Broker-owned crossing engines have gained an unfair competitive advantage over traditional exchanges, according to exchange groups’
responses to a call by the Committee of European Securities Regulators (CESR) for evidence on MiFID’s impact on Europe’s secondary markets.
Exchange groups NYSE Euronext, Nasdaq OMX and the London Stock Exchange (LSE), as well as the Federation of European Stock Exchange (FESE), an exchange body representing 42 securities exchanges, have all claimed they are at a disadvantage because many broker-owned crossing networks are not registered under MiFID as systematic internalisers (SIs) or multilateral trading facilities (MTFs).
The exchanges assert that even though the functions of broker crossing engines are the same as an SI or MTF, many are treated as over-the-counter (OTC) venues and do not have to publish pre-trade data. According to CESR’s database, only 12 venues are registered as systematic internalisers. The LSE’s submission cites a number of leading brokers' dark pools as examples of OTC venues.
“The MiFID definition of systematic internalisation is quite vague, which made it quite easy for banks to opt out of being classified in this way,” explained Adam Kinsley, director of regulation and author of the LSE’s response. “We have to fight quite hard or use tight waivers in order to introduce new functionality like dark order types, where as OTC venues have more flexibility. So it seems there isn’t a completely level playing field in this regard.”
Internalising client order flow is a practice that brokers engaged in long before MiFID, but Kinsley feels recent developments have to be taken into consideration.
“The landscape has evolved and broker dark pools have become more like systematic, organised venues,” he said. “The leading banks have dedicated services with brand names attached to them, which order routers will go and look at. A broker’s dark pool seems less of an incidental part of the business and more like a venue in its own right.”
The exchanges’ responses to CESR suggest that a tightening up of venue definitions would help ensure fair and transparent markets. “Crossing networks operated on a stand-alone basis should be classified as MTFs and crossing software used by investment firms should be classified as SIs,” wrote Nasdaq OMX in its response.
CA Cheuvreux, an agency brokerage, currently operates its internal crossing engine Blink, as an OTC venue. Unlike some other broker-owned OTC venues, it only keeps track of orders to find a match and does not allow orders to rest in the system.
Jerry Lees, head of alternative execution at Cheuvreux, thinks regulatory reform is a distinct possibility. “We plan to start resting orders in Blink in due course, so it has more of a dark pool element to it,” he told thetradenews.com. “We could have gone down the OTC route but have decided to wait to register it as an MTF, although this means taking more time, because we feel there will be regulatory change in this area soon and we want to be seen to be operating within the intent of MiFID.”
However, Lees argues that broker innovation has been driven by a desire to combat market inefficiencies. "I can understand the exchanges point of view, but brokers could argue that high exchange fees and decreasing tick sizes have made it harder to execute blocks and led them to look for an alternative,” he said. “There is also a lack of meaningful liquidity in dark pools at present, but still a real demand and need to trade blocks.”