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Royal Bank of Canada Gains by Putting the Brakes on Traders

BY NATHANIEL POPPER, INVESTMENT BANKING JUNE 25, 2013
<http://dealbook.nytimes.com/2013/06/25/royal-bank-of-canada-gains-by-
putting-the-brakes-on-traders/?ref=business>


The spoils on Wall Street generally go to the firm that is the fastest and 
most opaque. 

But one upstart contender is trying a distinctly counterintuitive approach.

The Royal Bank of Canada has risen up the ranks of the biggest stock 
trading firms in the United States by embracing a rather Canadian restraint 
and prudence.

At the center of the efforts by the bank’s New York trading desk is a new 
technology (Thor) that actually slows its customers’ orders so as to evade 
high frequency traders. 

And unlike nearly every other large bank in New York, it has elected not to 
open its own dark pool, where banks privately carry out customer trades 
away from the public exchanges. Recently, the firm has also been calling 
for regulatory changes in Washington.

While the big names like Credit Suisse and Goldman Sachs still trade many 
more shares of American stocks, the Canadian bank has become particularly 
popular with the largest, most sophisticated mutual funds and investors, 
according to a recent survey by the Tabb Group. 

Over all, it has risen to become the ninth largest broker for American 
stocks last year, up from the 18th largest in 2010, according to the 
brokerage and research firm Abel/Noser.

Its effort to shake up American stock trading is, to some degree, an 
outgrowth of a broader Canadian skepticism about the turbocharged American 
trading business. 

On Tuesday, the bank’s executives in Canada announced that it and several 
other investment firms would create a new exchange in Canada with the aim 
of having a trading platform that would be less hospitable to high-speed 
traders than the Toronto Stock Exchange.

Critics of modern markets say that recent innovations in trading have ended 
up creating conflicts of interests between banks with extensive trading 
operations and the customers who send them trades to execute. 

In some cases, the banks have an incentive to trade in exchanges that 
reward them with rebates, or in their own dark pool, rather than where they 
can get the best price for their customers.

Royal Bank of Canada says that its trading programs ignore the fees and 
rebates, and its customers say they notice the difference.

“They really go out of their way to try to find ways to support our 
business — sometimes actually to their own detriment,” said Robert McGrath, 
the head of trading at Schroders, which manages $360 billion and uses 
R.B.C. “That’s pretty unique in the industry.”

Mr. McGrath said that according to his firm’s analysis Royal Bank of Canada 
spends more than other brokers to get his orders done, and gets better 
results.

There are downsides. The strategy makes the bank less money on each trade 
than other firms receive, but it aims to make up for that by winning client 
loyalty.

“Our philosophy is, and we sit around here all the time saying it: Doing 
the right thing is not always the most profitable thing,” said Robert 
Grubert, the head of trading at R.B.C. “As business people that’s not 
great, but it’s an investment in our client and the long term.”

Canadian banks have generally been viewed more positively in recent years 
after they largely stayed away from the risky subprime mortgage market and 
sailed through the financial crisis. 

Canada’s six large banks were all recently ranked by Global Finance 
magazine as safer than any large American bank.

When it comes to stock trading, Canadian banks and regulators have taken a 
conspicuously cautious approach compared with their American counterparts. 

Canadian regulators last year put rules in place to limit both dark pools 
and high-frequency trading firms, which hit exchanges with tens of 
thousands of orders each second in order to take advantage of small 
discrepancies in stock prices.

Canadian banks, unlike American banks, have mostly hesitated to build their 
own high-speed trading desks. Although such trading accounts for about 42 
percent of all stock trading in Canada, much of that is done by American 
firms.

In the United States, Royal Bank of Canada’s stock trading staff of about 
130 sits together on a trading floor in the World Financial Center in Lower 
Manhattan. Its conference room is filled with pictures of soothing icebergs 
and idyllic Canadian prairies. There is a small team of employees whose 
only job is to study the structure of the complex stock markets and help 
explain it to clients.

The bank began its push to enter the big leagues of stock trading in 
America in 2009, just as the market’s computerized aspects went into 
overdrive. Before that, it was rarely a popular broker for investors 
looking to trade American stocks.

The man leading the effort, Brad Katsuyama, was educated in Waterloo, 
Ontario, and moved to New York after only a few years on R.B.C.’s trading 
desk in Toronto.

The operation that Mr. Katsuyama built certainly does not shun technology. 

In fact, it is made up largely of computer programmers who were hired from 
banks and high-speed trading firms. What the group aimed to do was look for 
ways in which the new market structure was putting investors at a 
disadvantage.

One of the first things that Mr. Katsuyama’s team noticed, members said, 
was that his traders were having trouble getting their trades done at 
exchanges that were geographically closer. They discovered that in the time 
that it took for a trade from R.B.C. to travel through fiber optic cables 
from a slightly closer exchange to a slightly farther exchange, a high-
speed trading firm could spot the trade, cancel its order on one exchange 
and raise the price on another to take advantage of the R.B.C. client.

The discovery led to the invention of the bank’s trading program, named 
Thor, which was approved last month for a patent. 

The program factors in the distance between exchanges and slows signals to 
the closer location so that the orders reach all of the exchanges at 
exactly the same moment.

Dan Royal, the head of trading at the asset manager Janus Capital, said 
that he noticed that after Royal Bank of Canada started using Thor, he was 
able to buy more stocks at the price he initially saw, rather than being 
forced to offer more for the same stock.

Royal Bank of Canada is generally among the best brokers in getting clients 
better prices, and has been improving each year, according to data from 
Abel/Noser.

On top of its technological innovations, the bank has recently become more 
of a public presence in the public debates about what the markets should 
look like, often standing as the lone bank in favor of a major market 
overhaul.

R.B.C. executives recently asked American regulators to introduce a program 
that would ban exchanges from paying rebates to banks that send in customer 
orders. 

Most brokers like the rebates, and exchanges argue that the payments are 
necessary to stop all the trades from going into dark pools. But the bank 
and other financial experts have said that the rebates encourage brokers to 
go where they get the biggest payment, not where they get the best price 
for their customers.

Richard Steiner, who leads these market structure efforts at Royal Bank of 
Canada, said, “You get to a point in the marketplace where unfortunately 
you need regulatory action to level the playing field.”

In the meantime, even admirers of the bank say that there is a limit to how 
many orders they will send to it. The bigger banks still see more orders — 
in part because of the dark pools they operate — and that makes them 
essential for investors who want to get their trades done immediately, even 
if it costs a bit more.

Mr. Katsuyama left Royal Bank of Canada’s offices last year to start an 
exchange that caters to longer-term investors like mutual funds. Few of the 
remaining people on the 36-person electronic trading team are from Canada. 

But Mr. Grubert said a certain Canadian sobriety still pervades the 
company. When the news of Thor’s patent approval came through, there were a 
few high fives.

“We don’t get crazy,” Mr. Grubert said. “That’s part of the culture.”

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