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The Broker Dealer Conundrum

Jeremy Grant’s article in the FT today, “Dark pools start evolving into brokerage operations”, points to something that is starting to be talked about with increasing vigour. This is the simple fact that, in the post-MiFID landscape, the roles of exchanges/MTFs and the broker dealers are starting to become almost interchangeable. The announcement that Turquoise has received FSA approval to offer an onward routing service follows similar announcements by NASDAQ OMX Europe and, of course, Baikal, which is making a big play of its complete smart workflow capabilities ahead of its launch in the summer. At the same time, BATS Europe is equipped with the same onward routing service used by its US parent and NYSE Euronext SmartPool offers connectivity to a “pool of pools”.

The aim of these initiatives is simple – to reduce the cost and complexity of navigating through an ever-diversifying number of possible execution options. This is exactly the same service that the large broker dealers offer to their customers and many of these brokers operate their own dark pools which, with their customers’ permission, they direct flow into first. The announcement last week that Goldman Sachs, UBS and Morgan Stanley have signed a “dark pool pact” is really just more of the same and follows similar announcements from Instinet and Credit Suisse last year.

Part of the problem is that the term “dark pool” now covers so many different types of venue and activity. On top of the exchanges, MTFs and broker pools mentioned here we also have buy-side crossing networks such as Liquidnet and Pipeline that will offer onward routing services too. To make matters worse each of them is treated differently by the regulators and so trying to form any consistent view across them all is pretty tricky.

As this situation develops, the primary exchanges and MTFs are being careful not to step on the toes of their primary customers (the brokers) whilst still meeting the very real requirement of different customer groups to best execute. At the same time the broker dealer community is committed to internalising as much flow as possible and so it seems almost inevitable that they will end up competing directly in more and more instances. When you look at the list of those firms that actually own the majority of MTFs it would appear that the broker dealer community recognised this fact some time ago.

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