More Investors Turn to Inverted Exchanges in Canada

April 27, 2023

Inverted markets have played a significant role in the growth of the Canadian Equity Market by increasing competition, reducing trading costs, and providing innovative products and services. Cboe Global Markets has increased its footprint in Canada to four trading platforms, which includes the inverted venue NEO-N.

A previous analysis, Cboe’s Equities Execution Consulting team took a deep dive into NEO-L, one of Cboe Canada’s four trading venues. In this analysis, our team focuses on NEO-N, the overall inverted markets composition, and the concentration of subdollar volume on inverted venues. The unique trading mechanisms of NEO-N, including size-time priority and an asymmetric speedbump, have fostered a healthy taker-maker ecosystem. As a result, investors experience better execution quality and orders can efficiently interact with fewer latency sensitive liquidity takers on Cboe NEO-N. 

Canadian Equities Market Composition by Exchange Type

Inverted markets operate with a taker-maker fee structure, which means market participants who add liquidity pay a fee, while market participants who remove liquidity receive a rebate. This model incentivizes active order flow and improves fill time for passive orders. In Canada, some non-displayed venues and Alternative Trading Systems (ATS) also use the inverted fee structure, providing market participants with anonymity and reducing market impact for large orders. NEO has two trading venues with an inverted fee schedule: NEO-N and NEO-D, a non-displayed marketplace.

The share of the Canadian market traded on inverted markets has remained consistent over the last year, with an average ADV of 215 million shares and an average ADNV of 2.6 billion. In 2022, the market volume and notional value shares remained stable at around 21% and 14%, respectively. However, from 2020 to 2021, the share of inverted venues exhibited stronger growth and reached its peak at 24% in May 2021. In the early part of 2021, as the equity market experienced increased volatility due to the COVID-19 pandemic, both inverted and fee-fee venues gained market share from the maker-takers which hit to a low of 55.8%.

Figure 1 Source: Cboe Canada

This trend is much different to market activity in the US, where there have been significant shifts in trading volume over the same time period. Notably, inverted exchanges in the U.S. have declined to less than 4% after peaking at almost 10% in March 2019 led by a shift toward broker Single Dealer Platforms (SDP).  Continue reading on Cboe Insights.

Canadian Inverted Market Structure

In Canada, the market composition of inverted venues remains highly competitive and fluid, with five main markets showing varying degrees of success over time. In 2022, we observed some inverted venues gained significant market share from other inverted venues. Despite this, NEO-N has maintained a consistent market share at an average of 16% of the inverted market over the last 12 months, indicating its resilience in the face of competition and ability to adapt to changing market conditions.

Figure 2 Source: Cboe Canada

Subdollar Securities in Inverted Markets

Subdollar symbol volume dominates inverted markets, accounting for more than 50% of inverted market share in 2021 and 2022. Securities in the $10-50 range made up the next largest segment at 19%, followed by $1-5 securities at 14%. In contrast, we did not observe significant concentration or dominance of subdollar securities volume on maker-taker markets. In those markets, subdollar securities made up just 25% of the maker-taker market volume in 2022, while $10-50 securities accounted for around 31%.

Figure 3 Source: Cboe Canada

Over the last 12 months, subdollar securities have held an average market share of 29% in Canada, which is notably higher than the 10% of total market share they represent in the US. When we look at subdollar volume in Canada by inverted and maker-taker venues separately, we find that approximately 30% of subdollar volume is executed on inverted venues. Specifically, the subdollar volume on inverted venues continued to increase from 28.6% in November 2022 to 29.5% in March 2023, highlighting the competition and popularity of subdollar securities on inverted venues.

Figure 4 Source: Cboe

Execution Quality of Subdollar Securities

Since subdollar securities play an important role in the inverted markets, we took a closer look at the notional value weighted spread of subdollar volume across different venues. Our findings indicate that inverted venues offer a tighter spread on subdollar securities compared to maker-taker markets. In particular, inverted venues exhibited a tighter spread in 79% of cases, with an average value that was 0.35 cents lower than the maker-takers over the last 14 months. Additionally, NEO-N stands out with a 43% chance of having an even tighter spread of approximately 0.19 cents lower than the average for all other inverted markets in 2022 and 2023.

The popularity of subdollar volume executed on inverted venues and its liquidity suggest a promising opportunity to enhance execution prices and lower transaction costs on NEO-N and other inverted venues.

Figure 5 Source: Cboe Canada

The NEO-N Trader

The unique size-time order matching priority and asymmetric speed bump on NEO-N levels the playing field for long-term investors and prioritizes natural liquidity demanders and suppliers.

It is also worth highlighting the NEO venues’ unique trader priority mechanism. NEO distinguishes between two types of traders operating in the market: Latency Sensitive Traders (LST) and market makers who employ sophisticated technology and automated trading strategies for their own accounts; and NEO traders who act on behalf of long-term investors, executing trades as part of their investment strategy and representing retail and institutional flows. The matching algorithm on NEO prioritizes NEO Trader orders over LST orders. According to the chart below, which shows distribution of different trade flows on NEO-N, 72% of NEO-N’s volume was represented by NEO Traders, and the distribution has remained relatively stable over the past year.

Figure 6 Source: Cboe Canada

NEO-N Unique Size-Time Priority

Another unique feature of NEO-N is its size-time execution priority for resting orders. The chart below shows the large passive order size on NEO-N typically originates from institutional and retail traders. Retail investors submitted more than 2,500 shares per passive order in the first quarter 2023, 5 to 6 times more than those submitted by LST traders and market makers. In addition to prioritizing NEO Trader resting orders over LST resting orders, NEO-N’s unique size-time order matching priority prioritizes larger resting orders over smaller ones. NEO-N provides more opportunities for long-term investors to be at the front of the queue at any given price point.

Figure 7 Source: Cboe Canada

To illustrate how the size-time ranking works on NEO-N when there are multiple potential matches at a given price and priority level, consider the following example. If any single resting order can completely fill the incoming order, it trades first. In cases where multiple resting orders can match the incoming order, the size-time ranking is determined based on the equally weighted ranking of three factors: the priority time, time of the last partial fill, and the remaining size of the resting order.

Figure 8 Source: Cboe Canada

In the case above, the order in the first row, which has the earliest time of last partial fill, second place of priority time and third place of remaining order size, would be filled first with a matched incoming order. This hierarchy encourages users to rest larger sized orders to optimize the probability of a fill.

Asymmetric Speedbump and Execution Speed on NEO-N

To enhance the trading experience for customers with passive orders, NEO-N implements a technical “speed bump” – a randomized 3-9 millisecond delay applied only to removing liquidity orders from LST traders. In February and March 2023, the daily time to first fill by LST traders remained steady around 5.0 to 7.0 milliseconds on average, while other flows were near 0. The speedbump facilitates the preference of passive orders interacting with natural liquidity takers, rather than latency sensitive traders.

Figure 9 Source: Cboe Canada

The figure below shows the average time to first fill for passive orders on NEO-N was 198 seconds in March 2023, 13% faster compared to 229 seconds on NEO-L. On average in first-quarter 2023, the first fill of a passive order on NEO-N was executed 15% quicker than the first fill on NEO-L. Leveraging a take-make fee model that attracts active orders helps to execute orders faster and further reduces the time to trade.

Figure 10 Source: Cboe Canada

Inverted exchanges have contributed to the growth of the overall Canadian equity market while maintaining steady market share over the last year. NEO-N offers clients a unique experience with its size-time priority for passive orders and asymmetric speed bump for latency-sensitive removing flow.

The analysis of execution metrics for securities traded on NEO-N reveals that investors can benefit from enhanced execution quality and greater interaction with natural liquidity takers, given the platform’s prioritization of long-term investment strategies and large resting orders. This empirical evidence suggests that NEO-N could be a valuable destination for investors seeking to optimize their trading outcomes. Member firms who are handling customer orders could simply update their routing and algorithmic strategies to reside passively on NEO-N to enhance parent level performance.

As Cboe Canada continues to bring innovative products and trading mechanisms to the market, our Equities Execution Consulting team will provide analyses to help inform your trading decisions and improve your execution quality.

For questions or to learn more about optimizing your trading strategies, please reach out to our coverage team.

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