On the train this morning, I was browsing through London’s Metro newspaper to see who the latest ‘victims’ in The X Factor, Strictly, I’m a Celebrity etc, were (incidentally, it’s probably the people that actually watch these programs, but that’s another story). I was a bit shocked, therefore, to come across a double page spread examining dark pool trading. I was even more surprised to see that it was, in fact, a pretty well-balanced article with only one small factual inaccuracy (Turquoise operates both a lit and a dark market). Other dark pool stories have cropped up recently too and so it prompted me to have a look at the latest stakes in Europe.
The chart below shows the official dark pool tally and the relative shares of the total reported dark market in Europe. What’s interesting is that you can see a steady rise in dark pool trading and that probably the biggest success story is UBS MTF. The reasons for its success are pretty simple – it has the widest stock coverage, it’s cheap and, right from the beginning, it has supported interoperable clearing.
What’s more interesting, though, is what the chart doesn’t show you. Broker Crossing Networks (or BCNs) are not obliged to report in the same way and so, whilst they still match orders away from lit markets, it’s very hard to get any accurate figures for their real volumes (either here or in the US). BCNs are absolutely in the sights of European regulators, however, and will be forced, under MiFID II, to become either full MTFs or Systematic Internalisers (a classic bit of clumsy Euro-fudging). Obviously this has got the big firms thinking hard, but I wonder what this means for the smaller firms for whom crossing client trades is one of their last truly profitable activities. The new rules will make automatic crossing a much more regulated activity, but the problem comes in exactly what activities these new regulations extend to. Obviously, the matching engines of the big boys get caught up in this definition, but what about using a spreadsheet to track different incoming client orders, or if I email a colleague on the desk next to me with a potential matching opportunity?
Yet again, then, it looks like the law of unintended consequences is going to come into play. Let’s just hope that this time the smaller firms don’t get voted off before they have a chance to have their say.
I completely agree, Turquoise was an odd venue for the Metro to focus on, especially given their main points that dark pools are used to trade large blocks of shares and avoid price changes on the main market; the average trade size on the Turquoise dark book is £5k compared to £8k on the LSE and its crossing price, like the majority of pools, is pegged to that of the primary!
It was also interesting that they focused on anonymity and avoiding volatility. Anonymity is an important part of an order-driven market whether it’s lit or dark and if you’re trading securities you’re exposed to the price movements, the way you choose to trade doesn’t affect your position at the end of the day.
As we’ve seen with Pipeline and Martoma, there’s a lot hiding in the dark but that doesn’t make it something to be scared of. The majority of mid-tier brokers rely on the dark for price improvement and reduced market impact on otherwise difficult to trade orders.
Unlike the reality shows, not all dark pools are the same, regulators should recognise and embrace these differences. There will always be trading away from the traditional exchanges but as long as this is used sensibly, reducing the cost of trading without affecting price discovery, it can only be a good thing. Everything in moderation.
This is exactly why we set up Qube Platforms to help brokers manage the transition of their BCN. It was very interesting to be at the exchange summit this week to hear how strongly the EC are behind the MTF and PRW proposals. With luck it will not curtail innovation that gives buyside and sellside the levers to control their flow e.g. QLX, Marketbourse to name but a few coming onto the market.
I wonder when UK online brokers will wake up to the fact that this means the RSP network which has serviced them for over a decade will have to end or change to being an MTF ?
Thanks Will for your comment – I agree completely with your last point – not all dark pools are the same. Just look at the average trade size on LiquidNet or Posit for example and compare this to the trade size on TQ or Bats/Chi-X dark books. That’s not to say one is better than the other – they are just different.