This from TDTRADING IN TRINIDAD DRILLING (TDG) ON THURSDAY CALLS FOR CHANGES TO MOC ELIGIBILITY & FREEZE MECHANICS OR VELOCITY PARAMETERS
On Thursday, Trinidad Drilling closed up 31% on 1.8MM shares. While TDG was NOT directly affected by the quarterly rebalance, it appears that the rebalance date was used by some “equity only” passive investors to buy their TDG shares. Recall that Trinidad was converted from a trust to a corp, effective last Friday. For passive accounts that elected the Equity Only benchmark (ie. chose not to invest in trusts), they needed to purchase TDG units when it was converted from a trust into a corp. It appears that some of these
2 A Division of TD Securities Inc.
purchases were simply lumped in with the quarterly rebalance in a typical “portfolio sweep” that is common for indexers.
Unfortunately, what looks to have slipped through the cracks, is that the TSX failed to make the new TDG symbol eligible for the MOC (market on close), even though TDG.un was included in the MOC facility and TDG.un was a member of the Composite Index. This went unnoticed all week until Thursday, when it was essentially too late to add Trinidad Corp. (TDG) to the MOC facility for Thursday’s session.
At 3:30pm on Thursday, TDG was trading at $11.16, up 3.8% on volume of 1.28MM shares (though 1.1MM of that volume was two large prints). At 3:40pm the stock was being purchased on the floor of the TSX. Within four and a half minutes, TDG was bid at $14 dollars, a 27% move on volume of 101,000 shares. At 3:44:26pm, the market on TDG was 14.00/18.00. Ten seconds later the market went 16.00/18.00. When the 16.00 bid was hit, the stock was frozen by Market Regulation Services (RS). The stock was NOT subsequently allowed to open before 4pm. When it was re-opened at 4:15pm, it traded at $16.00, which was originally deemed the closing price. Following an investigation in TDG by RS, they deemed the $16.00 closing price to be in contravention with market integrity. They cancelled the $16.00 trades and set the closing price as the last tick before the stock was frozen, which was $14.00.
There are a couple lessons that we believe we have learned from the TDG experience on Thursday:
1.
The TSX needs to ensure that, as Composite trusts convert to corps, their new tickers are immediately added to the MOC facility. With the pending changes to trust taxability in 2011, it is likely that we will see on-going conversion of trusts back to corps. As this happens, passive investors that are invested in the S&P/TSX Equity Index (ie. ex-trusts) will be buyers of these converted entities. These purchases will likely be benchmarked to the close on a particular date of choice. The TSX should ensure that the converted securities are immediately added to the MOC facility to provide a venue to handle supply/demand imbalances.
2.
In the past we’ve written about the need for the TSX “price freeze mechanism” to be updated. Specifically, the current rules for price freezes are based on a tick by tick rule (ie. if a tick is going to exceed a certain percentage, then a freeze occurs). Unfortunately, this does nothing to prevent a situation such as TDG from occurring. Specifically, the freeze mechanisms allowed for TDG to be moved almost 30% in less than five minutes because not one single tick triggered a freeze. In the past we have advocated that a “velocity” governor be used to trigger freezes rather than a single tick test. In the case of a velocity governor, the stock would be frozen if it moved more than a certain percentage over a fixed period of time. In fact, multiple time intervals could also be monitored. For example, a stock will be frozen if it moves more than 5% in any rolling 60-second period or it will also be frozen if it moves more than 15% in any 5 minute period etc. While we recognize that there might be quite a bit of debate with respect to how narrow the velocity governors are set, we think it would help to improve the integrity of the market place. This would undoubtedly be a rather large regulatory and technological undertaking, but we think the time is now for the Canadian marketplace to adopt this mechanism, especially in-light of the increasing frequency of malfunctioning algorithms and auto-strategies. We believe it is time to start an industry dialogue on this issue.
At the end of the day, we agree with RS’s decision to cancel the TDG trades at $16. Given that the last traded price of TDG was $14 before it tripped the freeze, we also agree with RS using this price to set the official close. That being said, we believe that had TDG been included in the MOC facility and that we had different trip mechanism in place for freezes, that TDG would not have closed at $14 on Thursday.