New Exchange on the Horizon: INN Speaks with Aequitas CEOAs the old adage goes, necessity is the mother of invention, and the saying has never been more relevant to what is happening currently in the junior resource markets. With most juniors struggling to raise financing in what has become a historically brutal market, alternatives to traditional capital raising venues are springing forth. 

In the interview below, Andrew Topf, INN Senior Editor, speaks with Jos Schmitt, CEO of Aequitas Innovations, which in June announced it was launching a new stock exchange to compete with the TMX Group. Comprised of 8 investor partners — Royal Bank of Canada (RBC) (TSX:RY,NYSE:RY), Barclays Corporation (LSE:BARC), BCE (TSX:BCE,NYSE:BCE), CI Investments Inc, IGM Financial (TSX:IGM,NYSE:IGM), ITG Canada, OMERS Capital Markets, and PSP Public Markets — Aequitas is seeking to develop a hybrid private-public exchange that it says will be more responsive to issuer and investor concerns.

INN: To start off, can you give me a brief background on how Aequitas came together?

Jos Schmitt: The history of Aequitas in a nutshell is, RBC, when they saw the entire Maple Group initiative coming to fruition and were asked to join, they were of the opinion that it was not the right thing to do. They were firm believers in the need for competition in the marketplace, meaningful competition, because you are creating an environment where you reestablish a monopoly, and where you then expect security regulators to manage that and become price regulators and do things that are not really typical of where their experience and expertise is.

When I left the TMX Group after the acquisition of Alpha [Exchange and CDS Clearing and Depository Services Inc.], they reached out to me to see if there was an interest to do something in this space, and the view was no, because there’s no benefit in launching another marketplace, because it’s just adding burden and cost to a system which is already complex enough.

But then a very interesting thing happened. They asked me to analyze, which I did with a couple of people, the issues and the challenges of the Canadian marketplace in a holistic way. Starting from a white piece of paper, if you want, it allowed us to look at what is not working, what could be the potential solutions, and then based on that, see if there is an opportunity to come with a new initiative.

INN: In June Aequitas announced that it planned to create a new Canadian stock exchange to challenge the TSX. Can you tell us what’s wrong with the TSX and why Canada needs a new exchange?

JS: I think that the marketplace needs competition. Without competition there is no pressure on the cost of doing business for all stakeholders. The issue is the investors. And two, without competition there is no innovation; innovation is trying to attract and develop new solutions in the interests of the issuers and the investors. And the third key element is that you see a very profit minded attitude focusing on what are going to be my figures for the next quarter, rather than thinking about, what are the problems that my investors have, what are the problems that my issuers have. So that’s one big reason, I would say, behind Aequitas.

The second set of reasons has to do with the impact of high frequency trading, which is detrimental to the long term investor.

But there’s also an impact for us on the issuers, because issuers don’t really like to see the type of activity that you see in markets today where stock prices show totally erratic behaviors, all the more so when you’re a smaller junior mining company. You don’t see much volume trading and then suddenly you see a lot of activity, and that is often linked to something that happened. You see then high frequency traders stepping in, and as soon as the event is gone they disappear again. But they suck at that moment all the opportunities out of the market to the detriment of the investors and those securities. So high frequency trading, for us, is a big challenge.

INN: Aequitas is pointing the finger at high frequency trading (HFT) as a main culprit in eroding investor confidence in Canadian markets. But is there anything that can be done to stop it? How would Aequitas tackle that problem?

JS: Absolutely. That’s what our entire trading model is built on. We are proposing a combination of technology, as well as some changes in the way that our market would operate, to eliminate all the predatory high frequency trading that we observe.

I want to be very clear. That is something that, your readers and site, I think, should also think about and never forget: That what you want to get rid of is the inappropriate high frequency trading. It doesn’t mean that all high frequency trading is bad. If you are a market maker today in today’s world where information and data circulates at high speed and in large quantities, you need to be technologically enabled to participate in those markets, or to provide liquidity in those markets in a good way.

But what we see is too much behaviour that is not adding any value to the market, and which is just causing the extraction of profits for a very small group of participants. As I said, our solution is really a combination of technology and a different way of operating in the markets, where long term investors get priority of execution over high frequency traders, where high frequency traders are not allowed to take liquidity in some of our trading books.

We will, in some of our trading books, eliminate the entire rebate strategy that the exchanges have developed to attract HFTs and to commit them to a maximum amount of volume. So it’s a holistic set of solutions that altogether will help us to address the type of threat in high frequency trading.

INN: HFT is pretty low on the TSX Venture, though. About two percent to six percent. Is that because these companies trade such low volumes? 

JS: Well, I think what you just said about they have low activity on the Venture, that is absolutely correct. High frequency traders, at least those who develop predatory activity, you will only see them in the securities that are already liquid because they will only be able to make money and to deploy their strategies if there is a lot of activity and a lot of volume. Otherwise there’s nothing to extract.

In the Venture world you see them in a very small subset of securities, the more liquid ones, of course, or, when there is suddenly a big liquidity event in the security then they come. They step in and then they disappear.

INN: The one problem that we have been hearing time and again is that the TMX Group is dominated by the big banks who really don’t care much about small-cap companies. They’re just trying to sell their own products. How would Aequitas be different?

JS: Well, that’s a very interesting point, and it takes you back to the fact of what I said earlier about changes in marketplaces. The banks are going to go where they’re going to make the most profit, and today if you want to make a lot of money in the marketplace you support high frequency traders, because they create volume. You can sell them co- location space in your data center. You can sell them expensive data feeds.

What is Aequitas doing differently? Our conclusion is that we need to bring the exchange back to its original purpose, and that means you have to listen to your investors and the issuers, and besides tackling high frequency trading, we also said that we need to do something more fundamental for the issuers. And we would like the issuers to understand that you don’t want to go public too quickly.

I think that in the Canadian marketplace, we have seen too many companies go public when they aren’t ready for it. They were not ready for the cost that comes with it. They were not ready for the burden that comes with it. You’ve got regulatory burden. You have a lot of financial reporting you need to do. It takes their attention away from what they should be doing, which is growing their business.

So for our exchange, we are coming with a listings approach where we are now going to come up with criteria that’s going to be more stringent than the TSX just to make sure that once you go public you are set up for success. We have come up with a solution that has been established and proven in other countries across the world and that we are missing, and that’s a centralized private market; a market where small and mid cap organizations can come to raise capital. But it will be an exempt market, so they can only get that capital from, of course, accredited investors, and accredited investors are individuals, but it’s also all types of investment vehicles that can look at that.

Often people say, “Well, there’s only so many accredited investors, and it doesn’t represent much value. It’s not enough capital. You need much more than that.”

Think about it this way. Does it make sense to have a company trading 7 hours a day, 5 days a week, and all you see traded is 5,000 or 10,000 shares? The perception of liquidity is not going to be there, so you need to come with different models. You need to bring the capital and the corporations together in a very efficient way, and that is what we want to achieve.

Does that mean that I want the small retail investor to be excluded from early stage investments? No, not at all. But I think that there we should look at other vehicles. It can be through firms, it can be through investment issuers, it can be through other vehicles where they can then benefit from the expertise of people who will make some right and diversified investments in those high risk companies. That is a model that we fundamentally believe in, and we think it is extremely necessary because we need to fundamentally do something to help the startups and the small to mid cap companies in Canada.

INN: Okay, let’s just talk about the mining industry specifically. You know that the TSX Venture has received a lot of criticism from small mining companies, for the seeming inability to attract venture capital right now. So what could Aequitas do to attract more venture capital into the junior mining sector?

JS: Well, I think the private market that we’re looking at is really a key vehicle in my eyes to achieve that. We have to make sure that we have mechanisms in place where accredited investors can be adequately informed without putting burdens on 200 or 300 pages of documentation. We then also have to give them an opportunity, and I think that this is extremely critical, and we’re missing that here in the market, to give them an exit opportunity.

The secondary component of the private market is very critical. We need to spend time in helping those corporations to get known, to get known publicly within Canada, and outside of Canada. I think that that is what the focus is, helping to commercialize those companies with potential investors domestically and internationally. I don’t see any benefit to the Canadian economy to try to attract foreign companies to Canada while we have challenges with the Canadian companies.

INN: We did a recent survey of junior mining executives, and one of the things that we found from our survey was that over-regulation is a top concern among junior mining companies. Is there anything your exchange could do about the high cost of complying with regulations?

JS: Yes, I think that once you’re a public company where everyone can make an investment, that is a world in which you need to be careful and you need to have the mechanisms in place to properly protect investors. But if you then look at the private market and the different type of investors that you will have over there, there I think that regulatory burden can be kept to a very strict minimum.

INN: Okay. Just sticking with the Venture, we’ve learned that the Canadian National Stock Exchange is slowly gaining traction as a competitor to the Venture. How do you plan to compete with the CNSX?

JS: Well, the big question that I have about the CNSX is what are they truly offering as a solution? The worry that I have in the way that they seem to be approaching things is, they want to make a listing very inexpensive. They want to establish a number of mechanisms where everything is based on disclosure by the corporations, so where the exchange is not really playing a role anymore in investing in any way, shape or form. So I am worried that there is a big risk that is being created.

INN: You mean too much risk for the investor?

JS: Yes, too much risk for the investor. The question is, who are they attracting? If you look today at the cash positions of many small companies, they will look at any opportunity to reduce the cost. But is that a solution for the issuer, or is that a solution for the investor? I think we have to give the issuers access to the right capital from the right investors with the right risk tolerance.

So let me be very clear. We will not set up a Venture exchange. We will support the entire Venture market with the private market that we are setting up, which we believe is the right answer to the needs of that marketplace. I said it before. Look at what’s happening in the US. Look at what’s happening in Europe. Look at what’s happening in other regions in the world. That is where the answer is emerging to meet the needs of small and mid cap companies.

INN: How will Aequitas decide whether a company would participate on your exchange privately versus publicly? Would there be a market cap cutoff?

JS: We’re looking at a number of key criteria. But to trade publicly, it has to be a company that has a market cap of at least $20-30 million, maybe a little bit higher than that. Or they need to have a substantial amount of cash, because they are working on a process that takes two to three years to be put in place. We are looking at potentially having analyst coverage as a core component, because analyst coverage is a big element of attracting investors and liquidity.

INN: Can you give us a sense of what has been happening with Aequitas since you announced your intention in June to compete with the TSX?

JS: We have done a lot of work in getting the organization ready to fully execute the details of how we’re going to tackle high frequency trading, defining how the private market will operate, topped with lots of market participants, issuers, investors, others.

INN: Just a clarification, so the exchange, would there be a bricks and mortar element to it, or would it be strictly online?

JS: The exchange will be computer-based. The technology would have connections for the various dealers and market participants, but there would not be an actual trading floor.

INN: How far away is the exchange from getting off the ground?

JS: We are waiting for the regulator to come with its point of view on what we want to achieve. As soon as we are comfortable with that, setting up the exchange will take between 12 and 15 months. I hope we’ll get some clarity on that in the course of December.

INN: What are your next steps?

JS: The next steps are really focused now on trying to come to a conclusion around the regulatory process, and as soon as that is done, we push the internal green button, and then we go full speed ahead with implementing the exchange that goes from effectively setting up the technology that we have selected and analyzed, to filing a formal exchange application, etcetera.

INN: Thanks for taking the time to speak with us.

JS: Thank you as well.

 

Securities Disclosure: I, Andrew Topf, hold no direct investment interest in any company mentioned in this article.

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