What price transparency?
news coverage suggests MEPs are determined to outlaw broker crossing networks
(BCNs). What do they hope to achieve?
Quite simply politicians want to put an end
to what they consider to be a less-than transparent, and, some might say, underhand
practice that allows banks to match client and proprietary flow internally, on
their own terms and without paying the costs associated with regulated markets.
Discounting for the moment motives of
post-crisis vengeance on banks, policy makers are driven by a desire to inject
greater transparency into financial markets in the belief that this will revive
investor confidence. When it comes to transparency, dark pool operators have
not always helped themselves. BCNs do not quote on a pre-trade basis and
reported trades are mixed in with OTC data, giving a hazy picture of their
activity at best. In May 2010, six banks attempted to shine a light on BCN activity by reporting aggregated turnover on a daily basis via Markit BOAT, but this done little
to appease regulatory concerns.
It’s worth noting that the BCN issue has
been on MEPs’ radar for sometime. Kay Swinburne MEP said in her 2010
own-initiative report on the MiFID review that “the absence of sufficient regulation for … BCNs
provides a competitive advantage to the OTC space and encourages an increase in
trading in the dark, undermining market transparency in general.”
Is it BCNs that MEPs want to eradicate or
all dark trading?
some would like to go back to the fictional period in which all trading was
done on exchange, other MEPs strike a slightly more pragmatic note. Fewer opportunities
to trade in the dark means, in theory at least, liquidity will naturally
migrate to displayed markets, or at least those with clear guidelines on pre-
and post-trade transparency.
nowhere more evident than in the Economic and Monetary Affairs Committee’s recent
amendments to MiFIR (the regulation accompanying MiFID II) which proposed cramming
as much OTC equity trading as possible into systematic internalisers, a (much derided
if misunderstood) category of venue created by the directive’s first version.
MEPs also proposed restricting the organised trading facility, a category of
venue introduced by the European Commission to capture BCNs, to non-equity instruments
only. This would force BCNs to become MTFs or systematic internalisers.
trading on regulated markets and a commitment to minimising OTC trading – which
accounted for 43% of European trading in March according to Thomson Reuters –
will improve price formation across European stocks, say politicians.
growing, the proportion of European equity trading conducted by BCNs is
believed to be only 3-4%, so the impact on price formation of closing down these
venues would appear questionable.
much attention have MEPs paid to the buy-side’s generally positive assessment
Not that much really. But there is at least
an acceptance that institutional traders need a differentiated source of
liquidity that offers them the opportunity to trade in size and mimimise market
impact. But MEPs insist that MiFID already addresses this issue adequately.
The original directive allowed trading
venues to forego the publication of pre-trade quotes as long as executions
fulfilled certain criteria, such as being over a certain size or transacted at
the mid-point. While buy-side traders make good use of the dark pools that
utilise pre-trade transparency waivers, the increasing prevalence of
high-frequency trading (HFT) in these venues has led the buy-side to make
greater use of safer environments like BCNs, where they can exert greater
control, in terms of selection of trading counterparties.
reduction in buy-side choice inevitable?
The buy-side may have no other option but
to use dark multilateral trading facilities (MTFs) or systematic internalisers
as their only method of limiting market impact if the MEPs are granted their
wish of no equity trading beyond MiFID’s three existing venue categories. In
addition, MiFID II could restrict systematic internalisers to only allow
crosses against proprietary flow and may require pre-trade quotes, which could
limit their effectiveness.
This debate is far from over though, with
the Council of the European Union, formed of representatives from national governments,
yet to have its say.
But brokers have been monitoring regulatory
developments for some time and are past masters at adapting to regulation. Even
if MiFID II takes a hardline approach to dark trading, who would bet against a
rebirth of the BCN in another form?Click here to vote in this month's poll on theTRADEnews.com on BCNs.