A little more transparency

The next few months are likely to determine the future of dark pools in Europe as the differing views of the Council of the European Union and the European Parliament are hammered out in Brussels. Both sides seem worried that too much off-exchange trading will damage price formation, but have very different ways of tackling the problem.

I very rarely hear heads of trading voice their concerns over price formation. But that’s not to say they are entirely comfortable with trading in the dark either. In an interview for the upcoming Q3 2013 issue of The Trade, I asked Louis de Kock, head of trading at fast-growing London-based asset manager J O Hambro Capital Management, about his views on the pros and cons of trading in dark pools, specifically broker crossing networks.

In line with many buy-side traders, de Kock viewed searching for liquidity in dark pools a little like interacting with high-frequency trading: very often useful, but dangerous if you don’t know what you’re doing – or simply have the full range of relevant facts at hand. 

“I think the critical issue is information leakage. We’d like to have more transparency on the other parties contributing flow to the broker crossing networks that we trade in. It’s a source of concern that, quite often, we’ll see a block of liquidity flash up, and then result in sudden price moves,” said de Kock. 

“Dark pools are still a mystery to many and we need to get better transparency:  true volumes are difficult to quantify due to the ways in which the volumes are reported. On the plus side, they offer an opportunity to tap large chunks of liquidity on an anonymous basis. But I just don’t know who else is participating, nor, more importantly, do I know how much volume goes through them. It’s hard to put too much faith in the TCA on your dark pool performance when you don’t have the full picture in terms of volumes.”

Brokers talk of a serious breakdown of trust between policymakers and the finance industry, arguing that the hidden agenda for many politicians is reducing trading volumes as a means of reducing system risk, regardless of the knock-on costs to pensioners and other end-investors.

There may be some truth in that but I can’t help feeling a little more transparency from dark pool operators to their users and the regulators might go a long way to restoring good faith.