFs & Structured Product 4% Real Estate 3%

Financial Services 22%

Technology 2% Other 2% Clean Technology 1% Mining 23%

TMX Group Annual Report 2010

2 TMX Group Annual Report 2010

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Regulatory Structure Securities Commissions Canada is one of the few countries in the developed world that does not have a national or federal securities commission. Historically, securities regulation in Canada was considered a provincial matter with individual provinces having their own securities acts or legislation. Each of the 10 Canadian provinces and the three territories continue to be responsible for their own securities regulation and have their own securities regulators 3.

For the last 45 years there have been multiple studies on how and why Canada needs a single Securities Regulator, yet there has been political resistance from a number of provinces and interest groups.

In order to provide harmonized securities regulation across the country, the securities regulators from each province and territory formed the Canadian Securities Administrators (CSA)4. The CSA is a voluntary umbrella organization of Canada’s provincial and territorial securities regulators whose objective is to improve, coordinate and harmonize regulation of the Canadian capital markets.

The members of the CSA seek to streamline the regulatory process by collaborating with each other on the formation of rules and regulations. The CSA has also developed a “passport system” through which a market participant has access to markets in all passport jurisdictions by dealing only with its principal regulator and complying with one set of harmonized laws.

The ten provinces and three territories in Canada, each have their own Securities Act and Securities Commissions or regulatory government departments. Thankfully, the Acts are largely harmonized in content, and there are an increasing number of National Instruments and National Policies which make it somewhat simpler for registrants and issuers to comprehend. The umbrella organization, the CSA5, although powerless from a legislative perspective, effectively administers the harmonization of various policies, instruments and orders such as Cease Trade Orders (“CTO”): While there are several provincial commissions, these four are seen as the key influencers: Ontario Securities Commissions (“OSC”) http://osc.gov.on.ca/en/home.htm Alberta Securities Commission (“ASC”) http://albertasecurities.com/Pages/Default.aspx British Columbia Securities Commission (“BCSC”) http://www.bcsc.bc.ca/ Quebec’s Autorité des Marchés Financiers (“AMF”) http://www.lautorite.qc.ca/en/index.html The OSC is seen as especially critical since all but one securities marketplaces are domiciled in Ontario, and the TSX Venture, while domiciled in British Columbia, is a subsidiary of Ontario based TMX Group. The TMX also owns the Montreal Bourse where, due to an historical agreement, derivatives are traded solely in Quebec.

3 These include the Alberta Securities Commission, British Columbia Securities Commission, Manitoba Securities Commission, New Brunswick Securities Commission, Ontario Securities Commission, Nova Scotia Securities Commission, Autorite des Marches Financiers (Quebec), Saskatchewan Financial Services Commission and the applicable departments for securities regulation in Newfoundland and Labrador, Prince Edward Island, Northwest Territories, Nunavut and the Yukon Territories 4 Introduction to the Canadian Securities Administrators http://www.securities-administrators.ca/uploadedFiles/General/pdfs/CSAPresentation20110704VF.pdf 5 http://www.securities-administrators.ca/

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Member and Market Regulation Prior to 2002, exchanges were responsible for regulation of their own markets. Two major changes in 1999 and 200 drove the need to establish an independent and neutral body to regulate trading across various markets. In 1999, the TSE, MSE, Alberta and Vancouver exchanges were restructured and formed 3 separate markets – one for senior equities (TSX), one for derivatives (ME) and a junior exchange (VSE/ASE which was later acquired by TSX and became TSXV). The following year, the TSE demutualized. At the same time, Canada’s regulators were forming a new regulatory framework to allow for the entry of new alternative markets to compete with exchanges. Market Regulation services (known as RS) was established in 2002 to provide an independent regulatory entity to provide regulation services to a variety of marketplaces. Member regulation at this time fell under the jurisdiction of the Investment Dealers Association (IDA).

In 2008, The Investment Industry Regulatory Organization of Canada (IIROC) was formed through the consolidation of Market Regulation Services Inc., and the Investment Dealers Association of Canada, under a recognition order from the CSA. IIROC is the Self Regulatory Organization (“SRO”) which oversees both member regulation of Participating Organizations (“PO”) and Alternative Trading Systems (“ATS”) & Marketplace Trading Rules known as “Universal Market Integrity Rules” (“UMIR”) is granted authority by the commissions. IIROC is the Canadian equivalent of the USA’s FINRA. IIROC carries out its regulatory responsibilities through setting and enforcing rules regarding the proficiency, business and financial conduct of dealer firms and their registered employees. As an SRO, IIROC is subject to oversight and regular operational reviews by the CSA. IIROC has established the Universal Market Integrity rules (UMIR) which govern all trading activity on Canadian equity marketplaces. IIROC enforces these rules by imposing sanctions for contraventions UMIR, including fines and suspension or restriction of market access.

The rule making process in Canada can be lengthy due to the regulatory structure.

Changes to UMIR rules by IIROC must be approved by the CSA. In addition, national rules and policies which are established by the CSA will be published for comment (usually for 60 to 90 days) and prior to being finalized by each member of the CSA. IIROC currently regulates securities trading on the following exchanges and ATSs in Canada: The Toronto Stock Exchange (TSX); Toronto Stock Exchange Venture (TSXV) and TMX Select (all part of TMX Group), CNSX Markets, ALPHA ATS (has applied for exchange status), CHI-X Canada, Instinet Canada Cross, Liquidnet, MATCH Now, Omega ATS, PURE Trading.

Listing services are currently provided by exchanges only. Exchanges are responsible for monitoring compliance by listed companies with the terms of Exchange listing agreements and policies. Where appropriate, they can deny pre-approval of certain transactions, require corrective disclosure, halt or suspend trading and, in egregious cases, or even terminate a listing.

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The Canadian Depository for Securities (CDS) CDS is Canada’s national securities depository, clearing and settlement hub supporting Canada’s equity, fixed income and money markets. It holds over $3.5 trillion on deposit and handles over 320 million domestic securities trades annually. Virtually all of these securities are in electronic format. CDS also provides international gateways and settles 40 million cross-border transactions with the U.S. annually and has custodial relationships with the Depository Trust Company, Euroclear France, JASDEC and Skandinaviska Enskilda Banken AB. CDS is regulated by the Ontario and Quebec Securities Commission and the Bank of Canada with working and reporting relationships to the Canadian Securities Administrators (CSA) and other provincial securities regulators and the Office of the Superintendent of Financial Institutions (OSFI).

Proposed National Securities Regulator In June 2009, the Government of Canada launched an initiative to establish a single Canadian securities regulator to replace the existing system of provincial and territorial securities regulators. A number of attempts to establish a national regulator have been stalled by political and territorial disagreements over jurisdiction.

However, the recently proposed version of a National Securities Regulator has gained traction for a variety of reasons: 1. Recent global financial disasters have highlighted the need to reduce systemic risk, and a single regulator, while not a panacea, would certainly provide consistency of approach throughout Canada 2. The economic reality is that the additional costs of registering in each province (either as an advisor, broker, or an issuer), poses unnecessary costs that might make Canada seem less competitive, and thus drive away business 3. The recent proposal has an “opt-in” clause which would allow for a national regulator, even if one or two provinces do not opt in; this is in keeping with Canada’s Constitutional history, in which not all provinces ratified the Canadian Constitution, Quebec finally signing only in 1985 4. The Constitutional debate whether Federal Parliament can assert jurisdiction over a matter which has been largely provincial for decades has already been proven with the recently ratified National Competition Act and the National Copyright Act; these were predicated on the fact that Trade & Commerce is a Federal matter in Canada

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5. The Majority Government is adamant that there is a need for a National Securities Regulator 6. Most of the substantial Securities Laws are effectively National Instruments, which means that they apply in all jurisdictions anyway 7. The Provincial concerns about loss of power have been mostly placated by the concept of a Transitional Office which would allow each province to retain a certain amount of power 8. Lastly, for the first time, this April 13 and 14, 2011, the arguments for the National Securities Regulator were heard at the Supreme Court of Canada; their decision is expected in the coming months.

In order to effectively manage the transition from the existing system to a proposed single regulator, the Canadian Securities Transition Office (CSTO) was formed in 2009.

The CSTO has developed draft legislation for a proposed Canadian Securities Act which has been put before the Supreme Court of Canada to determine whether the legislation drafted is within the jurisdiction of Parliament and whether the act can be adopted, creating national jurisdiction for securities legislation.

The CSTO has also prepared a Transition Plan6 outlining a roadmap for the transition from the existing system to the proposed single regulator which would integrate the regulators form existing jurisdictions. The Transition Plan estimates launch of the national regulator sometime during 2012.

However, there is still a possibility that the Supreme Court may agree with the Constitutional challenge by certain provinces, mainly Alberta and Quebec, to not allow Securities Regulation to now come under the Federal jurisdiction. The decision from the Supreme Court is expected in October 2011.

6 CSTO Transition Plan: http://csto-btcvm.ca/CSTO/media/MediaPublic/Content/Transition_Plan_for_the_CSRA.pdf

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Registration To understand the registration regime in Canada, one has to appreciate that Canada has never had a National Securities Regulator, and instead relies upon the Provincial and Territorial Securities Regulators who each have their own Securities Act. The current registration regime is somewhat complex due to the overall regulatory structure in Canada.

One must register in each province in which one wishes to act as a Securities Dealer, and to trade securities with, or for, clients in that specific province. The major provinces for registration are Ontario, Quebec, Alberta and British Columbia.

It should be noted that if one registers in Quebec, one is obligated to provide all relevant documents to clients and regulators in French. Translation cost and timing sometimes cause issuers or firms to not register in Quebec.

The nature of the proposed activity of the dealer will determine the type of registration and even regulator that will have jurisdiction over that dealer. There are several categories of registration. So it is first best for a future dealer to ask themselves the question: what products will the dealer trade, what clients will the dealer serve, and where are these products and clients?

While one must register in each province for securities dealings, for simplicity sake, we shall select Ontario as the sole jurisdiction to give a flavour for what can be expected of a dealer in Canada.

For simplicity’s sake, we shall assume that the proposed dealer will not deal with retail clients in Canada, only “accredited Investors” (net worth over CAD $1 Million or Annual Income over CAD $200,000) and other Broker Dealers.

IIROC PO Types & Capital Requirements: First, if a dealer intends to trade securities on the “Secondary Market” (i.e. – a marketplace, exchange or ATS), then they must register with IIROC as a PO. As per IIROC Rule 35, a dealer can be a type One, Two, Three Introducing Dealer or a Carrying Broker. Irrespective of the type, all IIROC dealers must adhere to the rules and bylaws of IIROC (www.iiroc.ca) Type One Introducing Brokers (IB) are not permitted to and do not custody client assets or settle any trades. Instead, the introducing broker contracts out the settlement of trades to a Carrying Broker. The IB must have a minimum capital of CAD $75,000.

All other IIROC Broker types need a minimum capital of CAD $250,000. The capital requirements might be higher, depending on the Joint Regulatory Financial Questionnaire & Report (“JRFQ&R”) which must be audited and filed at least 90 days prior to the application submission by the dealer. The JRFQ&R is not required for applicants who are already members of IIROC or another Canadian SRO. The capital can be share capital or subordinated debt, but if it is subordinated debt, the applicant must provide IIROC with copies of the Loan Agreement & Financial Statements

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Type Two Introducing Brokers can custody assets but can outsource certain portions of the compliance monitoring.

Type Three Introducing Brokers can custody assets and are responsible for all their own compliance monitoring.

While it is best to seek legal advice when making the application, IIROC provides an overview of their requirements here: http://www.iiroc.ca/English/About/BecomingAMember/Pages/default.aspx.

Canada has an insurance pool to safeguard investors, and bolsters investor confidence in Canada. The pool has rarely been used, and has a healthy balance sheet. All dealers must participate in and become a paying member of the Canadian Investment Protection Fund (``CIPF``) which guarantees (up to certain limits) investors assets. www.cipf.ca Further, to become an IIROC dealer, one must submit with the application a nonrefundable entrance fee of CAD $25,000. There will also be an annual fee which is dependent upon the capital used by the firm. Further, there is a onetime contribution to the IIROC Restricted Fund. IIROC maintains this fund which also gets “contributions” from fines levied upon members. The fund cannot be used by IIROC for anything other than investor education. It cannot go towards operating capital or compensation for anyone at IIROC.

Books & Records: IIROC Rule 200 governs the required books & records. The key is to maintain all records for a minimum of seven years, of which the first year must be readily available; this translates into keeping the records on site for the first year, and then storing off site for the remaining six years. Among many other things, the key requirements are to have accounting, trading, account opening, compliance reviews, and business conduct records. Also, one must maintain data entry, all business related systems, credit operations, accounting, trade blotters & cage documents.

Further, Dealers must supply IIROC with an Audit letter confirming adequate internal controls & books & records. The auditor must be selected from an IIROC approved list of auditors.

On top of the CIPF, Dealers must have required Insurance: Both a Financial Institutional Bond (“FIB”) and Mail Insurance is required as per IIROC Rule 400.

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Internal Controls: Increasingly, IIROC stresses with its dealers the need to have proper internal controls around each business line. There is an increasing concern about potential for fraud, wrongdoing, errors, or losses due to systematic risk. IIROC Rule 2600 explains that an applicant must establish & maintain adequate internal controls, but the applicant has to demonstrate this through it policies & procedures which get reviewed and tested by IIROC. Further, IIROC requires that there be a separation between Supervision, which is conducted by the business side, and compliance, which performs the oversight role.

In limited cases, they may allow smaller shops to combine the roles. But typically, the Ultimate Designated Person (“UDP”) is the Chief Executive Officer (“CEO”) and, as the name implies, the UDP takes responsibility for all the actions of the firm. The UDP can delegate supervision tasks out to other Supervisors, such as Head Trader, etc. However, he cannot delegate out his ultimate responsibilities. The appointed and registered supervisors, likewise, can delegate out supervision tasks such as reviewing trading exception and inventory reports, but the Supervisor cannot abrogate his or her responsibilities. To mitigate any confusion, IIROC asks firms to provide a Statement and organizational chart of “Delegation of Duties” for both Compliance and Supervisory staff.

The Chief Compliance Officer (“CCO”) similarly takes on the responsibility to ensure proper monitoring, registration, and overall adequate and proper resources are applied to oversee the firm’s regulated activities. The CCO reports to the UDP and must report to the Firm’s Board at least quarterly; increasingly IIROC looks for the CCO to provide a report to the Board with statistics of any negative trends or problems, along with resolutions. It is also common practice for the CCO to be on the firm’s Board in order to be aware of any proposed and current activities, and to steward the firm through regulatory waters.

Gatekeeper Responsibilities: All registered persons have a responsibility to report any wrongdoing, either within the firm, or by any clients of the firm. Typically any wrongdoing is sent up to the CCO, or if necessary, to the UDP or the Board itself. The firm has an obligation to make an assessment of the alleged wrongdoing, and, if necessary, file with IIROC a confidential “Gatekeeper Report.” Previously, firms may have simply turned away a bad client or salesperson, which would allow that person to continue their malfeasance unabated at another firm. With the new Gatekeeper obligations, IIROC now has better peripheral vision of seeing what clients may be executing at multiple firms simultaneously.

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Policies & Procedures (“P&P”): IIROC requires that each line of business maintains adequate P&Ps to cover each facet of their business. The primary purpose is to ensure that there are proper controls and resources in place and that employee know how to properly execute their duties.

Typically compliance would review and maintain the P&Ps, and ensure that every employee gets a copy. Best practices are to also provide a brief staff education session, and have staff sign an attestation annually that they have read, approved, and agree to abide by the applicable P&Ps. The P&Ps themselves should be updated at least annually, or if there are any changes to the firm’s business or to regulations around that business. IIROC examiners will review each firm’s process around P&Ps. The P&Ps are meant to also allow anyone to be able understand the business processes.

Anti Money Laundering (“AML”) Canada has taken AML very seriously for any institution in Canada that deals in money.

The essence is every firm must have AML P&P, and must perform an AML audit every two years. AML is extremely important at the initial account opening and whenever a client asks the dealer to move funds or securities. A dealers must always exercise due diligence to ensure they know their client and who they are dealing with at all times.

As such, account opening documents must capture all client information, should be updated every three years, or whenever a change occurs in the client’s suitability or financial standing, or when any other material change occurs. Further information can be found at the website of the AML regulators called FINTRAC: http://www.fintrac-canafe.gc.ca/

Five Year Business Plan: In order for IIROC to understand the dealer and be comfortable with them as a viable member, IIROC requires a five year business plan which provides both a narrative description of the proposed businesses, strategy, projected sales, profit and loss, finances, as well as financial forecasts to indicate that the firm will be profitable and not put investors or the dealer community at risk. IIROC uses this information to help formulate the firm’s Risk Adjusted Capital (“RAC”) which is calculated by IIROC, and must be monitored and maintained daily by the firm. Further, to ensure the firm has appropriate resources, skills and registrations, IIROC requires that the plan contains the firm’s proposed types of businesses and products.

Qualifications & Licensing for Executive & Directors: All Officers & Directors who are part of Mind & Management of the firm must have completed their Partners Directors & Officers (“PDO”) course. All courses for IIROC firms are administered by the Canadian Securities Institute (“CSI”`). The CCO reports to the UDP & the Board, and needs to complete the CCO ex am & have adequate senior compliance experience. The CFO also reports to the UDP and the Board, and needs to pass the CFO exam & have adequate financial accounting designations &/or experience.

60% of the Executives , and 40% of the Directors must have each worked in the Financial Services industry for at least 5 years, and must have completed their PDO, or have been working in that capacity in the last 2 years.

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Investors in the firm who own 10% or more of the firm, and who are active in the business must have their PDO course and be registered with IIROC as “Shareholder.”

Supervisors are the Heads of each business line. They are responsible for the designated line(s) of business, from account opening, to trade execution and settlement, to client complaint and dispute resolution. Which CSI Exams are required depend on the lines of business. Generally, the basic requirements for Equities & Fixed Income are the Canadian Securities Course (“CSC”) and the Conduct Practices Handbook (“CPH”). However, there are also courses on Derivatives, Options and Futures, and for Supervisors in those areas there is an “Options Supervisor” course and a “Futures Supervisor” course.

There are several other considerations for registration as an IIROC firm which can be found on the IIROC website. The last topic here is that one must register on NRD for all registered activities, be it for and IIROC PO or an EMD registered with the OSC.

National Registration Database (“NRD”): All firms, employees doing registered securities business, must be registered on NRD. NRD requires a full background of every registered person for the last 10 years, including personal description, education, background, registrations, regulatory infractions, previous home addresses, aliases, previous employment, previous supervisors, and criminal or civil charges or convictions, etc. NRD can be found at: http://www.nrd-info.ca/enrolment/enrl_index.jsp?lang=en.htm

Exempt Market Dealers (“EMD”) Recently the OSC came out with a reminder that only IIROC firms can trade securities on the secondary markets for clients in Canada. However, some registrants may want to operate a limited operation in Canada, offering a Hedge Fund or Merchant banking business, which does not require IIROC registration. The proposed EMD need only deal with Accredited Investors or Permitted Clients, and need only apply to the Provincial Securities Commission(s) where they will be dealing.

There is a passport system which can allow for multi jurisdictional registration while only being regulated (audited) by one jurisdiction. EMDs have different requirements than IIROC dealers in terms of Capital requirements, audits, registration, qualifications, Insurance, Certification, examinations etc. There are multiple categories which can be found on each province’s securities commission website. For expediency, one can look to the PSC for initial guidance: http://www.osc.gov.on.ca/en/home.htm In particular, one would be well served to read on that OSC site the recent registration reform which clarifies limitations and requirements for each dealer. NI 31-103, which became effective October 2009, is the essential registration reform document.

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Canadian Marketplaces Evolution of Canadian Exchanges Prior to the 1990’s Canada had 5 equity exchanges. The Vancouver Stock Exchange, Alberta Stock Exchange and Winnipeg Stock Exchange concentrated largely on regional small cap listings, mostly focused in the mining and energy sectors. The Toronto Stock Exchange and Montreal Exchange concentrated on large cap equities. Vancouver, Toronto and Montreal all traded equity options, Toronto traded equity index options and future and Montreal traded a variety of fixed income derivatives.

Canada was an early leader in automation of exchange trading. The TSE launched the first automated trading system in the world with the development of its CATS system in 1977 which was used to trade the TSE’s less active issues until the TSE closed its floor in 1997 and all TSE listed issues were traded on the CATS system. During the 1990’s, the Montreal and Vancouver exchanges also developed their own electronic book systems, capturing all bids and offers in price/time continuous auction market system.

Because Canadian markets had fully electronic order books, they were able to publish complete information related to orders in the book as well as trades executed. As early as the 1970’s, all trade reports included the Broker ID for each buying and selling dealer on all trade history displays. In the 1990’s, as all Canadian stock exchanges became fully automated, full depth of book information was provided to data vendors. Thus Canada developed high standards for market transparency long before many other jurisdictions.

In 1999 via a ‘realignment plan’ the TSX became the single senior equities exchange.

The VSX and ASE merged to form the Canadian Venture Exchange (CDNX) tasked with servicing junior equities. The Montreal Exchange relinquished all equities listing and trading and became the sole equity derivative market in Canada. (Eventually the Winnipeg Exchange was merged into CDNX).

At roughly the same time, the TSX published a document entitled “TSX – A Blueprint for Success” that articulated a clear vision of demutualization and eventual IPO, changing the traditional “member owned and operated” model of an exchange to becoming a “for profit” entity. The TSX sought and gained government approval to convert to a “for-profit” organization. This demutualization was completed in April of 2000.

Over the next five years, the TSX sought to solidify its position as the senior and most prominent marketplace in Canada. During this time they accomplished the following: 2001: acquired the CDNX – and renamed it the TSX Venture Exchange 002: entered into a JV with Standard and Poors (S&P) to have S&P manage the TSX suite of indices. The benchmark TSX 300 Composite Index was renamed the S&P/TSX Composite Index and membership was allowed to be changed from a fixed number of 300 constituents to floating number based on free float market capitalization. After a flurry of innovation – including anonymous trading, iceberg orders and a JV call market initiative – the TSX finally went public at the end of 2002

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2004: launched a Market on Close facility aimed at lowering volatility around, and cost of, rebalancing ETFs and Index based funds.

2007: announced merger with the Montreal Exchange. The resulting entity, TMX Group, would run the TSX (senior equities), the Montreal Exchange (options and futures), TSX Venture (small caps) as well as a number of side energy and derivative platforms.

As in other parts of the world, new alternative trading systems were launching new marketplaces to compete with traditional exchanges for order flow. While the TSX and ME were coming together, several other groups were getting ready to open Canadian Equity Alternative Trading Systems.

Development of the ATS Rules During the 1990’s, Canadian regulators began the process of assessing a framework for allowing new alternative markets to compete with the incumbent exchanges.

Canadian regulators opened the door to these new markets in 2001 with the creation of the ATS Rules7. The rules were developed to encourage innovation and competition by creating a framework to allow new alternative markets to compete with the established stock exchanges. The framework addressed issues of transparency, fair access and best execution. While the ATS Rules originally contemplated establishing both a data consolidator to create a consolidated tape and a market integrator to interconnect the new markets, industry participants influenced the CSA not to spend millions of dollars creating these new entities until it was clear that we would have a multiple market environment. Participants also believed that industry forces and competition would likely create solutions for both the issue of a consoli dated tape and market integration.

Following the creation of the framework, new market entrants were slow to emerge.

Canadian markets had traditionally been dominated by a few very large firms who were resistant to change and who had fought the entry of new markets like Instinet who had tried to operate in Canada in the 1980s. Two U.S. ATSs launched but were registered as International dealers who offered trading in U.S. securities only to Canadian institutions. It was not until well after the approval of the ATS rules, between 2005 and 2007 that the first ATSs were launched to trade Canadian listed issues competing directly with the TSX. In mid-2007, a number of dark and lit markets started up operations in Canada. Despite this slow start, within a few years, these new markets gained traction quickly and by the end of 2010, ATSs represented approximately 35% of the volume traded on Canadian-listed issues.

7 In 2001, the Canadian Securities Administrators (CSA) approved National Instrument 21-101, Marketplace Operations, and National Instrument 23-101, Trading Rules, known collectively as “The ATS Rules”.

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There were several reasons why ATS’s gained traction quickly in Canada at this time, despite participants initial resistance. The primary driver of adoption of the new markets was that regulators strongly supported completion and developed the concept of a “protected market”8. Any transparent market which published pre-trade quote information, was deemed to be a “protected market” and participants were required to “make reasonable efforts”9 to access any new markets in order to fulfill their best price obligation. A lack of clarity around what constituted compliance with the rule, meant that most dealers felt obligated to comply by finding an order routing solution that connected to all markets and would route to the best price available. The second reason that ATSs gained ground quickly, in terms of market share, was that one of the ATSs (ALPHA) was owned by the six largest banks in Canada10, who control a solid majority of order flow in Canadian issues. ALPHA owners were thus able to control their order flow and change routing parameters on the order management systems to direct much of their flow to ALPHA, virtually guaranteeing its success.

As in many other areas of the world, in Canada, the incumbent exchange has seen erosion of its dominance in trading and has had to struggle to compete with new and innovative competitors. Many of the new markets have adopted similar trading models to the existing TSX structure – offering continuous auction markets based on price/time priority. Most have also added new features and expanded trading hours to attract dealer flows. Figure 3 below shows the rapid growth of ATS market share from 2008 to 2011.

Figure 3: ATS Market Share (Q1 2008 to Q2 2011) 45% 40%

% of Total Volume Traded

35% 30% 25% 20% 15% 10% 5%

01 0 Q1 -2 01 1 Q2 -2 01 1

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-2 Q4

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9 00

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9 00

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-2

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0%

Light %

8 See National Instrument 23-101, Trading Rules: http://www.osc.gov.on.ca/documents/en/Securities-Category2/rule_20100128_23-101_unofficial-consolidated.pdf 9 NI 23-101 states that “A dealer and an adviser must make reasonable efforts to achieve best execution; in addition, UMIR 5.2 required dealers to make reasonable efforts to meet its best price obligations by connecting to all available “protected marketplaces” 10 ALPHA Trading is jointly owned by the investment dealer arms of BMO, CIBC, National Bank, Royal Bank, Inc., Scotiabank and TD as well as independent dealers Canaccord Capital Inc. and Desjardins Securities Inc., and the Canada Pension Plan Investment Board

How to Trade in Canada | 16

The Current Trading Landscape in Canada There are currently four alternative markets offering competing auction markets to the TSX – ALPHA, CHI-X, PURE, and Omega as well as the TSX’s own new market, TMX Select. These markets are all transparent markets which offer only slight variations from the TSX trading model.

Dark pools and dark trading currently represent a relatively small portion of the trading volume in Canada11. MATCH Now, a dark pool operated for dealers, is currently the largest dark pool, with approximately 2.3% market share while Liquidnet, despite its success in other parts of the world, has struggled to gain any significant market share in Canada, typically trading less than 0.2% of Canadian volumes. Several of the lit markets also offer dark order types and ALPHA has recently launched its ALPHA Intra-spread matching, enabling its dealers to internalize order flow.

By mid 2008, 6 Canadian ATSs were up and trading. They were:

Alpha Trading Launched 2008: Owned by the big 6 banks along with the Canadian Pension Plan Investment Board and two of Canada’s largest independent dealers – Canaccord Genuity and Desjardins Securities.

Alpha is the most successful of the Canadian ATSs, with market share of roughly 20% of Canadian volume; Alpha has thrived largely due to the flow commitments from its owners and the resulting HFT flow that migrates towards the market of first look. Alpha has recently submitted an application for exchange status to regulators. http://www.alphatradingsystems.ca/

Chi-X Canada Launched 2007: Subsidiary of Instinet Inc., wholly owned by Japanese Banking Giant Nomura Holdings. Chi-X Canada is the clear second choice to Alpha in the ATS wars.

Chi-X has been able to attract flow – with volume based market share of roughly 8.5% in August 2011 – based on best of breed technology, close relationships with a small number of key HFT players and innovative pricing schedules. http://www.chi-xcanada.com/includes/indexShow.jsp?thePage=/index.jsp

Liquidnet Canada Launched 2006: Owned by Liquidnet Holdings While Liquidnet originally traded only U.S. securities for Canadian customers, it was approved in 2006 to begin trading Canadian securities also. The buy-side only block trading system continues to struggle in Canada with August 2011 market share of just 0.14% of trading volumes. While the client base is loyal, and the offering is likely here for the long term, the prospect of significant growth are limited given the block dark offerings coming to market globally. http://www.liquidnet.com/globalPresence/canada.html

11 One of the first Canadian ATSs, Blockbook, a dark matching system, launched in 2005 but closed their operations in early 2009.

17 | How to Trade in Canada

MatchNow Launched 2007: Owned and operated by TriAct Canada Marketplace LP, a subsidiary of ITG Inc. MatchNow is ITG’s Dark Pool entrant in the Canadian space, operating a dark book for dealers and targeting both retail and institutional flows. With August 2011 market share of 2.32%, MatchNow is the leading dark venue in Canada. MatchNow could be challenged to continue growing in light of some of the regulatory proposals discussed elsewhere. http://www.triactcanada.com/at-a-glance.htm

Omega Launched 2007: Owned by Tactico, BRMS and Marlar Group Omega is the smallest of the lit Canadian ATSs. With roughly 2.2% market share in August 2011 and little differentiation other than price, Omega has not caught the street’s attention and risks being forgotten altogether as new marketplaces open up. http://omegaats.com/web/guest

Pure Trading Launched 2007: Owned by small cap exchange Canadian National Stock Exchange (CNSX) Pure was the first ATS announced and launched. Pure offers little in the way of innovative order types or leading edge technology. They have managed to carve out a niche (roughly 3.3% of Canadian volume in August 2011) primarily based on pricing, longer market hours and relationships. http://www.puretrading.ca/ More recently, following the initial influx of new ATS, several new players have emerged.

Instinet VWAP and CBX Cross Opened in the spring of 2011, both of the Instinet VWAP and CBX cross markets have enjoyed little success. The VWAP market suffers from the unwillingness of traders to commit to an all day strategy with no ability to cancel or alter the order under extreme market conditions. The CBX cross, a fully dark trading system that holds up prints until a block size can be achieved (block size is a generous term for sizes ranging from 1000 – 5000 shares depending on the stock’s ADV) that has proven both too complicated and too expensive to attract flow from outside of Instinet. (Net pricing is currently a multiple of any other marketplace ex-Liquidnet). Most days the two Instinet markets have little or no volume at all.

TSX Select In June the TSX opened a second market aim at the HFT players. With a symmetrical pricing model – 2 mills charged to make or take – the ATS is designed to attract first look from active orders and therefore attract the smart passive flow that is willing to pay for first look. While the take up has been slow – with just 1.01% market share in August – the innovative pricing model coupled with TSX Technology and shared sales and data resources put Select in a good position to gain share fairly quickly.

How to Trade in Canada | 18

Figure 4: Percentage Market Share by Volume (TSX Listed) Volume

Q2/11

Q1/11

Q4/10

Q3/10

Q2/10

Q1/10

Q4/09

TSX

60.30%

62.31%

64.30%

66.63%

66.85%

66.38%

73.41%

Light Markets

37.28%

36.00%

34.00%

31.94%

32.02%

32.54%

25.69%

Alpha

21.39%

22.55%

22.00%

22.10%

23.76%

25.54%

19.23%

Chi-X

9.50%

7.88%

6.92%

6.81%

6.76%

5.44%

4.80%

Omega

2.14%

1.80%

1.00%

0.64%

0.45%

0.29%

0.07%

Pure

4.25%

3.76%

3.88%

2.39%

1.05%

1.27%

1.60%

Dark Markets

2.42%

1.70%

1.70%

1.42%

1.22%

1.14%

0.94%

Liquidnet

0.24%

0.19%

0.13%

0.13%

0.12%

0.10%

0.06%

MATCH Now

2.18%

1.51%

1.57%

1.30%

1.09%

1.05%

0.88%

Source: ITG Canada Corp.

The most significant competitor for liquidity in Canadian issues is actually the U.S. marketplace. While less than 5% of all Canadian listed stocks are cross listed in the U.S., these stocks make up roughly 75% of the volume traded in Canada. There are currently 194 interlisted securities12 between Canada and the U.S. In recent months anywhere from 35 – 40% of the volume traded on TSX listed equities took place on U.S. venues.

Since long before electronic trading, one of the most popular arbitrage strategies in Canada has been the arb between U.S. and Canadian markets on interlisted securities. In recent years, this arbitrage has been dominated by the low latency HFT players. Several studies looking at the difference in volume change, between those stocks that are listed in both markets and those that are not, on days the U.S. market is close have suggested that interlisted arbitrage may account for as much as 20% of the Canadian volume in an interlisted name.

High Frequency Trading In its efforts to compete for order flow, the TSX developed a very attractive pricing model for HFTs which led to a rapid increase in HFT trading in Canada, just as the new alternative markets were beginning to gain traction.

As in other venues, the high-frequency players face substantial criticism for their impact on markets. While some of the criticism has been based on little actual data, there is no question that HFTs have had a dramatic impact on trading in Canada.

High-frequency traders have added capital and liquidity and contributed to tighter spreads. Their critics contend that they have made gaining any sort of top of book priority virtually impossible for traditional traders and that HFTs have provided little real liquidity. They have found that when trading in Canada, they have able to take advantage of the “crossing priority� rule (also known broker-preferencing) which enables them to often jump the queue ahead of other orders at the same price and match orders under the same broker ID. Although the TSX adjusted its pricing model in October of 2009, HFTs have gained a foothold in Canada and are not likely to leave.

12 http://www.tmx.com/en/pdf/Interlisted.txt

19 | How to Trade in Canada

Trading Access As described above, only a PO can trade directly on the Canadian Equity marketplaces.

However, a PO, with certain limitations, can grant Direct Market Access (“DMA”) to Institutional Clients who have adequate training & resources. Both the PO & the DMA client must adhere to UMIR & marketplace rules.

Becoming a PO, as summarized above, can be a laborious and expensive process; both initially and ongoing. However, if there is significant business potential, and/or a firm does not want to become dependent on another firm for their marketplace access, it might be worthwhile to become a PO. Currently IIROC requires POs to provide quarterly updates of all their DMA clients.

Technically, granting DMA access is still the purview of the TMX; however, with the multiple markets environment as described above, IIROC has de facto assumed the regulatory role of monitoring new DMA clients.

Each PO is given a unique PO #, or trading ID, which will identify that firm for orders and trades on the marketplace. All orders sent to Canadian marketplaces must identify both the firm and the specific user placing the order placing the order. The TSX still maintains responsibility for assigning firms the Trading ID (typically a 2 or 3 digit number). Each marketplace will also assign the specific user IDs (often referred to as a STAMP ID).

These user IDs are required electronic tags that tell the PO, the marketplace, the regulators who is behind each order (i.e., the specific trader or DMA client). There is limited information attached to the StampID, however, it helps to form the audit trail, and is crucial for beginning to understand the flow of an order.

Some marketplaces have a feature called “Anonymous” which allows a PO to disguise who they are from everyone except IIROC and the marketplace on which they trade (who need to know who is behind the order). An anonymous order will not show the firm’s Trading ID on public displays (order book and trade history); instead, the firm ID will show as “01” the code used for anonymous orders.

Each order has required regulatory markers. Some are Private Markers only seen by the PO entering the order, the marketplace, and IIROC. For example: StampID, Insider, Significant Shareholder, Short Sale markers are all confidential. However, some are Public Markers seen by everyone, such as PO Number, and some order specifics.

How to Trade in Canada | 20

Trading Regulations As discussed earlier in this document, Canada has had a long history of highly transparent markets, primarily because our exchanges were among the first in the world to have fully electronic order books and each order was tagged with the Broker ID (trading number of the firm).

The CSA has established the rules and policies which govern trading regulations while IIROC has written the specific Universal Market Integrity Rules , known as UMIR which govern all marketplaces and trading practices.

Best Price Obligation and Trade Through For many years, dealers have had a “Best Price” obligation, i.e., to obtain the best price available at the time of the trade for their client. With the advent of the multiple market structure, this was interpreted by regulators to mean that a dealer was required to “make reasonable efforts” to achieve best price. Initially, dealers themselves were obligated to be able to route to any market which had a better price. A lack of clarity around what constituted compliance with the rule, meant that most dealers chose to find an order routing solution that connected to all markets and would route to the best price available.

However, in 2011, the Order Protection Rule (OPR)13 came into effect which repealed the best price obligation on participants and required that marketplaces connect to each other in order to prevent trading through a better priced order on another market (similar to Reg. NMS). Implementation guidelines for the new rule also required full depth of book protection, not just at the best bid/offer14, consistent with the approach which has been adopted in Canada for many years, unlike the U.S. which has only top of book price protection. It is important to note that despite shifting the obligation for protecting “best price” to marketplaces, this in no way relieved the dealer for responsibility for overall “Best Execution” of client orders.

Order Exposure Rule and Client/Principal Trades A dealer is required to enter any client order which is less that 50 board lots (for most stocks this is 5000 shares) to a displayed market for execution15; i.e., he must ensure that the client order is given the opportunity to interact with the best price currently available in all visible markets at time of entry. This rule was designed to limit the practice of dealers withholding orders from the market and internalizing them to trade against on a principal basis.

13 CSA National Instrument 23-101 Trading Rules: http://www.osc.gov.on.ca/en/13654.htm 14 UMIR Rule 5.2 Best Price Obligation: http://www.iiroc.ca/English/Documents/Rulebook/UMIR0502_en.pdf 15 UMIR Rule 6.3, Order Exposure: http://www.iiroc.ca/English/Documents/Rulebook/UMIR0603_en.pdf

21 | How to Trade in Canada

Dealers may only trade against a client order as principal when the order is less than 50 board lots if they provide price improvement and execute the order at a better price than the current NBBO16. Both of these rules apply to regular client orders but have exceptions for specific order types such as Opening Price order, Market-on Close order, etc. The limitation on client/principal trades to provide price improvement in Canada also differs from current U.S. rules which do allow client/principal trades to occur on the NBBO, known as “at the touch” trades.

Price/Time Priority In general, Canadian visible markets are operated as continuous auction markets, based on price and time priority. This means that the best (highest price) bid and best (lowest price) offer will be filled first. The first bid/offer to establish a new price will have first priority. All subsequent orders placed at the same price, will be placed in strict time sequence based on their timestamp of entry to the market. Orders will be filled to the full amount of size disclosed to the market. Several markets also offer the concept of “iceberg orders”17 which must disclose some amount in the visible market to have any priority; however, the undisclosed or “hidden” liquidity will not be filled until all visible order have been completely filled and then any remaining portions of iceberg orders, which have been hidden will be filled.

Crossing Priority (Broker Preferencing) There is one exception to the price/time priority model that is a feature developed by the Toronto Stock Exchange in the mid-90s for large retail dealers, referred to as “Priority to Crosses ”18. This feature is also known described locally as “involuntary crossing” or “broker preferencing”. This feature is now used in several Canadian marketplaces (TSX, ALPHA and PURE) and allows orders from the same participant (i.e., dealer) to match with orders ahead of other orders posted at the same price, despite time priority, in the central limit order book.

An example will illustrate the way in which “crossing priority” or “broker preferencing” works: Assume that the electronic book for stock XYZ has 3 offers at $10.50 from Broker #25, Broker #07 and Broker #10. Broker #25’s offer was entered first, so according to regular

16 UMIR Rule 8.1 Client/Principal Trading: http://www.iiroc.ca/English/Documents/Rulebook/UMIR0801_en.pdf 17 An iceberg order allows a trader to submit an order but disclose only a portion of it. The iceberg order is filled up to its disclosed portion, until the disclosed amount reaches zero. The displayed portion will then automatically refresh to the original disclosed amount but t that point, is given a new time stamp and is placed at the end of the price queue.

18 Across is a trade in which in which the same broker is buying and selling. Typically, a cross has referred to a trade which is matched “upstairs” between two of the broker’s own clients, or between a client and the broker acting as principal, and then printed on the exchange.

How to Trade in Canada | 22

price/time priority rules, Broker #25’s order would be filled completely before Broker #07 and then Broker #10. However, under the “cross priority” feature, if an active buy order comes in from broker #10 to buy at the market (or at $10.50), that active order would reach past the other two brokers’ order which have higher time priority at $10.50 and would buy from Broker #10’s sell order – or effect an “involuntary cross” order. In other words, at the best price, preference is given to orders from the same participant ahead of time priority.

Short Sales Trade Rule The current short sale rule requires that an order which is selling short must be marked accordingly, and must be traded at a price no less than the last sales price19 (subject to some exceptions such as market maker obligations); i.e., at or above the price of the last sale price (referred to as at a zero-tick).

Insider Trading Rules An order which is for the account of a person who is an insider of the issuer of the security for that order or for the account of a person who is a significant shareholder of the issuer of same security must be designated as such with a marker (as specified in the market’s order specifications) when sent to the market.

Under the CBCA (Canada Business Corporations ACT), a person is required to send a report within 10 days after the end of the month in which he or she becomes an insider of a distributing corporation. Additional insider reports are required within 10 days following the end of the month in which there is any change in the person’s interest in the securities of a distributing corporation. Insider trading reports are found in the System for Electronic Disclosure by Insiders. (SEDI)

UMIR Rule 3.1 Short Selling: http://www.iiroc.ca/English/Documents/Rulebook/UMIR0301_en.pdf

23 | How to Trade in Canada

Proposed Rules The Canadian regulators, like many of their global peers, are currently working on a variety of proposed rule changes that could significantly alter the state of trading. Some of the more important proposals are:

Proposed Rules for Dark Orders and Dark Pools: The CSA and IIROC have been working in unison since early 2009 to develop new rules for both Dark Pools and also Dark Order types on lit trading venues. The most recent proposal – Notice 23-311 – was released on July 29th 2011 and contains 4 key components.

1. Passive fully hidden orders must meet, or exceed, a minimum size threshold. This proposal is actually a place holder rule that the regulators are trying to get approved, so if they decide a minimum size is required, they can implement it relatively quickly. The proposal would allow IIROC to set a minimum size for any order entered passively into a dark pool or using a fully hidden order in a lit venue. The rule would consider only the size of the child order being placed, not the size of a parent order being worked. As such, an agency trader trying to buy 100,000 XYZ would not be allowed to place less than X number of shares as a passive hidden order on any given venue, even though the sum total of shares exposed to the market may be greater than X. Currently it is believed that the minimum size, if and when the regulators implemented this rule, would likely be 50 board lots for all stocks regardless of the liquidity or price of any given issue.

2. On any given venue, lit liquidity gets priority over dark liquidity. This proposal would ensure that the matching algorithm at each venue prioritized visible orders when a marketable contra side order was available. Using the TSX for example, an inbound marketable order would first match with any visible liquidity (fully visible orders and the exposed portion of any iceberg orders) then would match with the hidden portion of any iceberg orders (partial exposed orders are considered visible and get priority over fully hidden) and then with any fully hidden orders at each price level. All of the lit markets currently use matching algorithms that conform to this proposal – the proposal is meant to formalize previous ‘suggestions’ from the regulators on priority.

3. Regulators will have the right to set a minimum exposed size for any iceberg orders.

Much like the minimum size proposal, this is a placeholder designed to allow regulators to make a future change more quickly if needed. The proposal, if enacted, would allow the regulators to set a minimum number of shares – or board lots – that must be visible for an iceberg order. (When iceberg orders were first reintroduced by the TSX in 2003 they had a minimum display size of 2000 shares which was later reduced to 1 board lot).

4. Minimum price improvement by dark orders. The regulators are proposing that dark orders would need to price improve, over the NBBO, by one full tick. (In the event the effective NBBO spread is only 1 tick wide the minimum price improvement would be reduced to a ½ tick). Often compared to the “trade at” notion in the U.S. markets, the

How to Trade in Canada | 24

idea is to prevent dark orders from jumping in front of visible quotes by some fraction of a tick, and potentially dis-incenting investors from placing visible bids and offers in the lit market. Orders over a given minimum size – likely 50 board lots – would be exempt from this minimum price improvement but would still need to satisfy the visible orders, on a given market, before printing at the NBBO. (As written dark orders over 50 board lots could price improve by some tiny fraction of a penny to avoid the new priority rules).

When considering the potential evolution of dark trading in Canada it is important to keep the “fair access” rule in mind. The fair access rule states that a market place cannot unreasonably discriminate between market participants.

This is generally believed to mean that, if a market allows one sell side firm to access its pool, then it must allow all sell side firms to access it. So Liquidnet is allowed to open their pool to buy side and not sell side, because they haven’t discriminated amongst sell side firms. Many on Bay Street were surprised – as expressed in various comment letters to the regulators – when Alpha was allow to limit aggressive orders in the IntraSpread pool to “retail” flow. This surprising decision has lead several vocal participants to ask the regulators for more guidance around the meaning of “unreasonable discrimination”. It is expected the regulators will address this when they address internalization and preferencing.

These proposals have been published for comment, with comments due by October 27th, 2011. The full process of accepting comments, responding, publishing a final rule and implementing will likely run through the summer of 2012.

Electronic Trading and Direct Electronic Access to Marketplaces Proposal (NI 23-103) Published on April 8th, 2011 and with comments submitted by July 8th, 2011 the proposed Electronic Trading Rules (ETR) are designed to regulate direct market access and so called sponsored (or naked) access to Canadian equity markets. The proposal sets out an agenda to ensure any participant that is going direct to market – without first touching the sponsoring brokers infrastructure – will be registered with Canadian regulators and therefore subject to audits, credit checks and potentially enforcement. The comments submitted suggest that the proposal needs to better define several terms and consider certain exemptions – a process that will likely take us into the summer of 2012 – but will probably result in the registration and regulation of sponsored access clients. This registration and regulation will not eliminate the regulatory hurdles of the sponsoring brokers. Indeed the role of the sponsoring broker will be better formalized, with mandatory post trade checks and the need for regular client education around evolving rules and regulations of the market.

25 | How to Trade in Canada

Harmonizing of Short Sale Rules In the fall of 2007, the U.S. markets removed the tick test on equity short sells. At that time, Canadian regulators felt the need to remove the tick test on any stock that was listed in both the U.S. and Canadian markets. Since then, we have run with 2 short sell rules, one for cross listed stocks (no tick test) and a separate one for stocks that weren’t cross listed – allowing shorts only when they are done at a neutral or uptick. The regulators have proposed removing the uptick rule for all securities, to form a uniform rule across all Canadian stocks, that is also harmonized with the U.S. rule.

Much like the current U.S. rule, the proposed Canadian rule will revert back to a tick test in the event a given issue trades down by more than X percent within a single trading session. Currently the proposal has the breaker kicking in at 10% and last for the remainder of that trading day and the next trading day.

The regulators have also added an exempt tag on short sells for those firms that are not sure if a given sell will be from a long or short position. This feature is aimed at those multi strategy proprietary trading firms – i.e. HFTs – that may have both bids and offers in the book at any one time. Rather than having them mark every sell as a short – potentially distorting IIROCs statistics on short selling activity – the regulators will have them mark all buys and sells as short exempt. This has the added effect of allowing regulators to identify HFT players and track their activity, essentially giving them the same information set that the SEC is building the Consolidated Audit Trail to capture – at a fraction of the cost and in significantly less time.

The regulators have been working on removing the tick test since late 2007, and it is widely believed they will be able to finalize this rule in the first part of 2012.

Circuit Breakers Shortly after the events of May 6th 2010, the Canadian regulators have been proposing marketplace circuit breakers that will halt trading in stocks that experience extreme price movements over a short period of time. Currently they are proposing that TSX listed stocks would trigger the circuit breakers if they experienced a move greater than 10%.

The breakers would be triggered for either upward or downward moves in the stock price.

Once the breakers are triggered the stock would be halted for 5 minutes. The breakers would not be triggered by any trade that printed outside of the NBBO. The initial trial of the circuit breakers would only consider stocks that are members of the S&P/TSX Composite Index and ETFs and ETNs whose majority holdings are listed equities.

The circuit breakers would only be in effect from 9:50 am to 3:30 pm Eastern time.

As the triggers would not prevent a bad trade from printing – i.e. a stock could trade at a price 12% below its price 5 minutes ago and then halt – IIROC has proposed that any trade that executes at a price more that 5% beyond the breaker trigger price would be cancelled.

How to Trade in Canada | 26

During the initial implementation the marketplaces would be notified of a stock halt manual – i.e. IIROC would phone each market to inform them – potentially resulting in different marketplaces halting at slightly different times. The 5 minute halt would end 5 minutes after the last trading venue was contacted and halted the stock.

The plan is for an initial roll out phase of between 6 and 12 months to evaluate the performance and impact of the breakers, potentially followed by rolling the breakers out to all Canadian equities.

New Market Regulation Fee Model Historically, the fees for markets regulation have been borne by the dealers based on their volume of trading market share. IIROC have undertaken a review of the source of their costs and determined that technology makes up 1/3 of their costs, and human resource costs make up the other 2/3s. They have further determined that the biggest driver of their IT costs is the cost of consume marketplace message traffic. As such they are proposing a new fee model that would determine dealers fees based 1/3 of their market share of message traffic and 2/3s based on traditional volume traded market share. The intent of this proposal is to allocate some of the cost of regulation to those firms that generate oversized message traffic and are driving up the costs of the regulator. Some exceptions will be made for designated market makers who have quoting obligations.

This proposal has gone through the comment process and IIROC seems intent of driving forward. They have suggested they will try and implement this in April 2012, to coincide with their new fiscal year.

Issues Not Yet Out For Proposal The CSA and IIROC have made it clear that they will be addressing both “broker preferencing” and internalization in the coming months.

Broker Preferencing (often called seeking the cross) is a fairly unique feature on several of the Canadian markets (Alpha, MatchNow, TSX and Pure) where the matching algorithm is Price/Broker/Time based. As such an inbound sell order on ticker XYZ from broker A would trade against a bid from the same broker ahead of an identically price bid from a different broker regardless of time priority. This feature has been a part of the Canadian market since it first moved into electronic matching and has been one of the controversial features in our marketplace. The regulators have made it clear that they will finally opine on the issue later this year, and it is widely believed they will attempt to outlaw such preferencing. (This would be consistent with their argument for minimum price improvement of dark orders).

Internalization: The regulators have clearly stated that they do not favour broker internalization. They have previously given guidance that any dealer that uses automated systems to match orders and then prints them elsewhere will be deemed a marketplace and required to register as such, and have used language in their proposals on dark orders to underline their goal of avoiding an internalization heavy marketplace. It is expected that at the same time they deal with broker preferencing, they will propose rules around internalization.

27 | How to Trade in Canada

Taxation Corporate Taxes As might be expected, there are both federal and provincial corporate income taxes.

There is no municipal or city income tax on corporations in Canada.

The federal income tax rate for 2012 is 15%. The Ontario 2012 provincial rate is 11%.

In general, broker-dealers follow the same rules as all corporations, including the rule that stock based compensation is generally not deductible for income tax purposes in Canada. There are, however, some special rules that just apply to broker-dealers, such as marking proprietary positions to market and special rules regarding taxation of dividends received and deduction of dividend compensation payments on short positions.

Like all jurisdictions, cross border charges between affiliates need to be carefully documented to ensure they meet deductibility criteria for Canadian tax authorities.

Of special interest to U.S. firms looking to set up in Canada, is a unique kind of unlimited liability corporation that exists under the incorporating legislation of several provinces.

This type of corporation allows U.S. firms to treat their Canadian subsidiary as a “disregarded entity” for U.S. tax purposes and thus the operations of the Canadian entity simply flow into the U.S. entity’s tax return.

Firms looking to establish a Canadian broker dealer should contact their tax advisors early in the planning process as the rules can be complex and subject to change.

Employment Taxes In addition to typical national pension and employment insurance taxes, several provinces also levy payroll taxes. In Ontario, for example, an Employer Health Tax of 1.95% is levied on all payments and taxable benefits given to employees.

Consumption or Sales Taxes There is a national 5% sales tax known as the Goods and Services Tax or GST. All provinces except Alberta also have a sales tax. Ontario has combined its 8% sales tax with the GST and the 13% sales tax is known as the Harmonized Sales Tax or HST. Generally this tax is payable on all goods and services used by the Canadian brokerdealer (except payroll costs).

Commissions paid by clients on equity trading are generally exempt from GST/HST. Consumption and sales taxes in the financial services area continue to evolve and are complex. As mentioned with income taxes, firms looking to establish a Canadian broker dealer should contact their tax advisors early in the planning process.

For Investors Dividends and Interest paid to non residents are subject to withholding taxes that vary by treaty with the recipient country. There are no withholding taxes on capital gains.

How to Trade in Canada | 28

Indexes and ETFs The Canadian Index calendar is dominated by 2 index families: the S&P/TSX group of indices – including the composite, 60 and Small Cap indices – and MSCI.

S&P/TSX The S&P/TSX Composite Index is a free float market capitalization index. The composite is comprised of a floating number of stocks that are quantitatively determined. To be included a stock must meet relative market capitalization and liquidity metrics as well as real minimum price and turnover hurdles and must meet a minimum listings time for seasoning.

Additions and deletions to the index are done on both a special needs and scheduled basis. Any corporate event that removes a composite stock or alters the float of a stock by a large enough amount will be dealt with around the closing of such event. All other adds and deletes are handled quarterly during the triple witch derivative expirations. Special event adds, deletes and float changes will be announces as early as 5 days prior to the trade where possible and should always be announced no later than the night before the rebalance. Quarterly rebalances will be announced after the close on the second Friday of the rebalance month (March, June, September and December) and will be effective as of the close of the third Friday of that month. All small free float adjustments are done resolved on an annual basis during the September rebalance.

Stocks in the Composite index typically account for 80+% of trading volumes in the Canadian market.

The S&P/TSX 60 Index is also a free float market capitalization index. However, unlike the Composite, the 60 is not a derived by purely quantitative means. The goal of S&P is to have the 60 is to replicate the sector balances of the Composite Index with the largest capitalization stocks. As such, they may choose to not add one of the biggest 60 market cap names if it will tilt that stocks sector to overweight versus the composite. All stocks in the 60 index must first be in the S&P/TSX Composite Index. Adds and deletions to the 60 are done on an as required basis, with any large corporate event handled around the closing of said event. Adjustments for smaller float changes are done at the same time as the Composite.

Due to the qualitative nature of adds and deletions to the 60, index announcements tend to have a larger impact on the market. S&P will typically delete underperforming stocks (e.g. Nortel) if they feel the stocks presence in the index undermines credibility. Such deletions will often be done during the quarterly rebalances to avoid excess portfolio churning, but on rare occasion may be done at other times during the year.

Stocks in the 60 index The S&P/TSX Small Cap Index is a made up of stocks with market caps (both free float and total) ranging from C$100 million to C$ 1.5 billion. To be eligible for inclusions stocks must meet minimum VWAP price levels (i.e. trade over $1) as well as turnover and liquidity metrics.

29 | How to Trade in Canada

The small cap index follows the same schedule as the Composite and 60, with minor float adjustments done during the 4 quarterly rebalances and additions done only in September. Deletions resulting from price moves are done at the time of any large corporate action or during the annual review in September.

The S&P/TSX Small cap was revamp in March 2007 to better reflect the performance of small cap stocks. Prior to 2007, the Small Cap was made up of all Composite Index stocks not in the 60 or Mid Cap Indices. As some corporate structures – namely unit trusts – were not eligible for the 60 or Mid Cap at that time, this resulted in oversized unit trusts dominating the performance of the small cap leaving the index with performance that was not representative of small cap stocks. As such, most small cap funds choose to use other benchmarks – most notably the Nesbitt Burns Small Cap Index. The Nesbitt Burns Index is a dealer owned index with little transparency, so as the S&P Small Cap gains a track record it is slowly becoming the small cap benchmark of choice.

MSCI The Canadian portion of MSCI – like that of all the developed markets – is a float-adjusted capitalization weighted index. MSCI typically splits markets into both large and small cap with the largest companies making up 85% of the total market cap being placed in the large cap index and the remaining names being placed in the small cap. MSCI has 4 quarterly rebalances that occur on the last trading day of February, May, August and November. The May (annual) and November (semi-annual) trades are the larger of the trades, used for more comprehensive reviews and updates of small float changes, with the February and August rebalances geared towards more pending actions.

The MSCI methodology is more subjective than that of S&P, thus their index addition and deletion announcements have a greater short term price impact on the market. They also have a much shorter seasoning period (adding IPO’d stocks to the index within weeks rather than the 1 year period S&P prefers) resulting in less time for the market to absorb stock before it is added to an index.

Typically U.S. and domestic asset managers are more likely to use the S&P Family of Indices and European and Asian asset managers are more inclined to use the MSCI indices.

Above and beyond the S&P and MSCI indices, both Russell and FTSE have Canadian names in the various global indices that occasionally result in significant rebalancing.

For those looking to trade around the index events the key dates are: S&P/TSX Family Quarterly rebalances take place during the “triple witch” options expiry – i.e. the third Friday of March, June, September and December. The September rebalance includes the annual review of free floats and is typically the biggest of the 4.

MSCI quarterly rebalances take place on the last trading day of February, May, August and November. The May and November semi-annual trades include float updates and are bigger than the February and August ones.

How to Trade in Canada | 30

ETFs The Canadian market has long claimed to be the inventor of the ETF, with the TSE Index Participation Funds introduced in 1990. (There is some dispute around this, with some arguing State Street beat the TSE by several weeks). However, there is no disputing the significant growth in listings and volume of ETF trading. There are currently over 200 ETFs listed on the TSX, routinely counting for more than 5% of total volume and/or value traded.

Four firms currently make up the lion’s shares of ETF listings – Blackrock, BMO, Claymore and Horizon – with several more (including ETF giant Vanguard) soon to join the fray.

With over 200 ETFs domiciled in Canada, and dozens of other Global ETFs partially comprised of Canadian stocks it is impossible to give hard and fast rules around the rebalance trades. Beyond that, many of the more impactful ETFs have little or no transparency around rebalancing methodology. Currently several larger dealers employ full time staff to monitor potential ETF related rebalance trades. These trades are growing in importance, and impact.

Canadian ETF Growth 200

$Billions USD / # ETFs

150

100

50

AUM(US$BN) Source: Blackrock Inc.

01 -2 Q1

10 20

09 20

08 20

07 20

06 20

05 20

04 20

03 20

02 20

01 20

00 20

# ETFs

19

99

1

0

1

3

14

15

16

16

20

25

45

76

108

157

171

0.4

4

3.1

3.4

5.5

7.4

10.6

13

18

15.7

28.5

38.4

42.8

31 | How to Trade in Canada

Derivatives The listed Canadian derivative market is small relative to its global peers. By way of example, the future on the S&P 60 Index traded a total of just over 4 million contracts for all of 2010, or well less than one day’s trading on the S&P500 E-Mini. Size trades in Canadian options are almost always done with large dealer block desks, with the majority of the resulting risk being offset to U.S. based global volatility books. Entering or exiting a large option position via the exchange is a difficult and costly task.

Canadian Pension Plans and Asset Managers are regarded globally as among the most sophisticated users of derivative products; however, most of their trading in these products is done outside of Canada. This is because historically, Canadian pensions were restricted to holding less than 20% of their plan in non-Canadian holdings. As such, pension plan sponsors and asset managers looking to sell mutual funds into self directed pension plans had to use derivative strategies to gain exposure to foreign markets while staying within the 20% limit. (The 20% limit was removed several years ago).

Figure 6: S&P Canada 60 Index Futures

How to Trade in Canada | 32

The single most significant trade driven by the Canadian derivatives markets is around the expiry of the S&P/TSX 60 index future. The clearing price on the expiry is based on the price of the first round lot trade for each of the 60 component stocks on the TSX. As such the various futures players, and swap books re-hedging positions will have extremely large trades that must be done at the opening price on the morning of the triple witch (3rd Friday of March, June, Sept., Dec). The TSX has a facility that lets basket players enter special market orders (called must be filled or MBF) after the close on the Thursday night. They then broadcast the pending imbalance on Friday morning in an attempt to attract offsetting liquidity and minimize the volatility around the expiration.

Equity and Index derivative trading is limited to a single exchange – the TMX owned Montreal Exchange at the moment. The ME’s ownership of the Canadian Derivative Clearinghouse (CDCC) and is exclusive right to trade derivative product based on the S&P/TSX Indices make for significant barriers to entry.

The global move to have OTC derivative product both trade and clear through exchanges and CCPs has the potential to open up this space, but with the TMX the current favorite to win government blessing to run the CCP this may further cement the TMX dominance in this space.

33 | How to Trade in Canada

Clearing Market Trades All listed market equities trades in Canada clear electronically through the country’s national depository, CDS (which has been described elsewhere in this report). Market trades settle on a T+3 basis. At the end of trading every day, each marketplace submits a balanced trade file to CDS. Executing brokers also submit a file to CDS. Overnight, CDS runs a comparison of the files and any differences (known as breaks) are reported to the brokers for resolution.

Given the large number of securities that are listed on both Canadian and U.S. marketplaces, CDS provides an efficient North American clearing and settlement gateway between Canada and the U.S. that allows participants to transfer securities electronically without physically moving them between two depositories in two different countries.

CDS can settle in both Canadian and U.S. dollars.

Broker Clearing Alternatives Brokers who register in Canada and become Participating Organizations in Canada can be self-clearing or may act as an introducing broker to a carrying broker. Currently there are four brokers in Canada that offer carrying broker services. Carrying brokers offer a range of services but in all cases provide the clearing (and often financing) functions for the introducing broker. The introducing broker trades on the market place and interacts with its clients under its own identity; however the clearing, settlement and recordkeeping are provided by the carrying broker.

Foreign Brokers (Europe/ Asia Pacific/ U.S.A.) may not want to become Participating Organizations and prefer to send orders to a Canadian Executing broker to trade in the Canadian domestic market. The Canadian broker would execute on a Canadian marketplace on their behalf, under their Canadian broker number. Once trades are executed, a notice of execution or block is advised to the client; who in turn agrees details and or provides any allocation requirements. The foreign broker is also required to have their own custodial arrangement for Delivery versus Payment settlement with the Canadian broker under whose number the trade was executed. Settlement occurs T+3 via CDS (or DTC sponsored membership via CDS); with the caveat that regulations allow for T+2 matching within CDS for most overseas client.

Institutional Delivery Institutional clients typically operate with brokers on a delivery vs. payment (“DVP”) basis.

They use a custodian to deliver/receive securities and make/receive payment with the broker on their behalf. All custodians are members of CDS. Regulations require all DVP trades to be matched by the broker and the client by noon on T+1

Retail Clients Retail clients generally hold their securities at their broker; brokers either directly or through their carrying brokers (more fully described above) hold the securities at CDS.

How to Trade in Canada | 34

Introducing NYSE Technologies’ Compute On Demandsm Trading firms need a fast and reliable low-latency infrastructure to support their trading strategies and meet the demands of clients. For some firms, traditional colocated solutions require too much capital expense and maintenance.

Compute On Demand is a new managed solution being initially launched in the US with a progressive global roll-out optimized for colocated trading environments, built by people who understand the dynamics of the markets. Connected to the Secure Financial Transactions Infrastructure® (SFTI®) network, it provides you with ultra-low latency access to hundreds of buy-side and sell-side traders around the world, as well as to hundreds of trading services. Compute On Demand allows you to focus your time and energy on the efforts that drive the success of your firm.

Customer Challenges Cutting the cost of a low-latency infrastructure. Building your own low-latency trading infrastructure requires large capital investments.

Reducing time to market. It can take a long time to work through your firm’s procurement systems to get equipment purchased and installed. Adding new service scan then take weeks.

Adapting to rapidly changing needs. Building and maintaining your own infrastructure requires long-term commitments to a set amount of capacity. Adding, or subtracting, servers is neither cheap nor easy.

Keeping hardware and software up to date. It takes a lot of time and technical expertise to research and build out low-latency trading environment. Keeping that infrastructure current may then involve negotiating a lengthy internal procurement process.

Retaining the expertise to maintain infrastructure. A large and dedicated operational group is required to maintain and monitor all aspects of trading solution, at all hours of the day and night.

Maintaining a secure platform. Making sure that your infrastructure supports a safe and secure trading platform requires a significant expertise and constant vigilance.

35 | How to Trade in Canada

Solution Benefits No capital expense required. With Compute On Demand, NYSE Technologies owns the infrastructure. You simply lease as much of it as you need.

Rapid start-up and expansion. All equipment is pre-provisioned, reducing startup timesfrom a few months to a few weeks. New SFTI® services can be added in days.Scalable dedicated hardware. Packages start from a single server and scale to fit acustomer’s requirements. Each server is allocated a local disk drive for fast I/O. Additional storage is available through the Storage-On Demand solution.

State-of–the-art equipment. NYSE Technologies takes full responsibility for building, upgrading and maintaining a state-of-the-art trading infrastructure.

24/7 maintenance and monitoring. NYSE Technologies provides management and monitoring of the hardware, network, operating system stack, and storage backed by our 24x7 Service Desk. Our market data and order entry expertise provides unrivaled support.

World Class Security. The servers are updated with the latest security patches, ensuring your data is kept private and secure.

How to Trade in Canada | 36

About NYSE Technologies A division of NYSE Euronext (NYX), NYSE Technologies provides broadly accessible, comprehensive connectivity and transaction capabilities, data and infrastructure services,and managed solutions for a range of customers requiring next-generation performance and expertise for mission critical and value-added trading services.

NYSE Technologies offers a diverse array of products, services and solutions to: the Buy Side, including order routing, liquidity discovery and access to a community of over 630 Broker-Dealers and execution destinations globally; the Sell Side, including high performance, endto-end messaging software and innovative market data products delivered on the world’s largest, most reliable financial transaction network; and Market Venues and Exchanges, including multi-asset exchange platform services, managed services and expert consultancy.

With offices across the U.S., Europe, and Asia, NYSE Technologies offers advanced integrated solutions for the global capital markets community, earning the ability to power trading operations for many of the world’s best financial institutions and exchanges. For additional information visit: nysetechnologies.nyx.com

37 | How to Trade in Canada

About ITG

Investment Technology Group, Inc. is an independent agency research broker that partners with asset managers globally to improve performance throughout the investment process. A leader in electronic trading since launching the POSITŽ crossing network in 1987, ITG takes a consultative approach in delivering the highest quality institutional liquidity, execution services, analytical tools, and proprietary research insights grounded in data. Asset managers rely on ITG’s independence, experience, and intellectual capital to help mitigate risk, improve performance, and navigate increasingly complex markets. The firm is headquartered in New York with offices in North America, Europe, and the Asia Pacific region. For more information on ITG, please visit http://www.itg.com/.

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