What are the major changes impacting market structure in Canada and the U.S.?

NARRATOR: Welcome to Viewpoint, A TD Securities Podcast. Listen in as we draw perspectives from a variety of thought leaders on key themes influencing markets, industries, and the global economy today. We hope you enjoy this episode.

AMY VAN ARNHEM: Hello, and welcome to episode eight of Viewpoint, a TD Securities Podcast. My name is Amy Van Arnhem, and I'm a senior relationship manager at TD Securities. And I will be your host for today's episode. I am joined by my colleague Peter Haynes, managing director and head of index and market structure research. Peter also handles relationship management for a few key Ontario-based institutional investors as part of our senior relationship management team. Peter is the host of our monthly podcast Geopolitics with Frank McKenna and is also a regular host of Viewpoint. While Peter began his career at TD Securities in 1995, I've had the pleasure of working with him for the past 15 years. Peter, welcome.

PETER HAYNES: Thanks, Amy, very much. And you didn't mention in there that we sat beside each other for years. So it's great to be here, and I think I have hosted something like 80 podcasts for TD Securities. And this is the first time I've been a guest, and it's your first time hosting.

AMY VAN ARNHEM: That's right.

PETER HAYNES: You did a great job on the intro, and I look forward to being part of this.

AMY VAN ARNHEM: Well, yes, that's right. This is my first time hosting Viewpoint. So I look forward to hearing your feedback at the end of the podcast today.

PETER HAYNES: Well, I'll be honest with you like I always am, so.

AMY VAN ARNHEM: Yes. So could you start off by talking about how you came to sit in the seat you are in today, and why what you do matters?

PETER HAYNES: I think about this a lot, actually. Why does anything we do matter in capital markets? My career has been focused on index benchmark issues. That's become very important over the last 10 years, as we've seen a parabolic increase in the amount of activity from benchmark-oriented portfolio managers. And ETFs, of course, have been a big part of that. So following the benchmarks has become extremely important for everybody because it's something that matters to the issuers, in terms of what's going on in their underlying, and it matters to the indexes themselves that are very active in the market. So that has been something that's really become important. And I'm in the crosshairs of that space on a daily basis. And I would think, market structure wise, I have certainly a curiosity around how markets work. And I would say, if anything, Michael Lewis' book Flash Boys, in 2014, that shone a spotlight on market structure. It became an issue about the plumbing of the market. And I know a lot of people get critical about some factual issues in the book. I actually thought the book was excellent because it did shine a light on some important topics. And what it did is it basically made every trading desk on the buy side have at least one person who became their in-house expert on market structure. And I was able to build relationships with those colleagues on the street, and have grown those relationships in the last eight or nine years. And it's been a lot of fun. And I know we're going to talk about market structure. It's definitely all-consuming at this time.

AMY VAN ARNHEM: So maybe outside of Michael Lewis' book that you spoke about, for the average investor, for a retail investor, what would be something that you would recommend that they look at or start to look at when they're trying to understand what is important in market structure?

PETER HAYNES: See, that's a good question. I wonder sometimes if individual investors really should try to get inside the plumbing. We should have trust in our regulators that are creating the rules, that are designed to protect individual investors as part of the mandate of the CSA or the SEC-- and hope that, certainly from an institutional perspective-- given the size of the orders and the fact that when you enter an order and institution to buy 500 shares, you're not just buying 500 shares. There's a lot behind it, most likely. I think, for those reasons, the institutions dominate the dialogue when it comes to market structure. I should say, though, to be fair, the retail firms-- retail-oriented execution firms have done a great job of making sure that rules that have been created set things up for the individual investor to succeed. And I think it's generally well known that the retail investor has never had it better in terms of market structure today versus any time in history.

AMY VAN ARNHEM: So you mentioned the regulators. Let's speak about the US regulators under SEC Chairman Gary Gensler. There's been a list of improvements that they would like to make to the US equity market structure. Could you discuss at a high level the most important files they are working on and how they might impact equity market structure?

PETER HAYNES: I think to answer that question the best thing I can do is to break it down into what we already know and what we are expecting to see from Chair Gensler and the commissioners at the SEC. It's said that he has something in the neighborhood of 50 different rules that he wants to propose. And the way the process works, typically in the US, is in the first year of the new administration when you get a new chair, they have a very ambitious regulatory process that they're trying to go through. They start with their rule filings in the first year. They get comments back from the industry. They make them final rules, and they hope that they can get those rules done before the administration potentially changes. And so, right now, Chair Gensler has just been literally feeding these files to the street on what seems like a continuous basis. When I look at the ones that have come out so far, there's really four that I think are important for our audience. First of all, there's been a lot of talk about transparency around short selling. And so between securities lending, which is the backbone of short selling, and short selling itself, Chair Gensler is pushing for number one transparency around securities lending transactions and then, in addition to that, transparency around who the participants are that are shorting stocks. And the thresholds they've got in place are very, very low. And I expect there to be quite a bit of pushback in the industry. There may be some, at the end of the day, type of symmetry between disclosure on the long side versus disclosure when you're short selling. T plus 1-- it's happening. We know it. It's going to impact Canada as well. The shortening of the settlement cycle to one day from two, where it's at today, that's a file that is important and has been put out there. On the ESG side, this is probably the most controversial of all the files that Gensler has come out with so far. Really pushing on the disclosure side, particularly around climate for issuers. And this is guaranteed to be litigated. There's just a view that they've gone through regulatory overreach here, and they're looking for issuers who, right now, as we know, and you know very well, Amy, are under an incredible amount of pressure to disclose a lot of information on ESG. And in this case, the view is that by asking for so-called scope 3 information and disclosure, that's just simply beyond the capability of the typical issuer. And it's almost certain that we'll see litigation on that file. And then, finally, on the ones that have been published so far, something called regulation ETFs-- which is sort of how marketplaces in the US are regulated if they're not exchanges-- they put out rules that were designed to try to rein in or really focus on trading of government treasuries. But in doing so, they actually put some proposals in there that people are looking through to existing ATS regulation on the equity side and saying, wow, this is actually going to impact, substantially, activities that are day-to-day and normal in the equity world. And that affects, as well, broker-dealers in terms of registration. So that file, which is a 650-page tome, is something that people are working through right now. What I would say, from my perspective, what I'm most interested in isn't what's been done so far. It's what we expect happening down the road. And that has to do with equity market structure itself. Chair Gensler has been very open that everything is on the table right now. So he's looking at payment for order flow, which is a controversial practice in the US retail space, where when you send an order in, the firm that executes the order actually sends you a rebate. This has been a very, as I say, controversial practice that's got a lot of attention. Is he going to ban payment for order flow? Quite possibly. What's he going to do with marketplace rebates, which he may ban? Tick sizes-- right now, we're stuck at a cent. Bid-ask spread is a cent. Maybe he's going to shrink that. Most likely, he will for low-priced stocks. Maybe he's going to change the definition of best execution in some way, shape, or form. And, probably, he's going to try to harmonize rules between ATSes or off-exchange trading and exchanges themselves. So that is a very ambitious list of things that he's looking to do on equity market structure. Expectation is we'll hear from him in the next few months.

AMY VAN ARNHEM: Somebody to definitely watch for. What do you think Canadian regulators have to pay attention to in regards to that then, Peter?

PETER HAYNES: That's a very good question. I would argue that some of the files that have already been published, we need to be paying attention to here in Canada, where you and I sit. T plus 1 is a natural. Obviously, Canada is going to move to a one-day settlement, in line with the US. And on the securities lending side and short sale disclosure, there's concern that there would be regulatory arbitrage if Canadian regulators did not follow the rules the US regulators are putting in place because so many of our large names in Canada are listed in the United States as well, so-called listed names, so we anticipate that we'll have to address those issues. And when it comes to equity market structure, we are inextricably linked. If they get rid of rebates on exchanges in the US, we absolutely have to do the same in Canada. So I would say, around equity market structure, T plus 1, and securities lending, and secured and short sale rules, Canada is going to have to be in sync with what the US does.

AMY VAN ARNHEM: Picking up on a topic that you raised answering that question on ESG-- as the investment community grapples with how to incorporate ESG into their framework, what have index benchmark providers been doing?

PETER HAYNES: This has been a very, very high-profile topic because the investor community is pushing for solutions from the benchmark providers to basically cater to their desires with respect to ESG demands of their clients, in some cases, when you're talking about asset owners as well. So what I have felt very strongly about is that when you think of our primary benchmarks-- the S&P 500, Russell 3000, S&P/TSX Composite, FTSE 100-- those are the bellwethers for various marketplaces and country benchmarks around the world. We need to leave those benchmarks alone. Don't touch them in any way, shape or form. So when it comes to ESG's impact on benchmarks, that should be felt when people are looking for solutions that I would put in the custom category. Don't change the primary benchmarks. If you want a solution, then that provider can give you some sort of customization. The one space where it's a problem right now is around multi-voting shares. And Canada, we've had multi-voting classes of shares for a long time. In the US, they're more of a recent phenomenon. I think something like 25% of IPOs in the US last year were with multi-voting issuers. S&P is currently on a rule that says multi-voting classes of shares cannot be added to the S&P 500. The ones that are in there right now, like Google and Visa and others, they can stay in. They're grandfathered, but no new names. Meanwhile, we have all these large companies coming public that are part of the US equity market but are not eligible for their most important benchmark, the S&P 500. So I don't like that decision. I do think it will get revisited by S&P's index committee, and I think that we will see a change to that rule. But otherwise, benchmark providers have so far steered clear of changing their benchmarks to deal with the flavor-of-the-day ESG demands. What I would finish with there is the war has changed everything. If you think back to what were the first screens-- and Amy, you know this when you were in equity sales. It was no tobacco, no liquor in my portfolio. But a lot of companies, a lot of investors would also have no munitions companies. And now, all of a sudden, munitions companies-- they've turned it around. These are companies that are building munitions to protect the people of Ukraine who've been invaded. And so this whole impact of the war around ESG is one that's evolving, and it's very interesting.

AMY VAN ARNHEM: So maybe you could spend a couple of minutes recapping how index providers reacted to the Russian sanctions, and then, also, if there's a read through for China from a benchmark perspective.

PETER HAYNES: Yeah, well, Russia was a mess. So Russia is considered an emerging market or was considered an emerging market. So, therefore, it was part of FTSE and MSCI's Emerging-Market benchmarks. Lots of people allocating more capital to emerging markets. Therefore, they had exposure to Russia as a result. So when the invasion occurred, and Russia basically became unenforceable, and sanctions were on, and you weren't allowed to put any money in there, the index providers very quickly put out consultations, which they knew the conclusion was going to be, we have to get rid of Russia. So what they did is they moved Russia to what they call standalone status. So the existing emerging market benchmarks became emerging markets plus Russia. And so if you're running an emerging-markets portfolio, you can either change your benchmark to be emerging markets plus Russia or what I think everybody did is they just simply eliminated Russia. The problem was there are long Russian stocks, or there are long synthetic instruments giving them Russian exposure, and they can't dispose of them. So what does the index provider do? They removed Russia at a price of 0. Now what does that mean? That means there's all these stocks that are held out there that are essentially unsellable today that sometime down the road may be worth something. The index takes Russia out at 0. Those stocks may be monetised down the road at $0.50 on the dollar. And that essentially means that the index itself is going to underperform the portfolios of the people that hold those securities. There's really no other choice. Now, the read through for China is very interesting. I've been arguing for a while, and this is something that people are talking about, that China should actually be a standalone benchmark regardless of the war. And that's because you have developed markets. And I think everyone agrees China is not in the developed category. You have emerging markets. And as China becomes bigger, it's becoming the dominant part of the emerging markets and, at one point, could be as much as 50% of the emerging-market benchmark. When you invest in emerging, you don't want that just to be a bet on China. You want China to be a different decision. And so it's dominating or will eventually dominate the benchmark. So I would argue China deserves standalone status, but not for the same reasons as Russia today. Taiwan changes everything. If we see China do something similar to Taiwan-- god-willing, they don't do that-- but if they do, then this is going to be the Russia situation multiplied by 20. And what's interesting right now is everybody's thinking, OK, I saw what happened in Russia. Do I need to rethink how I get exposure to China? If I've got synthetic exposure through derivatives-- uh oh. What if the same thing happens in China, and it's so much bigger, and all of a sudden, I can't get access to the securities because someone else holds them and pays me the return through a synthetic instrument? So I'll tell you what-- that is definitely a front-burner issue. I think the index providers are a bit scared right now of how to deal with that. Moving China to standalone would look like they're doing it in reaction to Russia when they wouldn't be, at least at this state right now. So stay tuned on that issue. It's high profile.

AMY VAN ARNHEM: Yeah, I think China definitely-- people are wondering whether there's any way you can actually preposition for an event such as that, just given the magnitude of impact it would have across the whole financial market system, so.

PETER HAYNES: I don't know what you do, frankly.

AMY VAN ARNHEM: Yeah.

PETER HAYNES: I really don't, so I don't have any advice. I just hope we don't get to-- I think if China gets standalone status, people continue to hold China. They just have emerging as one benchmark and China as a standalone. You don't sell China for the same reason because it's not being made standalone for the same reason. Again, Taiwan is definitely the wildcard.

AMY VAN ARNHEM: So it would it be great to close off the episode today by turning back to our home country, Canada. Maybe you could speak to what some of the market structure challenges are that Canada faces and also what some of the opportunities are as well.

PETER HAYNES: I think about this. This keeps me up at night. Because I think we come in every day, we sit-in our chairs, and we just assume nothing's ever going to change. And it changes every day. And then after a while, you realize, oh my goodness, I can't believe what changed. And so when I think of Canada and what's good about our market, the fact of the matter is we're the envy of the world when it comes to Venture investing. We have a Venture Stock Exchange. We have other competitors to the Venture Stock Exchange. We have clearly defined rules around investing in Venture where, perhaps, the regulation is gradual, meaning there's slightly less regulation on Venture names. When they migrate to the TMX, the big board, the rules are a little tighter. So the graduated regulators framework around, particularly, mining and energy names is awesome. The fact is we own the mining space globally. And we deserve that. We have the entire infrastructure from analysts, to accountants, to regulators, to lawyers, to investment bankers, to equity salespeople, like was your previous career. Everybody understands the mining space, and we're the envy of the world. And I hope we can continue there. And then, finally, I would say that our energy sector-- and Frank McKenna has said this a few times on the Geopolitics podcast-- we're going to be leaders when it comes to transition. You can trust the Canadian energy sector is going to lead that space. And I think that's something we should be proud of as well. When it comes to some of the things I worry about-- for whatever reason, we could lose the label as the mining go-to hub. I know a few years ago, there was some speculation that Barrick was going to move its listing primary listing to the United States. That didn't happen. But those types of decisions-- losing our key benchmark names for whatever reason would be of concern to me. Decarbonization is a major issue. It's on hold right now with the war and the need for energy independence. But the reality is we are very attached to the energy patch, and decarbonization strategies that don't take into consideration transition are worrisome. I think I worry about our border. I think capital doesn't stop at the border. So you say to yourself, why is a company Canadian? What about a mining company that has all of its operations in Africa, yet they're part of our benchmark? Why does that make any sense? I do worry that someday we may see just certain hubs of capital-- say New York, London, Amsterdam, Shanghai-- and that's it. And what does that leave Canada? And I think if we do end up in that sort of hub world, and Canada just becomes a scrapyard for small caps, on the same vein, the global brokers will dominate in that space because you'll only be focusing on companies that are part of these hubs. So I worry about that. I don't know if that's a tomorrow issue or a 10-years-from-now issue. And I would finish off by saying this isn't an issue for Canada. This is an issue globally for regulators who control markets. Is every security going to be trading in decentralized finance platforms without regulation? Everything defined as a security and tokenized and completely decentralized away from the exchanges? That's possible, and that's worrisome not just for Canada but for globally. So I think when you add it up, we're in a good spot in Canada, primarily because of our democracy. But there certainly are some concerns that I would have that do keep me up at night.

AMY VAN ARNHEM: Well, the decentralized theme is definitely a podcast in and of itself, so it's definitely something that is topical and everybody's thinking about right now in the financial markets.

PETER HAYNES: You're going to have to get a different expert to talk about that topic.

AMY VAN ARNHEM: Yeah.

PETER HAYNES: Or maybe bring my son in here because they know a lot more about crypto and digital than I do. There's a school of thought-- I've talked to some of my friends in the space-- that equity market structure folks will become crypto or digital market structure folks telling you, I'm 53 years old. It's not happening here. But certainly, there is a view that there's convergence in those two spaces. We'll have to see.

AMY VAN ARNHEM: Well, thank you very much, Peter. Thank you for joining us today. I have one final question. How'd I do?

PETER HAYNES: You know what, Amy, I would normally be constructively critical. I got to give you a 9 and 1/2 out of 10. I thought you did amazing, and I'm just happy to have a good partner. We're going to share hosting a Viewpoint with a couple of our other colleagues. Welcome to the club. I thought you did a great job, and I look forward to future podcasts that you're hosting.

AMY VAN ARNHEM: Thanks, Pete.

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