Given the 30 June settlement between BNP Paribas and US Department of Justice, which consists of an approximately US$9 billion fine and a one-year prohibition of clearing dollar-denominated oil and gas transactions beginning 1 January, for breaching US anti-money laundering sanctions, this could been viewed as a xenophobic prosecution by US regulators, explains David Weiss, a senior analyst at industry research firm Aite Group.
“There already a broad perception abroad that US regulators let domestic firms skate,” he said. “If the next firm or two targeted by US regulators are foreign, it could be particularly bad.”
US regulators should be more transparent on why they are invoking harsher punishments lately, Weiss suggested. “Does it have to do with their overall regulatory stance or because the firms are foreign ones? No one knows and it does not look good.”
The smoking gun
Attorney General Eric Schneiderman alleges that Barclays falsified the extent of the transaction volume and trading behavior of high-frequency trading participants in its LX dark liquidity pool to institutional clients who use the bank’s off-exchange trading venue.
“If this is true, fraud is fraud,” said Weiss. “But this does follow the industry’s long and rich history of the sell side’s less-than-optimal trading practices for institutional and retail clients.”
For Joseph Saluzzi, a partner and co-founder of Themis Trading, this is a natural result of the growth of off-exchange trading. “We have a bunch of liquidity trading off exchange that is pretty much going on unregulated and we do not know what goes on there. I think if there is another firm out there doing this, it will force regulators to act. Hopefully sooner rather than later,” he added.
“In 2009, off-exchange trading was close to 25% of the total cash equities market,” Saluzzi explained. “Now we are closer to 40%, with dark liquidity pools alone representing 15 to 17% of the volume. That is too big of a problem.”
The US Securities and Exchange Commission (SEC) issued a 2009 concept release on non-public trading, which looked at actionable indications-of-interests behaving like orders and whether that they should be classified as an order, he added. “The SEC knew that there was an issue, but never followed through with it. Now it is a case which the SEC will have to take very seriously.”
Saluzzi and Weiss agree that the short-term impact will be hard on Barclays but they differ on the impact it will have on buy-side investors.
“This has created a lot of questions for institutional investors,” said Saluzzi. “They will be looking for more proof from the buy-side and they are going to spend much more time doing their due diligence regarding a broker’s plumbing.”
On the other hand Weiss questions the credulity of the buy-side not knowing or suspecting what transpires in dark liquidity pools in general.
People who have been institutional trading for a few years and trade every day, must know that not all of their trades are executed against natural matches, he believes.
Despite poor executions they might have received on Barclays’ dark liquidity pool, institutional investors still came back and made it one of the largest dark pools, according to Weiss. “They must have gotten something out of it. No one makes a trading decision solely on a broker’s marketing material.”