Canada has a new stock market. The Canadian Trading and Quotation System (CNQ) became Canada's third stock market in June when it launched with three listings and nine members. The electronic micro-cap market was created to fill a void left by the demise of the Canadian Dealing Network three years ago.
Essentially a quotation service for over-the-counter dealers, the CDN had a reputation for shady dealings in fly-by-night companies. The nine-year old system was shut down by its owners, the Toronto Stock Exchange, or TSX, as part of a major reorganization of Canada's securities markets.
In contrast, the CNQ is a hybrid auction/dealer marketplace supported by sophisticated trading and reporting software from Australia's Computershare. Known as Horizon, the software is operational in some 50 up-and-coming markets around the world. CNQ is regulated by Market Regulation Services, the spun-off regulatory arm of the TSX.
Hundreds of small Canadian companies now trade largely in the dark without even the benefit of a Pink Sheets-type quote reporting service. All trading is done by telephone. Regulations do require dealers to report their trades to the so-called Canadian Unlisted Board, but the prices are not made public.
CNQ plans to build its roster of listings out of this underground market as well as from the ranks of companies listed on the TSX Venture Exchange. To coax issuers away from Canada's No. 2 exchange, CNQ is promising better liquidity and a streamlined regulatory process.
CNQ got off to a worse-than-expected start. Three listings and nine members are a far cry from the 50 issuers and 25 brokers it expected. Only two firms – Canaccord Capital and W.D. Latimer – have agreed to make markets.
Despite the meager showing, hopes are high for CNQ's success in some Canadian financial circles. Financiers say Canada must have a trading center for tiny companies if it wants to encourage venture capitalists to risk their money on new ideas.
At the helm of CNQ is Rob Cook, a 19-year veteran with the Toronto Stock Exchange. Cook spent his last six years with the TSX as director of market surveillance. In 2001, he became vice president of Market Regulation Services.
Cook recently talked to Traders Magazine's Peter Chapman about CNQ. (All monetary figures are in Canadian dollars.)
Traders: Are you disappointed by the weak launch?
Cook: We are not disappointed. We're actually quite pleased with the response so far. It is a smaller number of issuers than we expected. But there are a lot of companies that have told us they are planning to come to CNQ over the next few months. We have over a dozen companies that have applied.
Traders: Your goal is to fill the void left by the closure of the CDN?
Cook: We have two goals actually. First, to fill that void for companies that qualify. We are not going to replace the CDN entirely. We're not going to trade just any OTC stock. We are for qualified active companies.
Traders: And your second goal?
Cook: We want to provide an alternative for companies already listed on the [TSX] Venture Exchange. We're a different kind of a marketplace.
Traders: Why would you be better than TSX Venture?
Cook: There are two main reasons. First, our market model offers the advantages of both auction markets and dealer markets. We have an auction-based system. All orders go into a central limit order book. On top of that, we allow competitive market makers to post two-sided markets.
Traders: The TSX Venture is a pure auction?
Cook: Right
Traders: There are no specialists or market makers to supply liquidity on TSX Venture?
Cook: No.
Traders: So, how are imbalances handled?
Cook: They aren't.
Traders: They aren't? You mean if I have a buy order but there aren't enough sell orders then I don't get filled?
Cook: Right.
Traders: What is the second reason?
Cook: We are attractive to those companies already listed because we have a streamlined regulation program. We require companies to post prospectus level disclosure on our Website. We also require them to post monthly and quarterly [financial] updates. Also the CEO must post a "Certificate of Compliance" that says the company is in compliance with all the rules.
Traders: And what do they get in return?
Cook: In return for that, we don't do pre-transaction vetting of all of their transactions like an exchange would.
Traders: Transactions?
Cook: Transactions such as selling shares or making acquisitions. On an exchange, before a company does a transaction it must prepare and submit documentation. The documentation has to be accepted by the exchange before a company can enter into a transaction. We require them to post disclosure on our Website prior to doing the transaction including a "Certificate of Compliance" from the CEO. They then wait 24 hours before closing their transaction. It puts the onus on the company to be in compliance with the rules and it keeps us out of their boardroom.
Traders: An exchange gets much more involved with their business dealings?
Cook: Yes. Our's is a streamlined regulatory program.
Traders: CNQ sounds similar to Nasdaq's now-canned proposal to revamp the OTCBB with the BBX. Is it?
Cook: Well, the BBX appeared to be intended to provide a better market than the Bulletin Board as it would apply standards to the companies quoted. The CNQ standards are similar to what BBX would have been though our float requirement was higher and we had a financial standard that BBX did not. It also purported to offer an improved trading environment though it would still have been strictly a dealer market.
Traders: What was wrong with the CDN? Why was it shut down? Bad actors?
Cook: The CDN didn't have as much quality control as you would want over the issuers that were trading. It was strictly a dealer market and a dealer could bring a company forward. The CDN could refuse to allow a quotation. But they didn't have an agreement with the company that said the company would abide by the rules of CDN.
Traders: The relationship was between the CDN and dealer only?
Cook: Yes. It was strictly an OTC market.
Traders: And CNQ is not an OTC market because companies pay to list?
Cook: Yes. They pay to get a quotation. And they sign an agreement with us. They agree to be regulated.
Traders: Why not just resurrect the OTC market with better technology and better regulation? Wouldn't that be easier? Wouldn't you get better participation?
Cook: Well, how do you get better regulation if you don't have an agreement with the company to be regulated? That's the essence of this: a contractual agreement.
Traders: What about regulation by the government?
Cook: Well, then the next question is: which securities commission in Canada would approve? There is no appetite at the securities commission level to have an open and visible OTC market.
Traders: What are your minimum requirements for issuers?
Cook: There must be 150 public holders of the board lot. There must be at least 500,000 shares. The minimum float [capitalization] is $50,000.
Traders: You're not open to everybody.
Cook: Companies must be active. They can't be shell companies. They must have a business plan. They must have the ability to reach milestones in the development of their business. If they lack revenues, they must have a minimum working capital of $100,000.
Traders: The CDN had about 350 companies. About half qualified for TSX Venture?
Cook: Roughly.
Traders: How many companies do you expect to pick up from the OTC market?
Cook: There are many companies in different states of development and activity. We expect between 50 and 100 companies would qualify for trading on CNQ more or less immediately without changes to their business.
Traders: Are these being actively traded in the OTC market?
Cook: I couldn't tell you how actively traded they are because trading isn't visible.
Traders: That's the whole problem, I guess. Of the approximately 2,500 TSX Venture companies, how many could you see bringing on board in the next year or two?
Cook: Between 100 and 150 in the next year or two.
Traders: You can take companies from all over Canada?
Cook: We can take them from all over the world provided they are a reporting issuer in Ontario. Provided they are registered with the SEC. Most companies in Canada become Ontario-reporting issuers.
Traders: Including the bulk of those on TSX Venture?
Cook: Yes.
Traders: Where do you expect the average price of a share to fall? Will they all trade under a dollar?
Cook: Not all. But, on average, they may be. It depends on market conditions. We have no minimum price requirements.
Traders: How many decimal points do you go out?
Cook: The minimum trading increment is a half cent.
Traders: Despite CNQ being an auction, it seems dealers that become market makers still have a lot of privileges.
Cook: That's right. When they [commit to becoming market makers] they get order flow directed to them from other dealers. When a market maker steps up, then a non-market maker is not allowed to put all of his orders in the book. As in a dealer market, if you're not a market maker, you're not trading, you give all your orders to a market maker. In our market, you can only hit the bid or take the offer or you could cross inside the market. If you're not a market maker, you would direct all other orders to the market maker.
Traders: Non-market makers cannot post bids or offers? They can only hit or take those on the book?
Cook: Right. And they can cross.
Traders: If they get two orders that match from their customers?
Cook: Yes. Or they can cross as principal. We use the auction market to focus the liquidity and provide transparency. Putting orders into a central book that people can see. The addition of market makers provides additional liquidity to the market.
Traders: But still, most members are not market makers.
Cook: That's true. But when we started we had zero market makers. Within a couple of weeks two firms stepped up.
Traders: Market maker quotes are posted in the central limit order book?
Cook: Yes.
Traders: Market makers are required to post orders received from customers?
Cook: They are required to either trade against them or post them.
Traders: How does CNQ reconcile claims of strict price/time priority against dealers' desire to internalize?
Cook: Price and time priority means you cannot cross at the bid or offer. You have to improve the market.
Traders: Dealers must offer price improvement?
Cook: Yes.
Traders: Executions are automatic?
Cook: Yes.
Traders: Are market makers identified? Or can they trade anonymously?
Cook: They are identified.
Traders: Great. Thanks for your time, Rob
Cook: My pleasure.
