Auction markets, dealer markets, listing and the ATS

Two ways a price can form

In an auction market buyers and sellers submit orders to one place — an exchange's order book — and a trade happens when a buy order and a sell order meet. The price is set by the orders themselves: the best bid and the best offer standing in the book. Your counterparty is another investor. The exchange runs the book and, separately, sets the listing standards a company must meet to have its shares traded there. This is an order-driven market, and it is how Canadian equities trade.

In a dealer market there is no central book. Dealers post the prices at which they will buy (bid) and sell (ask) from their own inventory, and you trade against the dealer, who is your counterparty and earns the spread (Lesson 3.1). The price forms from the dealers' quotes, negotiated over the phone or a screen — hence over the counter, OTC. This is a quote-driven market, and it is how most bonds trade in Canada.

Worked example — one client, two trades, three venues

Trade 1. A client of Northshore Securities enters an order to buy 300 Tamarack Foods shares at $24.16. The order goes to the TSX's book, where a resting sell order at $24.16 from a client of Maritime Securities is waiting. The two orders match. Neither dealer took a position; the two investors traded with each other through the exchange. Auction market. Tamarack is listed on the TSX, which means it met — and keeps meeting — the TSX's standards for size, float and disclosure.

Trade 2. The same client wants $50,000 of a Prairie Grid Energy 5-year bond. There is no order book to send it to. Northshore's bond desk quotes 101.20 bid / 101.60 ask from its own inventory, and the client buys at 101.60 from Northshore. The dealer is the counterparty and the 0.40 spread is its income. Dealer market — OTC.

Trade 3. Next morning the client buys 300 more Tamarack. Northshore's router finds the best price not on the TSX but on Omega ATS, an alternative trading system run by Tradelogiq Markets. Omega matches the buy against a sell order resting on its own book — an auction mechanism again — but Omega did not list Tamarack and sets no listing standards. It only matches orders in securities that are listed elsewhere.

Exchange versus ATS

An exchange does two things: it runs a market and it lists securities, setting and enforcing the standards an issuer must meet. An ATS does only the first. It is a marketplace — a matching facility — for securities that some exchange has already listed. Canada's recognised exchanges are the TSX, TSX Venture, the CSE, Cboe Canada and (for derivatives) the Montréal Exchange; Cboe Canada is often mistaken for an ATS because it trades so many TSX listings, but it is a recognised exchange in its own right and lists issuers too. The pure ATSs — Omega, Lynx, Liquidnet Canada and others — list nobody.

OTC is not "unregulated"

The phrase means dealer-negotiated, nothing more. The bond dealer in Trade 2 is a registered investment dealer and a CIRO member; the ATS in Trade 3 operates under the same CSA marketplace framework as an exchange, and CIRO acts as the regulation-services provider for Canadian marketplaces, exchange and ATS alike. Unlisted does not mean unregulated, and over the counter does not mean under the table.

Four venues to classify

The TSX order book — auction, exchange, lists. A dealer's bond desk — dealer market, OTC. Omega ATS — auction mechanism, ATS, lists nothing. The Montréal Exchange — exchange (derivatives), lists contracts, cleared by CDCC.