High-frequency trading algorithms, restrictive securities regulations amplify financing struggles for junior venture companies in B.C.

Investor interest in the junior mining stock market has plummeted this year. Funds raised by mining firms listed on the TSX Venture Exchange have fallen 50% this year to $1 billion from $2 billion in all of 2012. But highly advanced trading schemes and outdated securities regulations could discourage more retail investors from a key segment of Canada’s venture capital markets and further stifle exploration activity by B.C.-based companies.

One of the key issues discussed by industry insiders at this year’s BC Securities Commission annual conference was the growing prevalence of high-frequency arbitrage trading, which involves stock traders using computer algorithms to take advantage of the split-second differences in stock prices that exist between the numerous stock trading systems that operate in Canada and around the world.

While high-frequency trading (HFT) has been touted as a way to increase the liquidity of stocks, a couple of U.S. studies published over the summer suggested such activity hurt retail investors because of the sliver of profit high-frequency traders earn with each trade that can take only half a millisecond to complete.

Trading is being based more and more on information versus value, said Randee Pavalow, chief compliance officer at Aequitas Exchange, a new exchange being developed in Toronto. You have lots of traders in the market trading based on small differences in price versus the fundamentals of the company. They are looking for arbitrage opportunities.

Bill Whitehead, an investment adviser and senior vice-president at Vancouver’s PI Financial, said high-frequency traders have already negatively affected investors.

Because their computer systems are so fast, when I hit enter, they automatically jump in front of my order, he said. That’s high-frequency trading. It’s an unlevel playing field. I think it’s a big problem. If I notice it, I’m sure hundreds of other brokers notice it.

HFT activity has continued to increase globally. According to Pavalow, more than half the trades in the U.S. are estimated to be from high-frequency traders. John McCoach, president of the TSX Venture Exchange, suggested high-frequency trades account for about 20% of market activity on the TSX and between 2% and 6% of activity on the venture exchange.

While the activity is relatively small in the junior markets, it still hurts the junior mining companies that have the potential to grow.

Bruce McLeod, president and CEO of Mercator Minerals Ltd. (TSX:ML), noted that high-frequency trades can derail the positive stock market movements associated with the release of positive company news.

We are an event-driven market in exploration and development, he said. To have an active, effective junior exploration market that’s event driven, to have high-frequency trading that can kill that momentum is something that has really impacted our market.

The issue is exasperated because Canadian equity markets in general are not as liquid as other larger markets. Pavalow suggested a majority of Canadian public companies trade less than 500 times a week.

So, we have a very illiquid environment, Pavalov said. You have to approach almost the $50 million market cap [level] before they start trading 1,000 times a week, which isn’t really a lot of trading.

McLeod noted that the current slate of regulations have unnecessarily limited the number of people who can invest in the junior markets. While investors can openly buy shares in public financings like an IPO, such a financing option is often costly to provide the detailed and lengthy disclosure documents required. Many junior companies that are in a position to raise funds have opted for private placements where there are prospectus exemptions. A commonly used exemption is the accredited investor exemption, which limits individual investors to those who have more than $200,000 in pre-tax net income or financial assets of more than $1 million.

He suggested new exemptions should be created to allow new or even existing shareholders who might already have invested in a previous share offering of a company to participate in certain equity offerings that are currently restricted to accredited investors.

The accredited investor [exemption] only looks at one thing: what is your ability to lose money without impacting your lifestyle? said McLeod. I think there is a more appropriate model than just your ability to lose money on an investment.