Will delay diminish dark pools’ chances of survival?

With Barclays’ fine for manipulating LIBOR receiving blanket coverage in the financial press, the postponement of a critical step in MiFID II’s path toward the statute books was barely noticed. But might the fall-out from finance’s latest scandal have an impact on the final wording proposed by MEPs in September? 

Private, clubby arrangements like the one that allowed banks to abuse the trust of clients and counterparts by submitting false estimates of their borrowing requirements are clearly a thing of the past. But the failure of self-regulation that allowed rate-fixing to be, … well, fixed, might also spell the end for other types of private clubs operated by brokers, such as dark pools.  

This would be a shame for investors – and potentially costly – because trading desks of asset management firms are evidently finding value in broker crossing networks (BCNs) that set their own rules outside the present MiFID framework for regulating trading venues. Combined, BCNs and dark multilateral trading facilities (MTFs) accounted for 7.43% of all equity trading in Europe during June. A good example of their appeal is Alpha Y, the dark pool launched in April by Société Générale to complement its existing BCN, Alpha X, available to clients since March 2009.

Alpha Y allows SocGen’s buy-side clients to match their orders against natural flow from peers, as well as orders generated by the French bank's various derivatives-related businesses, for example trades that result from managing the delta between an exchange-traded fund and its underlying constituents to minimise tracking error. This kind of flow can be very attractive to buy-side trading desks that are frustrated by the lack of liquidity in institutional size across Europe’s fragmented equity market landscape and who are wary of being gamed by high-frequency trading (HFT) flow, particularly in the lit markets. Alpha Y contains no HFT or prop flow, prioritises client orders over ‘house’ flow and allows the client to select the kind of flow it crosses against. So far the signs are that SocGen’s largely long-only client base is positive toward Alpha Y. Since launch the venue as averaged €120 million per day in terms of absolute value of buy and sell orders executed, which will be reported as around €60 million when the pool reports its volumes on a single-counted basis to Rosenblatt Securities, an agency broker which compiles monthly data on European and US dark pools.

When MEPs come to amend the European Commission’s original text – which places BCNs within the new organised trading facility (OTF) category of venues but restricts the type of trading permitted – a number of alternative scenarios present themselves. First, the politicians could vote to ban dark trading altogether, forcing all orders onto lit markets, potentially escalating market impact and therefore trading costs. Second, they could set a hurdle for trades that are allowed to forego pre-trade price transparency, but this would likely have the same impact as the first option because most trades are sliced up small by algorithms in the hope of searching out liquidity where it may reside across Europe's multiple equity trading platforms. Third – and perhaps the best hope for brokers – is that BCNs are recategorised as MTFs, but are permitted some greater latitude to offer client some kind of choice over who they interact with in the pool. The final scenario, which can be all but discounted, is no change from the present wording.

At close quarters, there are few parallels between the how LIBOR is calculated and how BCNs operate. But in a febrile anti-banker atmosphere, any mechanism whose lack of transparency can be used to advantage its participants is bound to be viewed with suspicion by outsiders. If the political temperature in September has been raised by a summer of discontent across Europe, MEPs might decide that support for dark pools would stretch their constituents' patience too far. 

Chris Hall+44 (0)20 7397 3819chris.hall@thetrade.ltd.uk